For growth investors and their advisors, the key question isn’t ‘what’s expanding?’ but ‘what’s changing?’ Baillie Gifford Partner Dave Bujnowski explains:
Thirteen years of growth stock outperformance came to a juddering halt thanks to war in Europe, post-pandemic supply chain shock, labor shortages and rampant inflation.
So, what’s next for clients interested in growth investing?
To answer that we need to look closer at the drivers of growth. It happens when the supply of a product or service meets demand. But neither supply nor demand is static. They’re powered by three different ‘engines’: expansion, disruption and replacement.
Which of these has driven growth in the past decade? And where might they take us in the future?
The expansionary growth engine revs up when demand for a product or service rises. This extra demand can come from macroeconomic causes such as low interest rates, or from innovations such as mobile apps.
Some expansionary growth engines are sputtering as macroeconomics become less friendly and the initial kick from the novelty of internet connectivity fades.
But other growth enablers of similar power are still emerging, offering new opportunities. The unearthing of new forms of data that unlocks solutions for problems never before addressed is one place to look. Where data meets healthcare is one potential expansionary engine.
The second engine, disruptive growth, revs up when demand doesn’t grow, but supply gets better at satisfying it.
For example? E-commerce in the US has more than doubled in the last decade and spending on cloud infrastructure now dwarfs investment in traditional data centers. Electric vehicle sales have passed the inflection point. With this kind of disruption, you don’t need an expanding economy for growth companies to emerge.
Replacement growth, the third engine, comes from demand that isn’t growing but changing.
Awareness of climate change and the demand for clean energy simply didn’t exist 20 years ago. Now it does.
As a system changes, so do its problems. But new problems mean new business opportunities.
So hard times don’t preclude growth opportunities. As a system contracts, expansionary growth engines may stall, but shifting ‘pain points’ within the system bring new opportunities.
Consider recent changes in abundance and scarcity. Abundance is what the past 10 to 15 years of technology have brought us. People can instantly connect with anyone in the world, have just about anything delivered in two days, and can binge on endless TV content. Advertisers have had a stream of data to help them target consumers.
But in the past two years, scarcity has entered our lives, reintroducing friction. Advertisers and regulators have limited the availability of certain types of data, and Apple has curtailed the ability of third-party apps to track users’ online activity. Data may not be scarce, but the pendulum is swinging to where leverage and value reside in the system. Labor is scarce and inflation is increasing the cost of doing business.
Why does this matter? Because, when abundance shifts to scarcity, the problems to solve – or demands to address – also change and value accrues to those who either control the scarce resource or who can supply alternatives.
Companies that can exploit first-party data – customer data they collect and own – seem well-placed. As do companies enhancing productivity and automation. And most of all, if systemic, expansionary growth gets harder to come by, then digital transformation stands to benefit: the cloud, data science, agile software development, etc. If the overall pie isn’t growing, companies will grow their slices by outcompeting in digital transformation.
While this is already well-understood by growth investors, its potency and duration are still underappreciated, as the term ‘digital transformation’ implies that moving from analog point A to digital point B means transformation is complete.
But point B is not an end state. It’s just the beginning. The digital world contains new, infinitely scalable tools (software, data, compute capacity) that can be used in infinitely scalable ways. And not only is the infrastructure we’ve installed over the past few decades infinitely scalable but so too is the resource that uses it best: human ingenuity and our capacity to solve tomorrow’s problems.
Isn’t that the most powerful growth engine of all?
© Baillie Gifford
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