Price-to-book value is the primary characteristic that drives approximately $4 trillion of growth and value style classification. Unfortunately, we believe this metric is not functioning as intended, which is driving the underperformance of value stocks.
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 stock prices 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: Ponemon Institute. Market capitalization is that of the S&P 500 index. 1975 2018 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 August 2020.
Research and Development Expenditures Relative to Sales
Weatherbie Specialized Growth Russell 2500 Growth
Focus Equity Russell 1000 Growth
Small Cap Focus Russell 2000 Growth
Source: FactSet – R&D% of sales weighted median data as of 9/30/20. Data is for mutual fund products and their benchmarks.
Alger Focus Equity Fund
Alger Weatherbie Specialized Growth
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, LLC, 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, LLC (“FAM”) and its affiliates as of October 2020. These views are subject to change at any time and may not represent the views of all portfolio management teams. These views should not be interpreted as a guarantee of the future performance of the markets, any security or any funds managed by FAM. These views are not meant to provide investment advice and should not be considered a recommendation to purchase or sell securities. Risk Disclosures: Investing in the stock market involves risks, including the potential loss of principal. Growth stocks may be more volatile than other stocks as their prices tend to be higher in relation to their companies’ earnings and may be more sensitive to market, political, and economic developments. 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. Investments in the Consumer Discretionary Sector may be affected by domestic and international economies, consumer’s disposable income, consumer preferences and social trends. 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. Assets may be focused in a small number of holdings, making them susceptible to risks associated with a single economic, political or regulatory event than a more diversified portfolio. Active trading may increase transaction costs, brokerage commissions, and taxes, which can lower the return on investment. Foreign securities and Emerging Markets involve special risks including currency fluctuations, inefficient trading, political and economic instability, and increased volatility. The Russell 1000® Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher growth earning potential as defined by Russell’s leading style methodology. It is constructed to provide a comprehensive and unbiased barometer for the large-cap growth segment and its performance does not reflect deductions for fees or expenses. The Russell 2000® Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe. It includes those Russell 2000 companies with higher growth earning potential as defined by Russell’s leading style methodology. It is constructed to provide a comprehensive and unbiased barometer for the small-cap growth segment and its performance does not reflect deductions for fees or expenses. The Russell 2500® Growth Index measures the performance of the small to mid-cap growth segment of the U.S. equity universe. It includes those Russell 2500 companies with higher growth earning potential as defined by Russell’s leading style methodology. 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Note that comparing the performance to a different index might have materially different results than those shown. The performance data quoted represents past performance, which is not an indication or a guarantee of future results. Before investing, carefully consider a Fund’s investment objective, risks, charges and expenses. For a prospectus or a summary prospectus containing this and other information about a Fund, call (800) 992-3863, visit www.alger.com, or consult your financial advisor. Read it carefully before investing. Distributor: Fred Alger & Company, LLC. Member NYSE Euronext, SIPC. NOT FDIC INSURED. NOT BANK GUARANTEED. MAY LOSE VALUE.
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