Key takeaways
- Capital spending boomed out of the pandemic as firms rushed to keep up with surging demand. Capex was 25% higher in 2022 than in 2021.
- At first, markets rewarded companies for aiming to take market share, but more recently have punished stocks that saw the highest capex growth.
- History shows markets generally reward companies that slow their investment spending, suggesting there may be opportunity as spending slows.
- Free cash flow yield remains the market’s North Star, especially as uncertainty continues to pervade.
Companies that expanded capital spending were summarily punished in 2022, as they have been more times than not throughout history. As economic uncertainty and earnings weakness stand to force more frugality this year, we see investable opportunity in the possible reversal, especially in those companies that see the largest spending retrenchment.
Among the most challenging aspects of investing is determining when markets are providing persuasive enough odds to make an off-consensus bet—and when they are not. While equities have indeed reacted to the recent banking stress, the market is far from pricing a drastic economic outcome. Beneath the surface, the choices between value and growth, or between cyclicals and defensives, do not appear obvious or compelling. In these situations, we believe in falling back on tried-and-true strategies, the core of which are focused on free cash flow (FCF) generation, the desirability of which has only been ratcheted up in a higher-rate world. A key part of that is the outlook for capital spending growth, which has surged past earnings growth and pressured market-wide profitability and cash flow generation. Markets punished companies for spending last year, as they normally do, and some firms are expected to see spending retrench this year as a result. As we head toward the first earnings season of 2023, we see this reversal in spending as a key opportunity as investors search for investable themes.
