February 14, 2020
Growth stocks have dramatically outperformed value stocks in 2020. Year-to-date, the Russell 1000 Growth index has risen 8.4% versus only 1.1% for the Russell 1000 Value index. That is a stunning divergence in a relatively short period. The top five companies in the growth index also happen to be the top five in the S&P 500. From a market cap weight perspective, these stocks account for roughly 29.7% of the Russell 1000 Growth index and 16.8% of the S&P 500. The performance of these top five companies has contributed almost 60% of the year-to-date return for both indexes. The top five companies are Apple, Microsoft, Alphabet, Amazon, and Facebook. The weighted average return of these companies is over 12% in 2020 and has driven the S&P 500 index up 4.6%. In contrast, the equally weighted S&P 500 index is up only 2.5%. The concentrated nature of this equity market has been a concern for many investors. There have been several reasons that have resulted in investment dollars flowing disproportionately into relatively few names. Better organic revenue growth is a major reason but share buybacks have also been a significant driver of out-performance for these top companies. The tax reform initiated in 2018 unlocked foreign cash holdings with the hopes that the repatriated dollars would go into capital investment, but far more money has gone into enhancing shareholder returns through share repurchases and dividend increases. Share repurchases have been a huge source of liquidity for the equity market, with repurchases totaling $700 billion in 2019. The buybacks have also been highly concentrated, with just 25 companies accounting for over half of the total. According to DataStream, Apple, Microsoft, and Alphabet collectively repurchased $116.7 billion worth of stock. Share buybacks are likely to slow and be less supportive of equities over the next few years. First, for at least two-thirds of top 25 companies, the amount of the buybacks are greater than net cash flow after capital expenditures and dividend payments and therefore are not sustainable. Second, it becomes harder to make a compelling case that share repurchases are an effective use of capital as PE multiples rise.
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