Investors should not “waste their time” looking at what a company does today, according to Baillie Gifford’s Kirsty Gibson, who says they would be much better off thinking about where it could end up in the future.
Gibson, a manager on the Baillie Gifford American fund since January 2018, previously dismissed the contention that active managers cannot beat the S&P 500 as “fundamentally wrong”, calling the US market “wonderfully inefficient”.
To prove this point, she pointed to professor Hendrik Bessembinder’s paper “Do Stocks Outperform Treasury Bills?”, which shows that all the wealth created by the US market from 1926 to 2016 came from just 1,000 – or 4.3 per cent – of its stocks, with just 90 responsible for half of this.
Source: Baillie Gifford
Additional research from Baillie Gifford found that in rolling five-year periods over the past three decades, 30 per cent of stocks on the index fell and around 50 per cent rose marginally, with these two groups cancelling each other out
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However, the remaining 20 per cent went up at least 2.5x times and this is where Gibson (pictured) and the team focus their efforts.
The manager said that while spotting these companies is no easy task, she believes they have a number of characteristics in common that hint at what they are capable of.
“The first thing would be strong competitive advantages,” she explained. “We’re looking for companies that have, or have the potential for, a strong competitive advantage – they have a deep ‘moat’. And it’s probably getting deeper over time.”
Gibson is not the first investor to extol the benefits of “the moat” – this is one of the cornerstones of Warren Buffett’s value investing approach, for example, and the “Economic Advantage” strategy used by Liontrust’s Anthony Cross and Julian Fosh.
The second common characteristic of exceptional growth companies that Gibson searches for – large market opportunities – may also sound obvious. However, Gibson said the most important point here is that these opportunities are not static.
“We would argue that it’s largely a waste of time analysing the company’s current products and markets when trying to ascertain its future value,” she explained.
“In the late 1990s, Amazon was an online bookseller. I would challenge anyone to describe what Amazon does now neatly in a couple of words, I think it’s evolved so much since that time.
“Further to this, when it first started, you could have analysed Amazon’s products and markets to death and you probably would still not have identified everything that makes the company valuable today. And consequently, we’ve really tried to focus on and think about what a company could be.”
Source: Baillie Gifford
According to Gibson, what a company could be or achieve in the long run depends on a third characteristic that exceptional growth stocks share: a clearly defined culture.
The manager said culture is often underappreciated as it only really matters if you take a genuine long-term outlook – she pointed out that if you are only worried about whether you should own a company for six to eight weeks, you are not going to spend much time thinking about the management’s long-term vision.
“It’s difficult to measure, it doesn’t fit neatly into DCF [discounted cash flow] or other financial models,” she added.
“But how a company is run makes all the difference when it comes to unlocking future growth opportunities. And we’re looking for companies whose culture makes them willing to invest in the future and embrace change, rather than focusing on quarterly earnings targets.”
So, if this culture is difficult to measure, how does Gibson do it?
The manager said obtaining the necessary level of insight into a company is not just a case of reading a couple of broker notes – Baillie Gifford’s use of this sort of research is minimal.
Instead, she and her colleagues aim to immerse themselves in the businesses: Gibson moved to the US for a month last year with her son and husband for an extended research trip to build “a fountain of knowledge”.
The manager said it is not just about visiting current holdings or even prospective ones, either.
“I spent quite a lot of time with a variety of different companies in the industrial biotechnology area,” she continued. “This is an area where at the moment, there are no investable companies for us in the public space.
“But we believe it’s a significant opportunity longer term, so that should things come to the public markets, we’ve got that knowledge-base in place before we decide whether or not we want to participate or buy into these companies.”
“And we think about the US in a global context. My colleague Helen, when I was in the US for a month, decided to move her family out to China for two months to spend some time with the internet giants there.
“I think this is really important, this idea that ultimately, if we want to learn as much as we can about a company like Amazon, we should probably be spending some time learning about some of the Chinese companies like Alibaba, and that’s what she spent two months looking into.”
Data from FE Analytics shows Baillie Gifford American has made 840.56 per cent since launch in 1997, compared with 433.72 per cent from the S&P 500 and 321.66 per cent from the IA North America sector.
Performance of fund vs sector and index since launch
Source: FE Analytics
The £2.4bn fund has ongoing charges figure (OCF) of 0.52 per cent.