Many growth companies have relatively high valuations and are often perceived by investors as “expensive.” This view, however, can overlook a company’s long-term potential. Successful companies often need time to grow into their valuations. Over the past 10 years, the market has consistently underestimated the magnitude and duration of growth for many companies that are beneficiaries of secular growth.
Valuation is a critical component of Jennison’s growth investment process. The goal of the research analysts’ valuation analysis is to identify underestimated growth opportunities at their inflection point of growth, early on in a company’s life cycle. There is no single overarching valuation methodology used across the firm. Jennison’s analysts use varying valuation methodologies that work best in their particular industry; many use multiple models to arrive at the valuation profile of a company.
P/E can be misleading in high-growth companies
Jennison’s deeply resourced investment team develops an informed view of each company’s earnings profile several years into the future. For companies that are growing revenues and earnings at a very high rate, and trade at high near-term P/E multiples, it is more challenging to forecast a likely outcome over the next several years than it is for companies with slower, but more consistent, growth.
For high growth companies, this year’s P/E, or even next year’s P/E, should not be emphasized because they will not adequately capture the true growth potential.
At scale, Shopify could have very high operating margins. Shopify’s business model is driven by high gross margin subscription services that are augmented by highly scalable fixed fee revenue generated from Shop Pay. Importantly, Shopify is focused on innovating, improving service, and addressing challenges, such as security threats. They continue to add services and capabilities that can benefit merchants of all sizes. In particular, Shopify has made big pushes into cross border ecommerce, shipping solutions, and small-to-medium business lending solutions.
Jennison’s way to value these businesses
In valuing these companies, Jennison’s analysts consider several scenarios based on a range of assumptions regarding growth, profitability, and size of addressable market. Additionally, by reverse-engineering a discount cash flow (DCF) model, we also seek to determine the strength of growth, returns, and length of the competitive advantage period reflected in the current market price of these companies. Ultimately, the objective of these efforts is to understand the value created by both the duration and magnitude of growth – areas that the market often gets wrong, usually by underestimating one or both.
If Jennison’s analysts believe the market is being too conservative, they may see the stock as a very attractive opportunity.
Growth companies must build an expensive moat – fast
The challenge in valuing these high growth businesses is that their growth opportunities and addressable markets are significant, of course. Emerging as an industry leader is critical because the company must take market share quickly and build up barriers to entry in order to lengthen its competitive advantage period. To do this, growth companies must invest a tremendous amount of their cash flow in sales, marketing, and engineering to build out their product suite. These investments will depress margins and earnings over the near term (about 1–2 years), but are necessary for long-term success.
As long-term investors, Jennison looks past these near-term investments and their impact on margins and earnings because their analysts are focused on how these investments will affect the business over the next 3–5 years. Forecasts become more difficult beyond that point. At the three-year period – when the company’s growth is typically more mature, its revenue base is normally higher and it has leverage and scalability. Jennison analyzes the margin structure and discounts the cash flows back to the present. If the discounted valuation is very attractive, Jennison will acquire the stock despite the fact P/E multiples on current earnings may be elevated.
If the analysis described above has correctly captured the growth rate, the duration and magnitude of the growth rate, and the size of the market opportunity, the investment should generate excess returns. If that thesis is not borne out – e.g., the analysis overestimated the size of the market opportunity or the product matures more quickly than anticipated – Jennison exits the position.
As the investment thesis plays out over time, Jennison will begin trimming the position size as the company reaches a more mature state and approaches an internal price target. If the thesis exceeds expectations, Jennison will revise its price targets upward.
Jennison’s growth investing
Most market participants are uncomfortable taking a longer-duration approach to valuation. This is the market inefficiency that Jennison’s market experts – as active fundamental growth investors – seek to exploit. In the long term, the market will always reward the best-positioned company, even if it looks expensive over the short term. The key is to realize when the market is being overly conservative and underestimating the opportunity.
Learn more about the three themes to watch for tech growth opportunities.
1 China and US data: “How e-commerce share of retail soared across the globe: A look at eight countries,” McKinsey & Company, March 5, 2021.
2 ASEAN data: J.P. Morgan estimates, Euromonitor, EDTA, and MOEA. As of December 31, 2019. Latam: Statista, EBANX; AMI. March and April 2020.
3 Resarchandmarkets.com, June 7, 2021.
4 Statista, as of January 2021
5 According to the World Bank, 1.7 billion adults remained “unbanked” as of 2017 (the most recent data), yet two-thirds of them own a mobile phone that could help them access financial services. World Bank, “The Global Findex,” April 19, 2018.
For Professional Investors Only. All investments involve risk, including the possible loss of capital.
Publishing date: September 30, 2021.
This material is only intended for investors which meet qualifications as institutional investors as defined in the applicable jurisdiction where this material is received. This material is not for use by retail investors and may not be reproduced or distributed without Jennison Associates LLC’s permission.
These materials are for informational or educational purposes only. The information is not intended as investment advice and is not a recommendation about managing or investing assets. Jennison makes no representations regarding the suitability of any securities, financial instruments or strategies described in these materials. In providing these materials, Jennison is not acting as your fiduciary. These materials do not purport to provide any legal, tax or accounting advice.
The views expressed herein are those of Jennison investment professionals at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice.
Certain third party information in this document has been obtained from sources that Jennison believes to be reliable as of the date presented; however, Jennison cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. Jennison has no obligation to update any or all such third party information. There is no assurance that any forecasts, targets, or estimates will be attained.
The financial indexes referenced herein are provided for informational purposes only. All indexes referenced are registered trade names or trademark/ service marks of third parties. References to such trade names or trademark/service marks and data are proprietary and confidential and cannot be redistributed without Jennison’s prior consent. Investors cannot directly invest in an index.
Jennison uses the Global Industry Classification Standard (GICS®) for categorizing companies into sectors and industries. The Global Industry Classification Standard (GICS®) is the exclusive intellectual property of MSCI Inc. (MSCI) and Standard & Poor’s Financial Services, LLC (S&P). Neither MSCI, S&P, their affiliates, nor any of their third party providers (“GICS Parties”) makes any representations or warranties, express or implied, with respect to GICS or the results to be obtained by the use thereof, and expressly disclaim all warranties, including warranties of accuracy, completeness, merchantability and fitness for a particular purpose. The GICS Parties shall not have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of such damages.
The S&P index(es) (“Index”) is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Jennison Associates, LLC. Copyright © 2021 S&P Dow Jones Indices LLC, a division of S&P Global, Inc., and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spdji.com. S&P® is a registered trademark of S&P Global and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC.
The MSCI All Country World Index is a free float-adjusted market capitalization weighted index designed to measure the equity market performance of developed and emerging markets. It comprises approximately 24 developed and 21 emerging market country indexes. The net benchmark return is reported net of reclaimable and non-reclaimable withholding taxes. Withholding tax rates used for the benchmark differ from, and may be higher than, the withholding tax rates used when calculating the composite return. The financial indices referenced herein are provided for informational purposes only. When comparing the performance of a manager to its benchmark(s), please note that the manager’s holdings and portfolio characteristics may differ from those of the benchmark(s). Additional factors impacting the performance displayed herein may include portfolio-rebalancing, the timing of cash flows, and differences in volatility, none of which impact the performance of the financial indices. Financial indices are unmanaged and assume reinvestment of dividends but do not reflect the impact of fees, applicable taxes or trading costs which may also reduce the returns shown. All indices referenced in this presentation are registered trade names or trademark/service marks of third parties. References to such trade names or trademark/service marks and data is proprietary and confidential and cannot be redistributed without Jennison’s prior consent. Investors cannot directly invest in an index.
Certain information contained in this product or report is derived by Jennison in part from MSCI’s MSCI Emerging Markets Index (the “Index Data”). However, MSCI has not reviewed this product or report, and MSCI does not endorse or express any opinion regarding this product or report or any analysis or other information contained herein or the author or source of any such information or analysis. Neither MSCI nor any third party involved in or related to the computing or compiling of the Index Data makes any express or implied warranties, representations or guarantees concerning the Index Data or any information or data derived therefrom, and in no event shall MSCI or any third party have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) relating to any use of this information.
Any use of the Index Data requires a direct license from MSCI. None of the Index Data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.
Jennison Associates LLC (‘Jennison’) has not been licensed or registered to provide investment services in any jurisdiction outside the United States. The information contained in this document should not be construed as a solicitation or offering of investment services by Jennison or a solicitation to sell or a solicitation of an offer to buy any shares of any securities (nor shall any such securities be offered or sold to any person) in any jurisdiction where such solicitation or offering would be unlawful under the applicable laws of such jurisdiction.
Please visit jennison.com/important-disclosures for important information, including information on non-US jurisdictions. In the United Kingdom, and various European Economic Area jurisdictions, information is issued by PGIM Limited. PGIM Limited registered office: Grand Buildings, 1-3 Strand, Trafalgar Square, London, WC2N 5HR is authorised and regulated by the Financial Conduct Authority of the United Kingdom (registration number 193418) and duly passported in various jurisdictions in the EEA. Jennison Associates LLC & PGIM Limited are wholly owned subsidiaries of PGIM, Inc. the principal investment management business of Prudential Financial, Inc. (‘PFI’). PFI of the United States is not affiliated in any manner with Prudential plc, incorporated in the United Kingdom or with Prudential Assurance Company, a subsidiary of M&G plc, incorporated in the United Kingdom. This information is intended only for persons who are professional clients or eligible counterparties as defined in Directive 2014/65/EU (MiFID II), investing for their own account, for fund of funds, or discretionary clients.
©2021 Prudential Financial, Inc. (‘PFI’). PGIM and the Rock symbol are service marks of PFI and its related entities, registered in many jurisdictions worldwide.