280 days down, at least 80 to go: How to find great growth stocks in this bear market

Conviction can be infectious. Engaging someone who is genuinely passionate about markets, has the courage to plant their feet, and the commitment to follow through on their process is exciting - whether you agree with them entirely or not. 

Nick Griffin, chief investment officer at Munro Partners, has such conviction. It is a conviction borne out of previous experience and an enviable track record. 

Griffin has been through five bear markets in his career, so he knows what he is talking about, and while conditions are difficult for all investors right now, he is supremely confident the Munro strategy will once again enjoy its time in the sun. 

It's a strategy focused intently on stock picking. As Griffin succinctly puts it, "the reality is equity markets are made up of a handful of exceptional companies and thousands and thousands of mediocre ones."

Pulling absolutely no punches, Griffin goes on to add, "you should spend your time trying to find those exceptional companies and spend a lot less time worrying about the cycle."

In this Expert Insights interview, Griffin provides more candid responses on how he and his team think about markets, what makes for a great growth company, how he is managing risk in the current market environment, and the three signals that he wants to see fall into place before dialling up risk. 

Note: This interview was taped on Thursday, October 13th, 2022. You can watch the video or read an edited transcript below. 

EDITED TRANSCRIPT

Why is stock picking the best strategy for markets right now?

Nick Griffin: We've been looking at equity markets for a long time. I've been looking at it for a long time in my career. Over time, you realise that stock picking is basically what it's all about. 

There will be a lot of guys out there who effectively try to go over or under certain countries or regions, or over or under certain sectors. And we just think that's a complete waste of time.

The reality is equity markets are made up of a handful of exceptional companies and thousands and thousands of mediocre ones. We can show you statistics that the entire wealth of the US stock market over the last 90 years is actually generated by less than 4% of the companies that are listed. Out of those, less than 4%, the top 50, make up nearly half the wealth. And in that timeframe, 25,000 companies were listed. So 50 companies out of 25,000 make up nearly half the wealth of the US stock market.

So it is a stock picker's game. You should spend your time trying to find those exceptional companies and spend a lot less time worrying about the cycle and whether you're going to be over it or under it, and that's what we've built our process on over 15 years at Munro. 

That's what gets us our double-digit returns through the cycle and that's why we like it.

How do you identify a great investment?

So having looked at them for a long period of time, we came to the conclusion that there are basically six great characteristics of a great growth company. 

1. The first one's really easy. It's got to grow. We would look at revenue growth. Any company that can grow at double GDP at least is something worth looking at. 
2. Second thing, you have to be able to leverage your growth. A lot of people can grow revenue. You’ve got to be able to grow your earnings. 
3. Third thing, you need a big runway. You need to be growing into a runway like electric cars are growing into a runway. And like digital advertising grew into a runway.
4. Fourth, we're looking for good ESG principles. That's definitely something we've brought into our process in the last few years. We find that the companies with better ESG credentials are usually the winners. 
5. Five, you're always looking for a large controlling shareholder and highly aligned management. They're generally the guys who win. Apple won. Nokia didn't. Amazon won. eBay didn't. It's always the founders that make it work. 
6. And the last one, the most important one, is customer obsession. If customers love your product, you can generally be a great growth company. So if you've got those six things, you can generally be a great growth company.

In terms of getting into the portfolio, those characteristics are great and can be a wonderful company. But the second thing you have to be wary of is price. And so to get into our portfolio, we would find these great growth companies that we like, and then find them mathematically at a risk-reward area that we think makes sense. 

The hurdle for getting into our fund is we have to be able to prove that the share price can double mathematically within five years.

And that usually means its earnings are going to double within those five years and the multiple stays the same, or sometimes the earnings are going to more than double and the multiple will come down. But that's what we're challenging the people at Munro to come up with - companies that are great, and then companies that are great at a price that we're happy to pay to get us that double within five years.

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How have you been managing risk?

We're obviously going into an economic slowdown. I think most people can see that's coming. And so in that environment, it is harder to find companies that will achieve our target, that will grow their earnings. There are plenty out there we still think can grow their earnings over a five-year view, but at least some of them on a 12-month view will struggle to grow. And so we've raised cash. 

It's a difficult environment. Let's take less risk. We raised about 40% cash in January. And we've been sitting on that cash since January. 

People have been asking me when we're going to put that cash back to work since January, and we still have it. We're still choosing to be quite patient here, and so, we're continuing to watch the environment. For people watching, you have to realise this is a bear market. This is a good, well-entrenched, bear market. But I've been through five of these in my career, and I've been through two really big ones, 2008 and 2000, and this one's setting up a bit like one of those ones.

You have been waiting for three signals to turn before investing your cash. Where do they stand now?

There are three things that will help you get to the end of the bear market. The first is that long-term interest rates need to peak. And so obviously, we've been fighting interest rates going up all year, which is making asset prices go down. We're very close to that. We actually thought we'd got there in July. We've since gone higher, towards 4% on the risk-free rate in the US, but we think we're very close to that point. 4% is really the number that's going to cause a fair bit of economic pain. So that one is a tick, in our mind.

The second one is that earnings estimates need to come down. At this point, the market consensus still thinks earnings will grow 8% next year in the US. We think that's highly unlikely, particularly with the strength of the US dollar. So earnings estimates need to come down, and they need to come down quite dramatically. And we're probably sitting on the precipice of that in Q3.

The last thing is just time. This is just us being a bit old and grey, or bald, in my case. Basically saying, you know, if you've been around a while, generally, it's at this point in the bear market where, as Warren Buffett would say, the tide goes out and you see who's not wearing any bathers. 

And at this point in time, it makes sense to me just be a little bit prudent to see what else could go wrong.

There are some things in the UK that don't look great to us. And there are potentially other things that could come along. And if you go back to 2008, Lehmans didn't go broke until September 2008. Your average bear market lasts 360 days and falls 37%. 

We're about 280 days into this one, and I'm willing to bet this one's going to go longer than 360 days. 

Just be a little bit patient in this period, because it's a process that just takes time. From the start of the year until now, it just pays to be patient and prudent and just take a little bit less risk while there's a lot of uncertainty. The sun will shine again. It always does. And sometimes you just have to be a little bit patient, and that's what we're trying to be here at the moment.

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Munro Partners is a global growth equities manager. Munro invests alongside clients to benefit from some of the key structural changes that are occurring in our world today. To find out more, visit their website.