The Changing Face of the U.S. Economy
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
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
S&P 1500 Index
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
Source: FactSet – R&D% of sales weighted median data as of 3/31/19. Data is for mutual fund products and their benchmarks.
Alger Focus Equity Fund
Alger SMid Cap Focus Fund
Alger Small Cap Focus Fund
The Board of Trustees of the Alger Small Cap Focus Fund has authorized a partial closing of the Fund effective July 31, 2019. Class A, C, I and Z Shares will be avail- able for purchase by existing shareholders who maintain open accounts and new investors that utilize certain retirement record keeping platforms identified by Fred Alger & Company, Inc., the Fund’s distributor. Class I and Z Shares will also be available for purchase by investors who transact with certain brokers identified by the distributor. Please check with your financial advisor regarding the availability of Class I and Z Shares for purchase at their firm. Class Y Shares will remain open to all qualifying investors. The views expressed are the views of Fred Alger Management, Inc. as of July 2019. Alger has used sources of information which it believes to be reliable; however, this publication is not intended to be and does not constitute investment advice. 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Growth stocks tend to be more volatile than other stocks as the prices of growth stocks tend to be higher in relation to their companies’ earnings and may be more sensitive to market, political and economic developments. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. A significant portion of assets will be invested in technology and healthcare companies, which may be significantly affected by competition, innovation, regulation, and product obsolescence, and may be more volatile than the securities of other companies. Investing in companies of small and medium capitalizations involve the risk that such issuers may have limited product lines or financial resources, lack management depth, or have limited liquidity. 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