Equity Insights offers research and perspectives from Putnam’s equity team on market trends and opportunities.
This month’s authors: Richard E. Bodzy and Gregory D. McCullough, CFA, Portfolio Managers
After several challenging quarters, large-cap growth stocks delivered solid returns in the early months of 2023, and we remain optimistic about their prospects. Growth stock multiples have pulled back substantially over the past 12 to 18 months. At the same time, forward revenue and earnings growth estimates have come down to more reasonable — less “heroic” — levels. Also, large-cap growth stocks may benefit as the Federal Reserve’s monetary tightening eases over the next 12 months.
What’s the key to capturing opportunities in this space? You have to be present to win. We believe great companies can become even better in challenging markets. For stocks we own, we are starting to see upside again in consensus growth estimates. And we continue to see structural tailwinds and exciting multiyear trends that we believe can drive sustained growth for many businesses.
Promising sectors in a less crowded space
Another trend in our favor is the fact that the growth stock universe has become less crowded. Broad-based ownership of growth stocks declined after value began to take over market leadership in 2020. Also, many companies today are no longer chasing every incremental dollar of revenue at any cost. This is especially true in the large-cap technology space. Cost management actions on the part of many businesses may contribute to margin integrity and profitable growth.
More broadly, we are optimistic about the innovation we believe will come from traditional growth sectors in the next 3 to 5 years. These sectors include technology, health care, consumer discretionary, and industrials. Conversely, the energy sector is coming off a massive run-up in 2022, and it has pulled back significantly year to date. Another sector with immense year-to-date challenges is financials, particularly some of the less well-capitalized banks.
AI moves beyond the buzzword phase
In the technology sector, excitement around artificial intelligence has been building for many years. But now we’re seeing strategic action and prominent real-world applications from some of the world’s largest tech companies as it relates to AI. For example, Microsoft added to its ownership stake in OpenAI, which owns the ChatGPT tool, by investing $10 billion more into the startup company. Microsoft has immediate plans to integrate features of ChatGPT’s AI-powered text-generating functionality into its Office 365 product suite. One can imagine how Outlook emails can be crafted more efficiently and inbox mail summarized succinctly. Similarly, Microsoft is integrating generative AI into its Bing search business in an effort to take on Google’s market dominance in search. Both of these initiatives present large potential new streams of revenue for the company.
We are optimistic about the innovation we believe will come from traditional growth sectors in the next 3 to 5 years.
The benefit of a thematic lens
In certain pockets of the growth universe, we see trends that are powerful and multiyear in nature. This is the source of the growth themes in our portfolio. Approximately 90% of our holdings are tied to one or more of our 12 themes. Among them are “The humanization of pets,” “Personalized medicine,” and “The experience economy.” Focusing on themes allows us to identify areas of the growth universe that demonstrate consistent, above-market growth, which we define as high single-digit top-line revenue growth and double-digit free cash flow growth.
It’s not enough to simply identify a business that is associated with a long-term growth theme. We scrutinize businesses in the context of their industries overall, and often we favor the “enablers” of growth themes and trends. Also known as pick-and-shovel businesses, these companies provide products or services that enable the growth of the overall industry.
Theme: 5G connectivity | Stock: American Tower (AMT)
American Tower fits into the enablers category. The transition to 5G technology is an important growth theme that we believe will play out in waves globally over the next 15 years as wireless data applications expand well beyond consumer smartphones. American Tower is well positioned as it rents space on towers and rooftop antennas to wireless carriers and broadcasters. This company is indifferent to which mobile provider will gain the most market share, which might be a challenge to accurately predict. Instead, American Tower may benefit from the $30 billion-plus in infrastructure that’s necessary to transition from 4G LTE to 5G.
Theme: Digital marketing | Stock: CoStar Group (CSGP)
Spending on digital marketing has risen as attention has shifted from traditional media to digital platforms. Companies know the increasing importance of mobile applications, search engines, and websites for driving the growth of their businesses. CoStar is the dominant information provider for the commercial real estate industry, offering data, tools, listings, and online marketplaces. CoStar is used for 80% of all commercial real estate transactions. Its top-line growth has been in the mid to high teens (primarily organic), with projected earnings growth of 20% over the next two years.
Theme: Increased screen time | Stock: Universal Music (UMGNF)
Relative to five years ago, we all know people spend considerably more time consuming content on mobile devices. We can access the content we want from almost anywhere, and device usage is growing rapidly as streaming platforms increasingly cater to consumers outside the home. We believe Universal Music is a significant beneficiary of this trend. The company collects a royalty every time a song is streamed from its massive library of artists. Whether these artists are streamed on Facebook, Apple music, Spotify, TikTok, or elsewhere, Universal Music will be paid. We believe the company will be a low double-digit grower for the next half decade while also being largely insulated from economic fluctuations.
The themes in our portfolio do not change often because they are based on secular trends and our multiyear outlooks. However, we are constantly considering new ones based on changing markets and consumer preferences. For the stocks we own, we don’t try to identify which day, month, or quarter they may outperform. We look for durable growth companies that tend to perform competitively within their industries across a full economic cycle. We also look for companies that offer the powerful combination of an advantaged business model and a capable, properly incentivized management team.
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The views and opinions expressed are those of the authors, are subject to change with market conditions, and are not meant as investment advice.
Our investment techniques, analyses, and judgments may not produce the outcome we intend. The investments we select for the fund may not perform as well as other securities that we do not select for the fund. We, or the fund's other service providers, may experience disruptions or operating errors that could have a negative effect on the fund. You can lose money by investing in the fund.
Large Cap Growth Fund holdings as of 3/31/23: Microsoft (10.74%); American Tower (1.59%); CoStar Group (0.55%); Universal Music Group (0.95%).
