Fundamental Growth Equity | December 2011
In a challenging economy, innovative growth companies have a distinct edgeBy Thomas Pence, CFA, and Michael Smith, CFA—Portfolio Managers Enterprise Fund
As recently as two months ago, some economists and investors feared that the global economy was on the brink of collapse. With the year winding down, it now appears that those fears may have been exaggerated. However, while the economy may avoid another recession, growth is unlikely to accelerate dramatically in the coming months.
As we enter the later stages of the current economic cycle, companies that can consistently generate robust sales growth may become increasingly scarce—and therefore, more valuable. We believe that some of the most successful growth companies will be those that can drive organic sales growth through innovation. By selectively favoring such companies, investors may be well positioned to navigate the period ahead.
Opportunities in several sectorsInnovative companies typically provide unique products or services that benefit from resilient demand, potentially allowing them to grow against a variety of economic backdrops. In fact, even when the economy is not humming along briskly, these companies may succeed in grabbing additional market share from competitors. Surveying the current market landscape, we believe that innovative growth stories can be found across market capitalizations and in several different sectors.
In health care, for example, Alexion Pharmaceuticals* has developed innovative products that set the company apart from other biotechnology firms. Alexion has delivered strong sales growth, fueled by geographic expansion and the success of its flagship drug Soliris—trends that look poised to continue. Soliris is used to treat rare diseases such as atypical hemolytic-uremic syndrome and paroxysmal nocturnal hemoglobinuria. We expect additional indications for the drug to ultimately be approved, enhancing its sustainable demand profile due to the limited options now available for treating these rare diseases.
Innovation has also been a critical component of success for some consumer discretionary companies. For instance, lululemon athletica's* solid sales growth in recent years can be traced largely to its technological innovations in the athletic apparel market for women. The company has produced clothing with unique fabrics that combine functionality and fashion, particularly for yoga exercises. We believe that its future growth prospects are significant because of the potential for further U.S. expansion, innovative apparel solutions for activities beyond yoga, and a promising new athletic-apparel concept aimed at the youth market.
Industrials firms—such as Rockwell Automation*—that can help customers "do more with less," thereby boosting their productivity levels and reducing their costs, should also fare quite well in a challenging economic environment. Rockwell Automation provides a range of power, control, and information solutions and services that are designed to solve its customers' manufacturing problems. Armed with these innovative offerings, the company has generated impressive sales growth, supported by both "catch-up" spending in developed economies and ongoing demand from emerging markets countries.
Innovative companies have posted strong sales growth, outpacing their sector averages
Year-over-year (YOY) sales growth
Concluding observationsGiven that economic growth is likely to remain sluggish for the foreseeable future, it may become more difficult to find fundamentally sound companies with prospects for strong and sustainable growth. As a result, those that can consistently achieve rapid, organic sales growth should command a valuation premium going forward. In our view, the best opportunities for outperformance lie in innovative companies with powerful secular tailwinds that have enabled them to carve out profitable niches within their respective sectors. As always, we think that a bottom-up, "surround the company" research approach is well suited to identifying such opportunities across the marketcapitalization spectrum.
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