In fact, companies with strong finances were criticized. It was considered a bad use of capital for a company to keep a large cash balance on its balance sheet with paltry interest returns, and not to resort to debt when it was so cheap. In the name of capital optimization, there has been strong pressure in recent years for companies to take on more debt. I would add that the same phenomenon has affected individuals and investors.
But after the sudden and sharp rise in interest rates in 2022 as central banks faced a resurgence of inflation, the situation has completely reversed: companies in excellent financial health are now the masters of the situation.
These companies now find themselves in a position of strength. On the one hand, since they have little or no debt, they are not directly impacted by the rise in interest rates. In fact, they will finally draw substantial interest income from their cash. Furthermore, they will be able to take advantage of the many opportunities that will present themselves in the coming months. Valuations of their competitors have fallen, making their acquisition more favourable. Moreover, while the need to find capital will monopolize their competitors, companies in good health will have the freedom to choose the best avenues to invest their capital, without worrying too much about the competition.
This is one of the reasons why “value” stocks could do much better on the stock market than so-called growth stocks in the months or even years to come. In my mind, value stocks are those of companies that operate in more traditional industries that are profitable (often for many years), whose businesses typically generate positive cash flows and that are in excellent financial health.
On the other hand, the securities of so-called growth companies typically aim for revenue growth at all costs, without much regard to the profitability of these revenues, nor to their level of indebtedness.
However, after years of underperformance, value stocks have outperformed growth stocks in 2022. Thus, the index fund iShares Value of the S&P 500 (“IVE”) recorded a drop of 5.4% in 2022, which compares very favourably with the 29.5% drop in the equivalent growth index (“IVW”). It’s quite a turnaround: over the previous four years, from January 1, 2018, to December 31, 2021, the growth index had left its value friend in the dust with a return of 129.4% compared to at 51.1%.
The drastic change that has taken place in the past year in terms of cost and access to capital will benefit companies that enjoy excellent financial health. This is one reason why I believe value stocks could continue to outperform for some time.
