The Changing Face of the U.S. Economy

FLYER

The Changing Face of the U.S. Economy

Price-to-book value used to be a good indicator of the market’s expectation of stocks. Now, however, we believe this metric is not functioning as intended. A large and important portion of companies’ assets— intangibles—is often not reflected on their balance sheets.

Figure 1: Companies’ Market Values Now Driven by Intangible Assets

What Is Wrong with Book Value? More than ever before, companies’market values are driven by intangible assets such as patents, brands, and R&D (see Figure 1). These assets are expensed and typically are not included on companies’ balance sheets. We believe book value, which generally doesn’t account for intangible assets, is a less accurate measure of a firm’s asset value and therefore its earnings power. This is driving the poor performance of low price/book stocks as new economy companies—growth companies—have more intangible assets. Innovation Drives Outperformance We believe the most significant contributor to this shift is innovation, which usually shows up in the form of intangible assets. In our opinion, innovation is the most powerful force in the economy, and it is increasingly a driver of fundamentals and stock returns. Academic studies and Alger research show that the most innovative companies grow their sales and earnings faster than the least innovative companies and consequently their stocks rise faster too (see Figure 2). Alger Has Expertise Investing in Innovation We believe we are seeing the changing face of the U.S. economy as companies shift from tangible to intangible assets. Our emphasis on innovation, as measured by R&D expenditures relative to sales in our portfolios’ holdings, is evident across our product lineup (see Figure 3). Our team of analysts research companies to value what may—or may not be—included on their financial statements. We believe our original, bottom-up research process can help us find growth stocks that should benefit from innovation, while avoiding value stocks that appear cheap and may simply be victims of change.

Intangible Assets as a Percentage of Market Capitalization

84%

32%

Source: Ocean Tomo. Market capitalization is that of the S&P 500 index. 1985 2015 Innovative Companies Have Outperformed Over the Past Decade

Figure 2: Innovative Companies Have Outperformed Over the Past Decade

Cumulative Excess Return

50%

S&P 1500 Index

Most Innovative

-31%

Least Innovative

Source: FactSet. Most/least innovative stock excess performance is derived from highest and lowest S&P 1500 quintiles based on R&D as % of sales,normalized for market value, using one month returns for 10 years ending 3/31/19.

Figure 3: Innovation Creates Investment Opportunities

Research and Development Expenditures Relative to Sales

Focus Equity Russell 1000 Growth

SMid Cap Focus Russell 2500 Growth

Small Cap Focus Russell 2000 Growth

16.7%

14.1%

12.4%

12.2%

12.0%

11.1%

Source: FactSet – R&D% of sales weighted median data as of 3/31/19. Data is for mutual fund products and their benchmarks.

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