Last week, in The Dream for ‘17, we looked “back” on 2017, the year that was. Spoiler alert: The World did not come to an end after the inauguration of our 45th president on January 20th.
This week, we’re reflecting on the global growth economy in 2016, by the numbers. It begins with GSV’s annual 10-Year Top Performing Stocks Study, which screens all publicly traded companies in the United States for the top 25 by total return over the past decade.
It is highly unlikely that GSV will fulfill its quest to find the “Stars of Tomorrow” by mining this list — success begets size, and size forges an anchor — but it is instructive to analyze the characteristics of top-performers.
While pizza might not seem like a growth industry — besides contributing to our obesity epidemic — number 6 on the list, Domino’s, surged in popularity with an ingenious app to track your order from click to home. Its stock CAGR outperformed Amazon (#7) and Google (Unranked) over the last decade.
The median stock performance of the top 25 companies over the 10-year period was a 31% compound annual growth rate (CAGR) — which implies that stock value is nearly doubling every two years, according to the “Rule of 72.” The median market cap at the beginning of the period (12/31/06) was $145 million. These would have been Micro Cap companies by today’s standards.
The median P/E for the top performers at the beginning of the 10-year period was 19x, slightly higher than today’s Market multiple. But as we’ve learned from past studies, a low or discounted P/E isn’t an important variable for ascendent companies. P/E ratios are often already high at the beginning of a period of outperformance.
Cleary, that the secret to big success isn’t about finding beaten-down stocks. It’s about identifying the fastest growers.
The key trait of top performing stocks is that they always have high earnings growth for the period of outperformance. The median EPS growth of the top 25 companies in this year’s study was 29%. EARNINGS GROWTH DRIVES STOCK PRICE OVER TIME.
Thee top-performing stock in this year’s study was Tencent. Founded in 1998, the Chinese technology and social media powerhouse has seen its stock price grow at a 42% CAGR over the past decade, catalyzed by compounded annual earnings growth of 48% in the period.
Tencent’s top ranking is a notable reminder of the increasing impact China will have on global innovation and growth. Interestingly, conventional wisdom is that the China growth story is yesterday’s news.
But it’s just beginning.
A key catalyst is massive urbanization that is constant around the world but exploding in China. If you look at the United States, there are 10 cities with a population of one million or more. In China, there are 160. These are young people who are embracing technology, brands, and digital commerce. They’re getting ready to change the World.
And days of cheap labor and knock-off manufacturing are long gone. China is intent on creating its own consumer brands, exporting them and putting up roadblocks for foreign players. Today, Alibaba handles more transactions than Amazon (#7 in 2016 Study) and eBay combined — the company recorded $17.8 billion in sales over 24 hours for its annual “Singles Day” event earlier this year. Alipay, its payment platform spinout, counts over 400 million users — a group larger than the entire population of the United States.
Xiaomi (Mobile Devices; $46 billion market value), China Mobile (Mobile, $222 billion market value), Vipshop (Digital Retail, $7 billion market value), Baidu (Search & Internet Services, $61 billion market value; #15 in 2016 Study), and NetEase (Gaming & Media, $30 billion market value; #23 in 2016 Study) are just a few examples of what China has in store for the World.
For the third Ten-Year Study in a row, Priceline was the second-ranked performer, with a 42% stock price CAGR over the past decade. Its 44% annual earnings growth rate ranked among the top companies on this list, but dropped significantly off its remarkable 62% growth rate for the 2005-2015 decade span.
Netflix came in at third. Interestingly, while the company’s 10-year earnings growth rate of 15% per year wasn’t particularly strong, its P/E expanded from 37x in 2006 to 302x in 2016. But EPS and P/E can be misleading metrics for Netflix. The company has purposely destroyed earnings to invest in content and distribution as the “Streaming Wars” heat up. Over the past decade, Netflix annual revenue grew from $990 million to a projected $8.8 billion in 2016 — a 24.5% CAGR that is more in line with the leaders on our list.
GSV 300 IN 2016
In 2015, GSV launched the GSV 300 Index, which we believe is the best representation of what is truly going on with growth companies, their valuations, and performance.
It is an index of 300 of the World’s fastest growing companies, selected systematically based on key fundamentals, including revenue and earnings growth, geography, valuation metrics, and market capitalization. Because the companies are not handpicked, the GSV 300 doesn’t look at all like the typical indexes that people use to analyze growth companies and growth investors.
The most relevant index for Institutional Investors to date has been the S&P 500, which is a good proxy for broad Market dynamics. But with a 5% long term growth rate, it hardly reflects conditions or performance for fast growing companies.
The fact that the S&P 500 is solely a market cap weighted index is problematic in that a $100 Billion Market Cap Company has 100x the impact on the Index as a $1 Billion Market Cap Company… not realistic in that a portfolio manager who viewed two portfolio companies as being equally attractive would have 100x more of that company in their portfolio.
The most well-known index, the Dow Jones Industrial Average (DJIA), is created with an even more bizarre rationale in that it is weighted by share price. So in other words, if one stock was $30 per share and another was $300 per share, the $300 stock would have 10x the influence on the DJIA as the $30 stock.
The GSV 300, by contrast, is constructed using a systematic three-step process, which is summarized below: Screening, Ranking + Scoring, and Index Weightage. For a full description of the GSV 300 construction methodology, please click HERE.
GSV 300 Snapshot
The average market capitalization of GSV 300 constituent companies is $5.7 billion, with a median of $1.4 billion. The 10 largest companies account for 27% of the index. By comparison, the top five companies in the 2,500-company NASDAQ Composite — Apple, Microsoft, Amazon, Facebook, and Alphabet (Google) — account for 29% of the index alone.
Looking at the GSV 300 by geography, 32% of the index weightage comes from U.S. companies. China is the second-largest geography at 18%, followed by India at 10%, and South Korea at 9%. By contrast, 95% of the S&P 500 and 86% of NASDAQ are represented by U.S. companies.
Performance & Valuation
There was no “Trump Bump” for the GSV 300, which fell 9% in Q4 and 15% for the year. U.S. and Chinese companies drove the action, down 16% and 26% respectively. Indian companies, by contrast, rose 3% in 2016. Segmented by GSV investment theme, “Sustainability” and “Cloud + Big Data” companies declined 20% apiece. “Marketplace” businesses gained a modest 5% and “Education Technology” enterprises were up 8%.
While we’re certainly rooting for stronger performance, our objective in launching the GSV 300 was to create a scorecard that reflects what is actually going on in the World of growth stocks.
The T. Rowe Price New Horizons Fund, for example, has pursued a strategy of investing in small, high-growth companies since 1961. While it is actively managed, Peter Lynch observed in Beating the Street that the fund is, “as close as you’ll get to a barometer of what is happening to emerging growth stocks.”
Since small companies are expected to grow at a faster rate than large companies, they usually sell at a higher P/E than larger companies. Logic might suggest, therefore, that the P/E of the New Horizons Fund would be higher than that of the S&P 500 at all times.
This isn’t always the case, and at times when it isn’t, the New Horizons Fund can be a smoke signal for an undervalued or overheated growth economy. Over the last 50 years, for example, the New Horizons P/E has risen to double that of the S&P 500 only four times.
Currently, the GSV 300 has a P/E (forward) of 25.7x, or1.5x greater than the S&P 500. Our thesis is that at over 2x, it’s a warning signal for growth stocks, and at under 1.2x, it’s a buying opportunity. We’ll monitor this trend, as well as the relationships of other key valuation metrics, to determine patterns over time.
There were a paltry 102 U.S. IPOs in 2016, but we started to see some bullish signs from the Market with Twilio’s successful offering on June 23rd. Despite recent volatility, it is trading at twice the $15 per share where it priced. It was followed by 63 IPOs, including notable listings from technology companies like Line, Talend, and Nutanix, which priced above range and popped over 27%, 42%, and 130% respectively.
The recent trend points to a broader opportunity for the best names to break through an IPO backlog that has been building over the last fifteen years.
Snap (Snapchat), a powerful new force in digital media, has already filed for an IPO that could value the company at $20-$25 billion, according to the Financial Times. The streaming music leader Spotify has also signaled its intent to go public. A 2016 $1 billion convertible note with aggressive IPO convert terms has become a countdown clock of sorts and CEO Daniel Ek has stepped in for co-founder Martin Lorentzon as Chairman of the business — another sign of a likely listing. (Disclosure: GSV owns shares in Snap and Spotify)
In July, Vice Media CEO indicated that he was in discussions with major banks about taking his $4 billion company public. Dropbox, which announced in June that it has become free cashflow positive, has had similar discussions, according to Bloomberg. At the Wall Street Journal’s 2016 Global Technology Conference, Palantir CEO Alex Karp indicated that the company had prepared itself should it decide to go public in 2017, which would create liquidity opportunities for employees. (Disclosure: GSV owns shares in Dropbox and Palantir)
China’s Didi Chuxing, which was valued at $33 billion in a September 2016 funding, could be primed to IPO now that it has absorbed Uber China. WeWork, where CEO Adam Neumann remarked in July that, “we’re not afraid to go public,” could surpass $1 billion in revenue run rate next year. The list goes on.
Stocks kicked off the New Year with a bang, with technology stocks finally participating in the post-election Market party. For the week, NASDAQ advanced 2.6%, the S&P 500 was up 1.7%, and the Dow closed within a smidgen of 20,000.
The Consumer Electronic Show (CES) is where over 100,000 people gather in Las Vegas to see what’s new and what’s next. This year, the buzz was about driverless cars, virtual reality, and drones.
Tech leaders such as Facebook, Alphabet (Google), and Amazon were all acting well, moving up 5.8%, 3.0%, and 4.1%, respectively. Chinese Internet stocks also came out strong, with the BATs (Baidu, Alibaba, and Tencent) all soaring.
What seemed like disappointing news for Tesla — that quarterly production would fall a couple thousand short of its 25,000, target — was actually greeted with a 7% rise in the company’s shares. Maybe it’s that the Gigafactory had some positive news. In any event, investors believe that the next stop for Tesla is delivering 500,000 cars in 2018.
We remain BULLISH on the outlook for equities and premier growth companies in particular. While rising interest rates have historically put the brakes on growth stocks, the modest valuation for many of the leaders, coupled with extraordinarily low yields, makes near term competition from bonds unlikely.