Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive and powered by Canada Life. For today’s Soundbites, we’re talking about the tech sector in today’s economic climate with Dustin Haygood, client portfolio manager with Aristotle Capital Management. We talked about the rotation to value and back again to growth, names he likes, and we started by asking about the biggest surprise in recent investment trends.

Dustin Haygood (DH): What’s been surprising has been large and sudden shifts in style leadership over the past 18 months or so. For much of the past decade, growth has outperformed value. Then, in 2022, the Russell 1000 value index outperformed its growth counterpart by over 20%. It was the largest outperformance by value since the tech bubble burst in the early 2000s. And now, in 2023, we’re seeing another large reversal, back towards growth. As we’re recording this, year-to-date growth is now up about 16%, while value is down 1%. This is why we think it’s important to take a long-term, thoughtful approach to understanding businesses, having a business owner’s perspective, rather than attempting to predict which parts of the market might be in favour in the short term.

What he makes of tech giants no longer being thought of as pure growth stocks

DH: This just goes shows that the line between what is ‘value’ and what is ‘growth’ is blurred, and companies can fluctuate between classifications. Value-style indices, they typically look for companies that have attributes like low price-to-book ratio. And if tech companies fall in price, relative to their book value, it’s always possible style indices may no longer consider them ‘growth’ or even reconstitute them as ‘value.’

Finding opportunities

DH: The most recent addition to our U.S. portfolio is Activision Blizzard. Activision is one of the largest video game companies in the world and owns some of the most well-known franchises, including World of Warcraft, Call of Duty and Candy Crush. We think it is an optimal investment, regardless of whether or not the pending acquisition by Microsoft goes through, and we’re attracted to its ability to develop games and monetize them over the long term, through sequels and downloadable content. We think it’s going to be able to increase its revenue from new products, like free-to-play content that relies on in-game transactions and advertising, and also should be able to leverage its wholly owned intellectual property for consoles and PCs — like the Call of Duty franchise — into mobile games which should also improve sales. E-sports are also increasing in popularity. This is where multiplayer video games are played competitively, often times in stadiums or arenas for spectators, and we believe Activision could increase its free cash flow generation as its live-event capabilities are further improved on.

Tech names that should do well in a value framework

DH: We own technology companies like Microsoft, which has high recurring revenues, margins, returns on invested capital and free cash flow. It’s successfully pivoting to a cloud-first, mobile-first strategy, and uniquely positioned to benefit from digital transformation efforts with its enterprise customers that are increasingly looking to improve their technological capabilities. We also own Ansys, which develops simulation software. Their software allows design engineers to, in effect, crash-test products virtually before they are ever physically created. It’s an underpenetrated market, with, we estimate, only 1 in 10 design engineers currently using simulation software, even though simulation significantly reduces development time and costs. So, with the scale of its user base and the reputation of the industry, we think Ansys will benefit as simulation software becomes more widely used, products become more complex, and there’s a desire to speed up the time it takes to get products to market.

And finally, what’s the bottom line on technology stocks in a value world?

DH: There are value-oriented investors out there that dismiss some of the world’s greatest businesses because they trade at above-average price-to-earnings ratios. We believe this can create opportunities for investors like us, who look at valuation holistically. What is the predictability of cash flows? What is the range of outcomes? What are the long-term prospects of the business? These are some of the questions that are important to consider when we estimate the normalized earnings power and intrinsic value of a technology company, or any company for that matter.

Well, those are today’s Soundbites, brought you by Investment Executive and powered by Canada Life. Our thanks again to Dustin Haygood of Aristotle Capital Management. Visit us at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.

**

Go back to the article.