Following clear signals from the Federal Reserve that it’s ready to keep raising interest rates to make sure inflation reaches its goals and does not come back to haunt the markets again, the talk of a possible recession is again in the news. Investors flock to value stocks when markets waver and recession fears mount. The reason behind this trend is simple: investors don’t want to pay a higher premium for risky or growth stocks when there’s no certainty on the economy and recession is expected. Value stocks, on the other hand, are safe and do not lose value even when broader markets are showing signs of weakness. A report by GMO published in June this year entitled “Value Does Just Fine in Recessions” argued that value stocks have performed well in almost all recessions in the US history except the COVID 19 recession in 2020 since that event was unique and peculiar. The report said that in the next recession, whenever it comes, value plays will perform well just like they did in the past recessions. The GMO report also analyzed value stock returns during recessions that happened over the past 55 years.
The report said that “every version of value besides price/ book performed better in an average recession month (even including Covid) than in a non- recession month since the end of 1969.”
Why Value Stocks Do Not Underperform During Recessions?
The GMO report then discussed the issue of value traps from an interesting angle. The report answers the question of why value stocks do not underperform or disappoint during recessions? What’s the secret behind their tenacity during recessions? The report finds the answer to this question by making a contrast of value traps to what it calls “growth traps.” According to GMO, many value stocks prove to be value traps when recessions start, but in the growth stocks universe, stocks that disappoint investors and become “traps” outnumber those in the value universe.
“We see spikes in value traps and growth traps in all three recessions. The last year has been a really interesting case as well. The U.S. does not seem to be in a recession at the moment, but the vast majority of growth stocks have both disappointed on revenues in the past 12 months and seen future revenue growth estimates come down. Each of the top 10 growth names in the U.S. were officially traps in the last year, although the scale of the issue varies by company. Apple disappointed by 4% on their revenues and saw their future growth expectations fall by 4% as well, whereas Tesla disappointed about 9% and saw its future growth forecast come down by a massive 34%. The huge prevalence of growth traps last year does call into question the common narrative about the 2022 growth carnage. Rather than being a case of growth stock valuation premia coming down due to rising interest rates, I’d argue that an awful lot of the pain was from growth stock valuation premia coming down because the growth stocks proved less growth than investors had hoped.”
The report says that value and growth stocks both have the capability to disappoint during recessions. It’s just that the damage done to investors by growth traps is far more than what is done by value traps.
Billionaire hedge fund manager Howard Marks in an interesting memo to the clients of his hedge fund, Oaktree Capital Management, draws some important differences between value and growth stocks and touches upon the reasons why growth stocks fall during recessions. Marks said that when growth stocks are rising, they incorporate a certain kind of optimism that “can evaporate” during recessions. Since growth investing involves betting on companies with hopes that these companies will perform well in the future, lack of optimism during market downturns results in the growth stocks’ decline. But Marks then makes an interesting comment:
"When I consider this new world, I think fundamental investors need to be willing to thoroughly examine situations – including those with heavy dependency on intangible assets and growth into the distant future – with the goal of achieving real insight. However, this is, to an extent, antithetical to the value investor’s mentality. Part of what makes up the value investor’s mindset is insistence on observable value in the here-and-now and an aversion to things that seem ephemeral or uncertain. Many of the great bonanzas for value investors have come in periods of panic following the bursting of bubbles, and this fact has probably led value investors to be very skeptical of market exuberance, especially when concerning companies whose assets are intangible. Skepticism is important for any investor; it’s always essential to challenge assumptions, avoid herd mentality and think independently. Skepticism keeps investors safe and helps them avoid things that are “too good to be true.”
High Growth Value Stocks to Buy According to Seth Klarman
Seth Klarman of Baupost Group Methodology
For this article we scanned the second quarter of 2023 portfolio of legendary value investor Seth Klarman and picked 12 companies which have shown strong revenue growth.
Seth Klarman opened a $41 million position in discount stores operator Dollar General Corp. (NYSE:DG) in the second quarter of 2023. Earlier in August Edward Jones upgraded Dollar General to Buy from Hold amid attractive valuation, reduced impact from the internet competition and long-term growth catalysts for the industry.
As of the end of the second quarter of 2023, 57 hedge funds in Insider Monkey’s database of hedge funds had stakes in Dollar General Corp. (NYSE:DG). The biggest stakeholder of Dollar General Corp. (NYSE:DG) during this period was Brandon Haley’s Holocene Advisors which owns a $202 million stake in the company.
Coho Partners Relative Value Equity Fund made the following comment about Dollar General Corporation (NYSE:DG) in its second quarter 2023 investor letter:
“Dollar General Corporation (NYSE:DG) has experienced an unusual period of execution issues exacerbated by external pressures on its core consumer. It began as a problem of riches as the success in meeting the needs of existing and new customers throughout the pandemic started to catch up with the company toward the end of 2022. At that point, supply chain wobbles suggested the distribution infrastructure couldn’t keep up with the growth. Given DG’s ability to quickly course correct, we believed these issues would be resolved within a few quarters. What we failed to appreciate was the cascade effect the distribution center bottlenecks would have on the company’s expansive store base. Inefficiencies in the distribution centers led to labor inefficiencies in the stores and out-of-stocks on the shelves. This, in turn, resulted in decreased customer satisfaction, declining traffic trends, and the need to invest in price to win customers back. This all took place in the context of a core customer base that was being impacted by the roll off of government stimulus, lower tax receipts, and a cut to SNAP (supplemental nutritional assistance program) benefits.
Garrett Motion Inc. (NYSE:GTX) makes turbocharger and electric-boosting technologies for light and commercial vehicle original equipment manufacturers. Insider Monkey’s database of hedge funds shows that 35 hedge funds out of the 910 hedge funds had stakes in Garrett Motion Inc. (NYSE:GTX). In late July GTX posted second quarter results. GAAP EPS in the quarter came in at -$1.88. Revenue in the quarter jumped about 17.6% year over year to $1.10 billion. Garrett Motion Inc. (NYSE:GTX) also upped its FY’2023 revenue outlook to $3.8 billion to $4.03 billion from $3.79 billion to $3.98 billion.
As of the end of the June quarter, Seth Klarman’s hedge fund had a $46 million stake in Garrett Motion Inc. (NYSE:GTX).
Ireland-based biopharmaceutical company Jazz Pharmaceuticals Plc (NASDAQ:JAZZ) ranks 10th in our list of the high growth value stocks to buy according to Seth Klarman. Jazz Pharmaceuticals Plc (NASDAQ:JAZZ) earlier in August posted adjusted EPS of $4.51 for Q2, beating estimates by $0.08. Revenue in the quarter jumped 2.6% year over year to $957.32 million, beating estimates by $15.16 million. Jazz Pharmaceuticals Plc (NASDAQ:JAZZ) also raised its full-year 2023 guidance.
As of the end of the second quarter of 2023, 44 hedge funds in Insider Monkey’s database of 910 funds were long Jazz Pharmaceuticals Plc (NASDAQ:JAZZ).
Earlier in August Theravance Biopharma Inc. (NASDAQ:TBPH) reported second quarter results. GAAP EPS in the period came in at -$0.28, missing estimates by $0.07. Revenue in the quarter jumped 23.9% year over year to $13.75 million, missing estimates by $1.67 million.
Seth Klarman’s hedge fund Baupost had a $76 million stake in Theravance Biopharma Inc. (NASDAQ:TBPH) as of the end of the second quarter. Overall, 21 hedge funds in Insider Monkey’s database of 910 hedge funds had stakes in the company.
Amazon.com, Inc. (NASDAQ:AMZN) is one of the best high-growth value stocks to buy according to legendary value investor Seth Klarman. Amazon.com, Inc. (NASDAQ:AMZN)’s sales grew in the second quarter, driven by fast delivery for Prime deal and ads. Revenue in the period jumped 11% YoY to $134.4 billion. Analysts were expecting Amazon.com, Inc. (NASDAQ:AMZN)’s sales to total about $131.4 billion.
A total of 278 hedge funds in Insider Monkey’s database of 910 hedge funds reported owning stakes in Amazon.com, Inc. (NASDAQ:AMZN) as of the end of the second quarter. Klarman has a $125.66 million stake in Amazon.com, Inc. (NASDAQ:AMZN).
7. New Oriental Education & Technology Group Inc. (NYSE:EDU)
Seth Klarman’s Stake Value: $163 million
Educational services company New Oriental Education & Technology Group Inc. (NYSE:EDU) ranks 7th in our list of the best high-growth value stocks to buy according to Seth Klarman. Baupost owns a $163 million stake in New Oriental Education & Technology Group Inc. (NYSE:EDU). In July New Oriental Education & Technology Group Inc. (NYSE:EDU) posted fiscal Q4 results. Revenue in the period jumped 64% year over year to $860.6 million, beating estimates by $42.19 million.
As of the end of the second quarter of 2023, 26 hedge funds tracked by Insider Monkey had stakes in New Oriental Education & Technology Group Inc. (NYSE:EDU). The biggest stakeholder of New Oriental Education & Technology Group Inc. (NYSE:ED) was Panayotis Takis Sparaggis’s Alkeon Capital Management which owns a $170 million stake in the company.
Seth Klarman has a $225 million stake in software company SS&C Technologies Holdings, Inc. (NASDAQ:SSNC).
As of the end of the second quarter of 2023, 43 hedge funds out of the 910 funds in Insider Monkey’s database had stakes in SS&C Technologies Holdings, Inc. (NASDAQ:SSNC). The biggest stakeholder of SS&C Technologies Holdings, Inc. (NASDAQ:SSNC) was Richard S. Pzena’s Pzena Investment Management which owns an $850 million stake in the company.
