How Coronavirus is Reshaping the Blue-Chip Universe
Defining potential winners and losers—near and longer term.
- The current health crisis and economic dislocation are clouding near‑term earnings forecasts for many U.S. companies, including blue chip names.
- Three key categories help to define how companies may be impacted—both near and longer term.
- Certain companies have key qualities that single them out as advantaged long‑term businesses—even if they are negatively impacted near term.
Equity markets have rebounded well from the pandemic‑related lows of March 2020, displaying an encouraging level of resilience. While this is positive, we remain circumspect about the potential time frame for economic recovery. Our sense is that the current crisis could have a longer‑than‑expected tail, delaying the recovery beyond what the market consensus is currently anticipating. Meanwhile, the environment is likely to remain uncertain for some time.
Regardless, our investment approach and portfolio focus remain unchanged. We continue to look for high‑quality companies that can potentially produce durable growth in earnings and free cash flow over time.
Given the extreme economic dislocation, near‑term earnings forecasts for many companies have become clouded. To better understand the longer‑term picture and potential outcomes, we allocate the companies within our investment universe into three main categories.
- Category 1—Long‑term losers: This includes companies that are being negatively affected by the current health crisis and the severe economic dislocation in the short term, but that are also likely to be negatively impacted on a longer‑term basis.
- Category 2—Long‑term beneficiaries: This includes companies that are negatively impacted by the current crisis in the short term but that we see as being potential beneficiaries over the longer term. These companies could emerge from the crisis in a potentially improved position.
- Category 3—Short- and long‑term winners: This category has fewer names but contains those select companies that are currently benefiting in the short‑term environment and are also expected to be key longer‑term beneficiaries.
Identifiers of Quality
The companies that we look to invest in have various, consistent qualities that single them out as potentially advantaged long‑term businesses. Such attributes include high barriers to entry, low availability of substitute products, industry leadership, and pricing power with both suppliers and customers. Also essential is capable management that can allocate capital effectively and efficiently. These quality identifiers are particularly relevant for companies currently allocated to Category 2, for example. Despite earnings being negatively impacted in the short term, and share prices falling sharply in some cases, these qualities give us confidence that the companies can not only recover, but go on to excel, longer term.
At this point, it is worth highlighting some of these “all season” growth companies—examples from both Category 2 and Category 3—and what we believe are the durable qualities that identify them as potential long‑term growth compounders.
Under Pressure in the Short Term, but Potential Long‑Term Beneficiaries
Technology/consumer services giants Alphabet (Google) and Facebook are good examples of companies currently in Category 2. Both have been hurt by the current crisis and suffered steep share price declines during March; however, we believe that both businesses could ultimately be beneficiaries of the current environment.
The largest portion of both Google’s and Facebook’s revenues comes from digital advertising, an area of spending that has seen significant cuts in the current environment as companies can turn it off very quickly during times of stress. Compare this to TV advertising, for example, which tends to be more contractual in nature and paid forward, so not as easy to unwind.
What is most encouraging however, and underpins our positive long‑term view of each business, is that as quickly as digital advertising can be switched off, it can be switched back on again. Digital advertising is the most measurable, and return‑on‑investment visible, spending that companies have at their disposal. As such, we believe that it will be the first place they return to as soon as any budget becomes available.
Also potentially benefiting Google and Facebook on a longer‑term basis is the growing “cord cutting” trend currently evident among companies and consumers. This trend (which is perhaps most prominent elsewhere, among content streaming platforms) is also increasingly evident in the advertising realm. Prior to the onset of the crisis, many companies had already set aside substantial sums for TV advertising. However, with limited new content presently being made and, crucially, with no live sports being shown on TV, companies are looking to reallocate their TV advertising budgets to digital, and, in many cases, this money has been making its way to Google and Facebook. And once the cord is cut, be it by companies or consumers, data has typically shown that a large percentage never go back.
Short‑Term Beneficiaries and Potential Long‑Term Winners
Clearly, Category 3 is where we want to be most invested, but these companies are also fewer in number. A prime example is Amazon. Since the onset of the crisis and the subsequent shuttering of all but essential retail (brick and mortar) businesses, Amazon has seen a notable acceleration in revenue growth. In our view, the increase in revenues is likely to come at a cost of margins in the near term, as the company was not prepared for the sudden and substantial increase in demand. However, we believe these costs will subside as the company is able to add capacity, which we believe should improve efficiency. Amazon has already hired 175,000 additional staff in the roughly two‑and‑a‑half months since the start of the crisis.
Growth Has Continued to Outperform Value
This Is an Unusual Feature of the Current Crisis
As of May 18, 2020
Past performance is not a reliable indicator of future performance.
Indices rebased to 100.
Sources: Refinitiv Datastream. © 2020 Refinitiv. All rights reserved. Frank Russell Company “LSE”, and S&P Indices (see Additional Disclosures).
Longer term, we believe the sharp revenue acceleration that Amazon has seen in the past couple of months will ease in time. However, we think that there are some long‑term consumer behaviors that are being forged currently with many shopping online—and with Amazon—for the first time and across a wider range of categories. We think that this trend will continue and could help Amazon to penetrate some significant market categories, like groceries and consumables.
Some concerns have been voiced about the elevated valuations of higher‑growth companies, particularly in areas like technology. An unusual feature of the current crisis is that growth‑oriented names have continued to notably outperform their value and defensive counterparts.
As such, certain technology sector names, for example, may appear expensive currently, relative to the broader market. It is our job as investors to research these businesses in detail, all the time looking for any unique qualities or advantages, as well as potential limitations, and determining our own fair valuation based on this analysis. Take Amazon, for example. Amazon is the dominant player in the retail sector, with the potential to extend its reach into other key retail segments. The company’s other main businesses, Amazon Web Services and its advertising arm, have offered additional, diversified revenue streams, and the company has generated substantial levels of free cash flow. The combination of these features has given us comfort in our position in Amazon.
There is no magic formula or silver bullet for finding quality, durable growth companies. It involves a lot of hard work, digging, and detailed research and analysis. And in unprecedented times like today, it involves continuous engagement with company management teams, asking difficult questions, checking and rechecking investment theses, and ultimately deciding if the company’s longer‑term strategy can still be delivered.
While consensus opinion is anticipating a relatively quick, “V shaped” U.S. economic recovery, we are of the opinion that a recovery may take longer than expected and be more “U shaped” in nature. We anticipate that earnings revisions will be necessary for many companies, which makes us more cautious about the near‑term outlook, particularly given the rapid recovery we have seen in the stock market so far. That said, we do believe generally that there is a solid return opportunity in U.S. equities, especially looking out over an 18- to 24‑month time horizon.
What we’re watching next
As an investment team, the message that we continue to reiterate is: “Don’t let perfect be the enemy of the good.” Even some of our highest‑conviction holdings will likely see earnings revisions if the businesses have been closed or unable to trade during the crisis. However, with the quality attributes these companies possess, we believe that they will bounce back in time and continue to deliver potential earnings and free cash flow growth over the long term.
The companies mentioned above represented the top 3 largest holdings in the US Large-Cap Core Growth Equity Representative Portfolio, as of March 31, 2020.
The specific securities identified and described do not represent all of the securities purchased, sold, or recommended for the portfolio, and no assumptions should be made that the securities identified and discussed were or will be profitable.
Key Risks—The following risks are materially relevant to the strategy highlighted in this material: Transactions in securities of foreign currencies may be subject to fluctuations of exchange rates which may affect the value of an investment. The portfolio is subject to the volatility inherent in equity investing, and its value may fluctuate more than a portfolio investing in income-oriented securities.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2020. FTSE Russell is a trading name of certain of the LSE Group companies. Russell® is a trade mark of the relevant LSE Group companies and is used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor or endorse the content of this communication. The LSE Group is not responsible for the formatting or configuration of this material or for any inaccuracy in T. Rowe Price Associates’ presentation thereof.
The S&P 500 Index is a product of S&P Dow Jones Indices LLC, a division of S&P Global, or its affiliates (“SPDJI”) and Refinitiv Datastream, and has been licensed for use by T. Rowe Price. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); Refinitiv Datastream is a trademark that has been licensed for use by SPDJI and sublicensed for certain purposes by T. Rowe Price. T. Rowe Price’s product is not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates, or Refinitiv Datastream and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P 500 Index.
This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.
The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.
Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.
The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.
EEA ex-UK—Unless indicated otherwise this material is issued and approved by T. Rowe Price (Luxembourg) Management S.à r.l. 35 Boulevard du Prince Henri L-1724 Luxembourg which is authorised and regulated by the Luxembourg Commission de Surveillance du Secteur Financier. For Professional Clients only.
Switzerland—Issued in Switzerland by T. Rowe Price (Switzerland) GmbH, Talstrasse 65, 6th Floor, 8001 Zurich, Switzerland. For Qualified Investors only.
UK—This material is issued and approved by T. Rowe Price International Ltd, 60 Queen Victoria Street, London, EC4N 4TZ which is authorised and regulated by the UK Financial Conduct Authority. For Professional Clients only.