The case for growth

We believe that growth forecasts reflect the human tendency to be overconfident and therefore do not fully account for mean reversion or instantaneously reflect new information. The overconfidence effect contributes to an overpricing of traditional growth companies and causes investors to underreact to new sources of unanticipated growth.

Go to the profile of Ben Stapley
Mar 01, 2017

The theory behind our approach to growth investing

Within the Behavioural Finance Team at J.P. Morgan Asset Management, we believe investor decision making is shaped by behavioural biases that lead to a divergence between price and fair value. At its most basic level, investors tend to be overly optimistic about growth companies and overly pessimistic about value companies. These views are routed in the human tendency to be overconfident, where individuals have excessively rosy perceptions of their own abilities. The overconfidence effect has been described as “perhaps the most robust finding in the psychology of judgment”[1] and can cause share prices to under-react to new information which conflicts with the prevailing judgment. The overconfidence effect contributes to an overpricing of traditional growth companies and causes investors to underreact to new sources of unanticipated growth.

A key manifestation of the overconfidence effect is found in sell-side analyst forecasts. The evidence suggests that analysts fail to fully account for the powerful mean reversion in growth rates, implying that earnings forecasts for fast growing companies tend to be overly optimistic. This is illustrated in Exhibit 1, where the red line shows the lacklustre portfolio return from holding stocks with the best ex ante growth forecasts. Clearly the forecasts were fully anticipated in share prices. The blue line, conversely, shows the significant returns from holding those stocks with the highest ex post realised growth. The implication is clear: analysts failed to correctly forecast the highest realised growth stocks. The real growth stocks were unanticipated.

How do we exploit behavioural biases?

These behavioural inefficiencies can be exploited by building a portfolio with higher price and earnings momentum and higher quality than the market to access unanticipated growth. We believe companies that exhibit positive earnings and share price momentum will on average deliver growth ahead of analysts’ forecasts. This is because overconfident investors and analysts exhibit anchoring and herding behaviours that leads to trends in earnings forecasts and share prices. Strong upward revisions to forecasts are often an indicator that a stock will outperform going forward. In addition, stocks that have performed well over the last 12 months tend to continue to perform well and conversely stocks that have performed poorly tend to continue to underperform.

Additionally, we find that companies with high quality characteristics are more

likely to sustain periods of unanticipated growth. We define high quality as those companies that are profitable, have sustainable earnings and have a management team with strong capital discipline. We seek to avoid companies whose profit growth and margins are not sustainable. We expect management to be prudent, not profligate, with shareholder funds and are wary of companies that have a track record of issuing shares to make acquisitions, rather than financing growth through internally generated cash flow.

In particular we like to build a portfolio with higher profitability than the market. This reflects our belief that investors tend to place too much weight on earnings growth, which is not persistent, at the expense of profitability, which is persistent. Unlike growth, Return on Equity (ROE) reverts to the mean very slowly (Exhibits 2 and 3).

Our stock selection approach is entirely bottom-up and can result in differentiated sector allocations compared to traditional growth strategies. We believe that our focus on unanticipated growth differentiates us from many growth managers out there and this is evidenced by our peer group positioning with the JPM UK Equity Growth Fund now first quartile in its peer group over 2, 3, 4 and 5 years.*

Ben Stapley is the portfolio manager of the JPM UK Equity Growth Fund. Read more

[1] DeBondt and Thaler (1995). *Morningstar. Past performance is not necessarily a reliable indicator for current and future performance. Morningstar peer quartile ranking for JPM UK Equity Growth A Acc shares vs. IMA UK All Companies universe for periods to 31 January 2017. Morningstar™ rankings/universe: © Morningstar. All Rights Reserved.

For Professional Clients only – not for Retail use or distribution. There can be no assurance that the professionals currently employed by J.P. Morgan Asset Management will continue to be employed by J.P. Morgan Asset Management or that the past performance or success of any such professional serves as an indicator of such professional’s future performance or success. This is a promotional document and as such the views contained herein are not to be taken as an advice or recommendation to buy or sell any investment or interest thereto. Reliance upon information in this material is at the sole discretion of the reader. Any research in this document has been obtained and may have been acted upon by J.P. Morgan Asset Management for its own purpose. The results of such research are being made available as additional information and do not necessarily reflect the views of J.P.Morgan Asset Management. Any forecasts, figures, opinions, statements of financial market trends or investment techniques and strategies expressed are unless otherwise stated, J.P. Morgan Asset Management’s own at the date of this document. They are considered to be reliable at the time of writing, may not necessarily be all-inclusive and are not guaranteed as to accuracy. They may be subject to change without reference or notification to you. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Changes in exchange rates may have an adverse effect on the value, price or income of the product(s) or underlying overseas investments. Both past performance and yield may not be a reliable guide to current and future performance. There is no guarantee that any forecast made will come to pass. Furthermore, whilst it is the intention to achieve the investment objective of the investment product(s), there can be no assurance that those objectives will be met. J.P. Morgan Asset Management is the brand name for the asset management business of JPMorgan Chase & Co and its affiliates worldwide. You should note that if you contact J.P. Morgan Asset Management by telephone those lines may be recorded and monitored for legal, security and training purposes. You should also take note that information and data from communications with you will be collected, stored and processed by J.P. Morgan Asset Management in accordance with the EMEA Privacy Policy which can be accessed through the following website Investment is subject to documentation which is comprised of the Prospectus, Key Investor Information (KIID) and either the Supplementary Information Document (SID) or Key Features/Terms and Condition, copies of which can be obtained free of charge from JPMorgan Asset Management Marketing Limited. Issued by JPMorgan Asset Management Marketing Limited which is authorised and regulated in the UK by the Financial Conduct Authority. Registered in England No: 288553. Registered address: 25 Bank St, Canary Wharf, London E14 5JP. 580ff790-f9bf-11e6-b437-005056960c63

Go to the profile of Ben Stapley

Ben Stapley

Fund Manager, JPM UK Equity Growth Fund, J.P. Morgan Asset Management

Ben Stapley is portfolio manager of the JPM UK Equity Growth Fund within J.P. Morgan Asset Management's UK Equity team.


Go to the profile of John
John 6 months ago

Go to the profile of John
John 6 months ago