Compound earnings: Equities markets’ reliable growth engine
Global Head of Equity Client Portfolio Managers Phil Wood and Global Head of Multi-Asset Adam Hetts analyze the drivers of stock market returns over the long term and discuss why we believe equity investors should prioritize earnings growth in their objective of consistently generating excess returns.
10 minute read
- As stock prices typically follow earnings, we think investors should prioritize earnings growth to achieve their objective of consistently generating excess returns.
- Specifically, investors should seek to identify attractively valued companies with earnings visibility that are capable of delivering quality earnings growth.
- With the pace of disruption increasing, we believe companies that provide innovative solutions have the potential to generate durable earnings growth, as do their customers who embrace these services.
We believe equity investors should prioritize earnings growth, as data indicate it is the main driver of stock market returns over the long term.
Investors have no shortage of constructs through which to view the equities universe. Prominent among these is categorizing stocks into growth and value styles. Contrary to conventional wisdom, we don’t view these categories as a binary choice. Seeking companies capable of compounding earnings over a multi-year horizon and exercising valuation discipline are both essential – and complementary – components of a fundamentals-based investment process that aims to maximize excess returns.
The contribution of earnings growth to broad equities market returns cannot be overstated. Over time, data suggest that stock prices follow earnings. But solely focusing on unearthing high-growth opportunities is not enough; investors must also be valuation conscious.
Applying valuation discipline with respect to selecting and holding securities can prove beneficial when navigating the market cycle. We consider this approach a complementary, middle path that bridges the gap between growth and value strategies. By replacing sometimes-rigid style investing with a more pragmatic – and nuanced – approach, equities investors stand to position themselves to more fully participate in the earnings growth that we believe is the main driver of long-term equity returns, while also reaping the benefits inherent in maintaining valuation discipline.