Boston - While headlines and investors remained focused on the pandemic, geopolitics and other unknowns, the market was busy breaking records. In fact, the S&P 500 Index returned over 20% in the past three-month period ended June 30 — the best quarterly result in over 20 years.
While no company has been immune to the economic calamity of the pandemic, many businesses have actually thrived as consumers' demand for their goods and services accelerated. Many of these structural winners have also been able to capitalize on the financial advantage of asset-light business models to generate growth and profitability.
These secular and financial advantages have not gone unnoticed, with returns and valuations for some stocks reminding investors that long-term rewards are not without risks.
Secular evolution of the digital world
Just as our "normal" way of life came to a standstill, our digital world went into the overdrive. Digital adoption of commerce, entertainment, education and communication — just to name a few — eclipsed the most bullish growth projections.
Prior to the pandemic, for example, less than 4% of spending for groceries took place online. According to research by Bain & Company, the online spend increased to more than 10% during the height of the pandemic.
Another illustration of a dramatic shift in consumer behavior has been in health care. Telemedicine is redefining access, consumption and cost of care, and the speed of adoption has been rapid: A survey by Conceptual MindWorks found that the percentage of medical practices conducting telehealth visits has grown from just 6% pre-pandemic to 85% as of April.
Structural advantages and valuation risks
Companies enabling and driving these adoptions are long-term beneficiaries of structural change and ensuing superior revenue and earnings growth (as depicted below). Another less talked-about structural advantage is a financial one, as asset-light business models have been able to generate exceptional growth and profit yields.
Information technology is an example of a sector with a superior revenue, earnings, performance and profitability profile. Net profit margins for the sector are two times that of the S&P 500 Index. Investors have taken note and many of these structural winners — particularly within pockets of IT software, security, cloud computing and services — have been exceptional performers to date and command a sizeable premium.
Opportunities amid uncertainty
In the next few months, we anticipate that volatility will prevail as continued macro, political and pandemic uncertainty, along with earnings deceleration, could act as an overhang on the market. Investing in tomorrow's leaders today requires foresight, patience and fortitude.
Bottom line: Amid persistent volatility, we believe an active, balanced and valuation-sensitive approach can triumph over short-term angst.