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The Case for UK Growth

Updated: May 17, 2022

In his 1992 Chairman’s Letter, Warren Buffett wrote that the investment approaches ‘value’ and ‘growth’ are “joined at the hip”. In many respects, the same can be said of ‘growth’ and ‘income’. Companies must decide on a regular basis how much profit to pay out as income and how much to retain to generate growth and thus future income. Even those ultimate growth stocks - the revenue-less start-ups of the 90s tech boom - were expected at some point to be paying dividends (the reality was somewhat different). So, the question about the merits of so-called UK Growth really boils down to whether now is a good time for companies to invest.

"For equity dividends to fall every year for the next 50 years in real terms, economic growth would need to be dismal"

One of the most interesting issues at the moment is whether the real 50- year Gilt yield of -1.5% signifies a bleak growth outlook or a rosy one. Standard theory suggests the former, the idea being that returns from investing in financial assets such as Gilts should reflect returns available from investing in the real economy.

Many defined benefit pension funds also assume something similar – real liabilities get discounted using the real long-term Gilt yield, the rate at which pension scheme assets are presupposed to grow. Since a proportion of most schemes’ assets are invested in equities, the implication is that equity dividends will grow in line with Gilt yields less the current 4.1% market dividend yield (this is the Gordon Growth Model). For equity dividends to fall by 5.6% every year for the next 50 years in real terms, economic growth would need to be dismal. Indeed, it would require the worst depression on record.

On the other hand, it might be the case that -1.5% real long-term interest rates are what are required to get growth going. As economist Paul Samuelson famously observed, at a permanently zero or sub-zero real interest rate, it would make sense to invest any amount to level a hill for the resulting saving in transportation costs (there is a message here for Philip Hammond).

Is there a correlation between bond yields and dividend growth? None at all. In fact, the correlation is very slightly negative. This suggests the growth outlook may well be rosy.

And, since ‘growth’ and ‘value’ are joined at the hip, this bodes well for value investors too.

Published in Investment Week

The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.

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