Indices of listed companies may not be capturing the performance of the overall UK economy. Large parts of the fastest growing businesses in mature economies take place outside the stockmarket. And, within listeds, the fastest growth is typically in mid-cap companies rather than the mega-caps at the top of the FTSE 100. Investors need focus to identify the listed companies that capture the innovative areas of the British economy. Some big traditional sectors, featuring strongly in today’s indices, seem destined to shrink longer term. Growth funds should actively tilt away from sectors such as banks and retailing towards technology-enabled businesses.
Investors should aim to find growth niches, and strategies with a genuine competitive edge. Winning businesses share key characteristics such as sales growth, good cashflow and stable or growing profit margins. Growth can be driven by technology, regulation or changing consumer tastes. With research, investors can find British listed companies with the potential to scale-up technological leadership in a global business sector. Investors should value the potential for a company to reinvest cashflow to secure above average returns. Some of these UK mid-cap companies have the potential to grow organically without significant additional capital.
Valuation and eventual liquidity can be difficult in growth companies, but the key is to manage risk. Some types of businesses sharpen their competitive edge as they grow, building a moat as a barrier to competition, or driving down costs. This network effect is often found on platform-type businesses, where attractive unit economics may be combined with lower costs of customer acquisition as a platform scales-up and becomes better known. Investors should plan to capture growth, rather than believing that today’s indices represent the UK economy.