The plunge in growth stocks since the equity market highs of 2021 has been remarkable, providing an attractive entry point into a number of long-term structural growth themes and recession-resistant businesses. Most recently, we have been making the most of attractive valuations in fintech and insurance to add exposure in our Evolving Consumption, Digitalisation and Ageing themes.
As investors crowded into almost anything technology-related during 2020, we became increasingly wary of highly-rated tech companies. We have consequently been underweight technology, payments and e-commerce for some time in our global thematic equity portfolios. This is now changing as we begin to see value emerging. Great themes can make lousy investments, particularly if investors overpay for them or commit at the wrong time. For this reason, the five mega themes that we use as our starting point for thinking about long-term global equity investment contain a range of subthemes that we believe will be most fruitful over the next five years – in this case in an increasingly tough environment for businesses, consumers and investors. Regardless of which sub-theme we are pursuing, we are always looking for quality businesses that offer above-GDP growth over a 10-year time horizon.
The equity markets’ travails this year have been a great opportunity for us to cherry-pick companies that we have admired but could not have purchased at 2021’s year’s eye-watering valuations. There will undoubtedly be more opportunities available before this bear market has run its course. At the moment, however, financial technology is becoming one of our larger global thematic equity exposures.
We particularly like payments companies because currently they are widely misunderstood
We particularly like payments companies because currently they are widely misunderstood: their volumes are often compared to pre-Covid levels, without adjusting for prices being as much as 20% higher, which in turn means that they have the potential to beat consensus estimates despite lower volumes. Where volumes will get to over the medium term is open to debate, but there is undeniable real resilience in the sector and valuations are attractive - particularly if inflation and interest rates normalise.
One of our key buy-list stocks is Mastercard, a company that succeeded in growing its revenues during the Great Financial Crisis. This is partly because it operates large-scale debit and credit card networks and therefore continues to benefit as consumers switch from debt to credit payments as economic conditions tighten. Mastercard also provides good nominal hedge if prices remain high, and will be a key beneficiary of a post-Covid rebound in business travel and international payments.
We have also recently bought shares in Paypal, whose payment and credit services are used by 400m customers. A boom in internet shopping and unrealistic growth expectations turned Paypal into a lockdown darling during 2020-21, but its share price has since plunged precipitously to below pre-pandemic levels as online sales declined towards their long-term growth trend. This has presented a good entry point for buying into the long-term growth of online commerce at attractive levels at a time when PayPay is actively getting its house in order by cutting costs, improving efficiency and productivity and investing in areas where it can grow profitably. As with Mastercard, Paypal is also likely to benefit from tighter economic conditions: e-commerce grew during the last consumer recession and we can expect to see similar resilience in online sales during the current economic slowdown as consumers scour the internet for bargains.
More off the beaten track is Jack Henry, a flourishing provider of banking software to US banks and financial institutions. These number in the thousands, giving Jack Henry a broad and deep market into which it can sell the digital plumbing that enables these businesses to modernise and continue to function. Providing essential software makes the Jack Henry book of business highly recurring – a much-coveted attribute as we enter a weaker economic backdrop – and it also has a payments business that will benefit as nominal prices rise. Like Mastercard, Jack Henry proved its mettle as a resilient, durable business during the Great Financial Crisis.
Insurance in Asia is a high-growth business
Insurance is a second area of financials where we are seeing good opportunities to lock in long-term growth at attractive valuations. Insurance is often assumed to be a low-growth and decidedly old-economy investment. Not so in Asia, where an increasingly wealthy and ageing middle class are doing precisely what increasingly wealthy and ageing people have done elsewhere – buy more insurance. The result is that insurance in Asia is a high-growth business that still has relatively low levels of market penetration, making it a key long-term sub-theme that straddles our Ageing and Evolving Consumption mega-themes. It is worth noting that Asian insurance can be as much about investment and saving as it is about pure insurance, because companies such as AIA and Prudential provide consumers with a way to access global markets via products that include a growth element based on equities and bonds. This makes for more diversified revenues and the potential to sell investment products that are highly scalable and have strong recurring fees.
With the Hong Kong stock market languishing at ten-year lows, we have increased our exposure to this long-term growth theme by adding to our holdings of AIA at relatively cheap valuations. Insurance sales in many parts of Asia depends heavily on meeting face-to-face with customers and networking, both of which continue to be difficult to do under China’s Dynamic Zero-Covid restrictions. Any relaxation in China’s Covid policies will act as a positive catalyst to Asian insurance sales, and the current indicators are encouraging that we may see much higher levels of vaccination and freedom of movement following the Chinese Communist Party’s recent National Congress.
In focus: PayPal
PayPal’s services are available in more than 200 markets around the world, and the company’s platform, which includes Braintree, Venmo and Xoom, enables consumers and merchants to receive money in more than 100 currencies, withdraw funds in 56 currencies and hold balances in their PayPal accounts in 25 currencies.
Founded in 1998 as Confinity, the company rebranded to PayPal with the goal of creating the world’s first digital platform. It surpassed 1mn users in just two years and was purchased by eBay in 2002 before being spun out again in 2015. The company’s growth trajectory continued through partnerships and acquisitions, and in 2019 it became the first foreign platform provider to be approved for online payment services in China.
Expectations for PayPal’s growth potential were raised to unrealistic levels by a surge in online shopping during the pandemic. As economies reopened after lockdowns and employees returned to work, online purchases declined towards their long-term growth rate and disappointing earnings projections from PayPal caused the stock to fall from a record high of US$308 in July 2021 to just $86 at the end of Q3 2022.[1]
PayPal has been highly active in putting its house in order and re-setting its strategy. The company no longer expects to reach 750mn active accounts by 2025, abandoning a goal that sent costs soaring in 2021.[2] It has announced cost-cutting measures to save US$2.2bn in 2022-23, a US$15bn share repurchase programme and it has shut 4.5mn accounts, many of which had been created by fraudsters to benefit from an incentive to encourage spending on the platform.[3] The firm has also committed to working with activist shareholder Elliott Investment Management on a comprehensive evaluation of capital-return alternatives, and is focusing on sustainably improving its cost base to deliver an expansion in operating margins in 2023. We welcome Elliot’s activist engagement with Paypal and our analysis suggests that its share buyback and cost cutting programmes leave the shares trading at a material discount to fair value.
[1] Source: Bloomberg
[2] PayPal, Q4 2021 Results, February 2022
[3] PayPal, Q2 2022 Results, August 2023
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