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Investors have been piling into growth shares, particularly in those in the tech sector, for a number of years. The likes of the ‘Magnificant 7’ in the US have outperformed the broader market and gone from strength to strength.
However, the escalating conflict between in the Middle East has got me thinking about my own investment portfolio. Geopolitical tensions are on the rise and investors are on edge.
While it’s easy to panic, a quick glance at some recent history has given cause to think twice about buying tech growth shares right now.
Market corrections favour dividends
I’m writing just ahead of the market open on 2 March and global stock markets remain volatile following the latest escalation in the conflict between the US/Israel and Iran.
Recent history shows that during such times, companies paying stable dividends tend to hold up better than high-growth names trading on lofty valuations.
The dividend yield cushion helps to cushion some of the losses even when share prices fall, whereas growth stocks often see their valuations compress rapidly when sentiment turns sour.
During both the 1999-2001 dotcom bubble and the 2007-2009 Global Financial Crisis, reliable US dividend payers outperformed growth shares considerably.
That’s largely because tech growth shares are priced on high multiples of expected future earnings while dividend payers generally continue to provide a tangible return.
With the current geopolitical backdrop creating fresh uncertainty, that same dynamic could return. But does that mean all growth shares should be avoided right now?
Exceptions to the rule?
I think BAE Systems (LSE: BA) is an interesting case. The defence contractor trades on a price-to-earnings (P/E) ratio north of 30 following yesterday’s 5.5% share price jump. That sort of valuation is typically associated with high-growth technology stocks rather than traditional industrials.
Yet the company operates in a sector directly benefiting from heightened geopolitical tensions. Sadly, global defence spending continues to rise as governments reassess their security postures, and BAE’s order book remains robust.
However, there’s no such thing as an obvious win in the investing game. The current valuation is already quite high relative to the broader FTSE 100. That means a lot of the expected future growth is being reflected in the current share price.
Add to that the fact that defence contracts are typically long-term, multi-year agreements with fixed pricing. Any uptick in orders today may not translate into meaningful earnings growth for several quarters, if not years.
BAE also faces stiff competition from US defence heavyweights such as Lockheed Martin and Northrop Grumman. Both of these companies benefit from larger domestic budgets and preferential access to the Pentagon.
My verdict
For now, the broader risk-off environment makes dividend-paying defensive stocks more appealing than richly valued growth names.
While BAE Systems offers an intriguing exception, the timing of any potential benefit remains uncertain. The current valuation offers a limited margin of safety if we see a broader stock market correction.
Investors willing to tackle the ethical challenges of investing in the sector and taking a long-term view may find BAE worth considering despite the price tag.
But until geopolitical volatility subsides and the earnings visibility improves, I think I’ll be sticking with recent history and staying more defensive with quality dividend payers.
