There is more than one way to approach growth equities

The last few years have ushered in a new macroeconomic era with shorter and more volatile cycles, increased geopolitical instability and accelerating technological change. One of the most dominant narratives to emerge in the new era is that of the “Magnificent Seven” and US exceptionalism. However, as recent market moves have highlighted, there are other ways to think about growth equities that may help uncover still underappreciated opportunities. A globally diversified approach that dynamically combines a qualitative growth framework with insights on the structural trends that are reshaping economies, sectors and companies could help investors look at growth equities differently. Here are four action items for investors seeking to capture the opportunities that this different perspective may bring.

1. Embrace diversification on a global scale
   Stocks have become more correlated to the sector or theme they belong to rather than the region as technological advancements have enabled companies to have global operations and revenue streams. At the same time, growing regional divergence is a key feature of the new regime in which companies now operate as geopolitical rivalry is driving governments to protect their strategic sectors. Managing that complex picture requires, in our view, a globally diversified investment framework that balances the rich opportunity set we see in the US with meaningful exposures to other markets, most notably Europe, where amid peak pessimism we have identified numerous quality companies that we believe have the potential to surprise.
   
   In our opinion, diversifying on a global scale could also reduce the risks stemming from an over-reliance on a handful of US-domiciled stocks that have witnessed a spectacular rise in value based on a largely linear AI development narrative. As AI competition intensifies, we think it is likely that this model will come under increased scrutiny with potentially adverse implications for narrowly diversified portfolios.
2. Understand emerging structural trends
   For much of the post-pandemic period, equity markets seem to have been largely driven by US exceptionalism and AI dominance. In our view, this singular narrative masks a more complex reality of shifting structural trends that will increasingly impact companies, sectors and markets globally. So, what are these trends telling us today?
   • Despite the heightened uncertainty relating to policy direction and the eventual impact of US tariff policies, we believe the global economic cycle remains robust, underpinned by both consumer resilience and historically high levels of employment.
   • We expect that US exceptionalism is likely to continue but also see tentative signs of growth picking up in Europe, driven by lower interest rates, high personal savings rates and signs that the manufacturing cycle is bottoming, which again could be positive for select growth-orientated stocks.
   • In addition, we see signs that the broadening of the AI revolution is starting to take place, with technology enablers of the digital transformation playing an increasingly important role.
   • On the downside, US-imposed tariffs and other countries’ retaliatory responses could have a chilling effect, but while the outcome is still in flux, it again underscores, in our view, the importance of assessing potential impacts through the prism of sector dynamics rather than just focusing on a given company’s location.
3. Double down on fundamentals
   In practice, we find that these trend insights have their greatest value when they can be combined with a repeatable fundamental research framework. For instance, in our own approach, we seek to systematically answer the following questions with quality as the underlying theme to help us identify promising growth companies for our portfolio:
   • How sustainable is revenue growth?
   • Can it translate into high and improving free cash-flow margins and return on capital employed?
   • How attractive is the potential for capital returns, be it dividends or share buybacks?
   • To what extent do valuations reflect fundamentals based on our discounted free cash-flow model and is there any upside?
   • Are fundamentals improving and is there scope for exceeding consensus earnings expectation?
4. Dynamically align with areas of high-quality opportunity
   In our opinion, leveraging such a robust framework with trend insights on a global basis can provide the wider scope and flexibility needed to navigate today’s more complex and volatile environment, with the explicit emphasis on quality acting as a stabiliser.
   
   We believe that attractive areas often emerge from targeting stocks with the most compelling combination of growth, quality, capital returns and valuation upside. And we think an active approach to portfolio construction can help to continuously exploit these opportunities across sectors and regions.
   
   The market is now generating abundant opportunities for quality growth companies, for example in Europe, where low starting valuations and high personal savings rates provide an attractive backdrop for retailers with strong franchises to win a higher share of customer spend. Globally, digitalisation aided by AI will likely drive generational technological transformation, but the benefits extend well beyond today’s perceived winners. To support the build out of datacentre capacity, energy supply and distribution will need to expand to meet rising power demand. Availability and efficiency of data and analytics can also drive higher growth for payments and market data services companies. These are only a handful of the examples where we believe a dynamic combination of a fundamental research framework with insights into trends can help optimise exposure to quality opportunities.

Putting this approach into practice: two case studies 

German defence company

This company has enjoyed a rapid expansion of its order book and free cash flow since 2022, helped by Germany’s decision to raise defence spending to over 2% of GDP after decades of underinvestment. Despite recent share price strength, we think the valuation remains attractive given the defence contractor’s quality characteristics, including strong organic revenue growth bolstered by both cyclical and secular tailwinds. We believe long-term trends in European military expenditure coupled with short-term drivers like geopolitical instability could drive double-digit revenue growth and margin expansion for the next 5 – 10 years.

UK exchange and analytics platform

The projected growth rate and quality of free cash-flow generation of this company has improved meaningfully following the successful integration of a premier financial data analytics platform in 2021. It has successfully normalised debt levels in the three years following the acquisition and is, in our view, well-positioned to accelerate organic revenue growth while reducing capex. The company remains defensive at its core — generating approximately 70% of recurring revenues from data and analytics — but also offers idiosyncratic upside potential through the higher volatility trading volumes of its exchange business. Its 35% dividend payout ratio has grown sustainably over the last two decades, yet the company still trades at a discount to its information services peers.

What’s next?

We believe that equity markets offer a rich seam of opportunities for growth-orientated active investors able to cut through the heightened noise and complexity. But we think that finding those opportunities amid market concentration and US exceptionalism requires a different approach. Key, in our view, is both a strong fundamental research framework and the ability to dynamically combine global diversification with insights into how structural changes are reshaping economies, sectors and companies.