Dividend Update: How uncertainty has led to an unprecedented opportunity for investors

13 October 2020

Most investors have heard of America’s famed “FAANG” stocks – Facebook, Apple, Amazon, Netflix and Google. Replace Netflix with Microsoft and we have by far the five biggest stocks in the S&P 500. In fact, they make up over 20% of that index – well above the 18% that the then-five-biggest stocks accounted for at the peak of the dot-com bubble back in 2000. But what’s less well known is that Europe has its own version of the FAANG stocks – what Goldman Sachs has labelled the GRANOLAS, and are the 11 biggest stocks in Europe. They’re made up of Glaxosmithkline, Roche, ASML, Nestlé, Novartis, Novo Nordisk, L’Oréal, LVMH, AstraZeneca, SAP and Sanofi.

Priced for perfection

Having performed well relative to all areas of the European stock market in 2019 and early 2020, the GRANOLAS’ returns really exploded as the coronavirus lockdown began in March. That’s because they were seen as major beneficiaries of the pandemic: six are pharmaceutical firms, Nestlé is a food company, two are IT companies and two are consumer discretionary firms.

But at the other end of the spectrum, value companies – especially banks and energy – were seen as casualties of the crisis: banks because of potential write-downs, and energy firms because of the drop in oil prices. And their share prices suffered.

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The upshot of all this is that right now, the GRANOLAS are in our view pricing in perfection, but there’s very little margin of safety for investors if there’s some bad news flow affecting them. On the other hand, banks are pricing in a depression, even though they’re profitable. Similarly, energy companies are priced as if the oil price will always stay low – which we don’t think will happen.

So what’s going on here? We think the current differential is reflective of the uncertainty among investors at present. People are willing to pay a premium for firms that are perceived to be safe, but are avoiding companies where there is perceived uncertainty

We believe that if only some uncertainty in the world is removed, such as through a vaccine or a decisive result in the US election, or if at least uncertainty doesn’t increase, there could be a quick convergence.

Economic fortunes to converge too?

There’s been lots of debate about the shape of the economic recovery after the pandemic, with investors talking about U-, V- and W-shaped recoveries. But we think a K-shaped recovery is actually what we are now experiencing.

How does that look? After an initial plunge, the economy picked up slightly thanks to all the stimulus packages we’ve seen. But from there, there was a divergence – the stimulus mainly helped large caps, tech firms and pharmas, which continued to recover. But other areas of the economy – travel firms, retailers, small businesses – were still in lockdown, so continued to suffer.

We strongly believe this gap is unsustainable, even in the short term: there has to be some kind of convergence.

Historic price dispersion presents a unique opportunity
Over the past 20 years, growth companies have on average been 80% more expensive than value firms. That seems fair, because they’re growing faster, more profitable, and – in some cases – have a competitive edge.

But as a result of everything we’ve seen over the past few months they’re now trading at a 200% premium – three times as expensive. Surely that can’t persist. If we enter a depression, even growth companies won’t meet the expectations priced into their shares, so share prices will converge. But if there’s no depression, value companies are priced way too cheaply. What should happen? Share price convergence.

Whenever there’s been such a huge differential between growth and value in the past, there’s always been a price reversal, sometimes quick. We believe investors are currently presented with a unique opportunity to exploit.

In our next blogs we'll be discussing the prospects of the high dividend style and why it represents such a compelling investment opportunity now that dividend cuts and many of the headwinds facing the approach seem to be behind us.

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