When earnings growth subsides, growth is all that matters
16 November 2006
Despite a slowing US economy, Rupert Della Porta, manager of the F&C North American Fund and Head of US Large Cap Equities at F&C, has identified opportunities among US growth stocks in anticipation of a hike in valuations.
"As we look out over the next year, growth will become an increasingly important theme for US equities. We are in an environment of decelerating earnings growth, with interest rates likely to remain flat for the next 6 months and inflationary pressures likely to subside," said Della Porta.
Della-Porta said the US economy was healthier than headlines suggested and said the strong employment market was likely to offset the impacts of a deteriorating housing environment. Nevertheless he stressed that although earnings would continue to grow, this would be at a slower pace than in the recent past.
"This kind of environment alone does not make growth stocks more attractive, but it does imply that earnings growth may become increasingly scarce and subsequently rewarded with higher valuations.
"Indeed, valuations in the market have narrowed significantly over the past few years and this year has seen the valuation gap between growth and value stocks narrow even further. Growth stocks with the best top-line numbers have actually underperformed benchmarks by more than 10 percentage points in the last 12 months, while companies with the fastest earnings growth have outperformed by a similar amount. With US companies' margins at peak levels, we believe that top-line growth will now become an increasingly important driver of earnings and that exposure to growth stocks will be well rewarded as a result."
Della Porta has been focusing his attention on technology stocks and has identified a number of opportunities.
"Furthermore, the combination of growth with strong free cash flows and high return on equity represents a potent formula for strong returns, and we believe that the Technology sector is ripe with such opportunities. We see strong IT spending growth driven by emerging markets, Microsoft's new Vista platform launch, and innovations in both consumer and enterprise technology markets. We find many large-cap names such as Hewlett Packard, IBM, Cisco and Motorola attractive given their strong cash flow generation and market-leading return on equity."
