The Case for Disciplined Capital Allocation

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• GARP companies have historically outperformed due to steady earnings and reasonable valuations, creating an opportunity for disciplined investors.
• Companies with strong management teams that deploy capital wisely—avoiding empire-building acquisitions and focusing on high-return investments—consistently outperform peers.
• Short-term focus on quarterly results and momentum trading creates alpha opportunities for long-term investors.

For many investors, today's market feels unstoppable. AI-driven stocks are soaring, passive investing is reshaping capital flows, and momentum continues to outshine fundamentals. The temptation to chase these trends is strong—after all, why focus on valuation and management quality when rapid gains seem within reach?

But history shows that markets have a way of punishing speculation. Time and again, we've seen significant corrections—whether during the 2015–16 correction, the COVID-19 crash, or the market turbulence in 2022—where valuations reset dramatically. Investors who fail to differentiate between sustainable growth and momentum-driven hype risk getting caught in these cycles.

David Giroux, Chief Investment Officer and Head of Investment Strategy at T. Rowe Price Investment Management, has spent over 26 years managing more than $100 billion in assets across multiple market cycles. His track record isn't built on hype or short-term trading, but on deep fundamental analysis, disciplined capital allocation, and a long-term perspective prioritizing sustainable returns.

As David explains, his team models every company over a five-year horizon, focusing on long-term fundamentals rather than short-term speculation. This contrasts sharply with many investors today who make decisions based on quarterly earnings reports, market sentiment, or social media trends. While others chase fleeting momentum, David prioritizes companies with strong management teams, disciplined capital allocation, and valuations that make sense in a broader market context.

This discussion explores why valuation in context is critical, capital allocation is the key to sustainable growth, and a disciplined, long-term mindset is the antidote to speculative hype. When the noise fades, those who invest with discipline—not speculation—will be the ones left standing.

Finding real value in a market distorted by passive investing

For decades, investors have relied on price-to-earnings (P/E) ratios and other valuation metrics to assess whether a stock is fairly priced. But in today's market, these numbers tell an incomplete story.

The composition of the stock market has changed, with technology stocks making up a historically significant share of indexes, while the relative weighting of industrials, energy, and financials has declined. This sector shift means that historical valuation ranges no longer apply as they once did. A P/E of 20 in 1990 might have meant something very different than a P/E of 20 today.

David explains that valuation alone is not always a reliable metric, especially in a market with a shifted composition. He points out that with growth-oriented sectors like technology now dominating major indexes, traditional valuation benchmarks may not be as applicable as they once were. Broad comparisons to past valuation ranges can be misleading without considering structural changes in the market.

But passive investing has exacerbated these distortions. As money flows into index funds and ETFs, many stocks rise not due to business performance but simply because they are included in major indexes. This automatic buying pressure can inflate valuations, making some stocks look artificially expensive while overlooking others.

Thinking long-term in a short-term market

Markets today move at an unprecedented speed, with investors reacting instantly to quarterly earnings, breaking headlines, and short-term speculation. While passive investing fuels broad market movements, short-term trading exacerbates excessive optimism and overreaction cycles.

Rather than blindly reacting to market swings, investors should ask:

• Is the company growing sustainably?
• How is capital being deployed?
• Does management prioritize shareholder value creation?

Companies that reinvest earnings efficiently through acquisitions, R&D, or dividends generate long-term success. By maintaining a multi-year perspective, investors can avoid common pitfalls of speculative investing.

Unlocking sustainable value

In an era where meme stocks can soar on social media buzz, it's easy to overlook the enduring importance of strong leadership. But great companies aren't built on hype—they are shaped by management teams that make disciplined, strategic decisions.

"A good management team deploys capital wisely, whether it be buying back stock, doing bolt-on acquisitions at high returns," explains David.

One of the most well-known case studies in capital allocation is General Electric (GE). Under Jack Welch, GE became an industrial powerhouse. But under poor leadership in later years, the company overleveraged itself and misallocated capital, leading to a steep decline.

When Larry Culp became CEO, he refocused GE's capital allocation, shedding underperforming divisions and improving cash flow. This disciplined leadership approach helped GE stabilize and rebuild investor confidence.

Smart capital allocation: The key to outperformance

Companies that excel in capital allocation consistently outperform their peers. Instead of blindly reinvesting in growth, great companies ask:

• Where is capital best deployed for long-term returns?
• Are acquisitions actually accretive to earnings?
• Do stock buybacks add value or just artificially boost EPS?

David emphasizes that investors should watch how leadership deploys capital. Firms that allocate resources efficiently—rather than chasing the next trend—tend to win in the long run.

The power of focusing on US companies

When it comes to geographical diversification, David offers a contrarian perspective: the benefits of international diversification may be overrated for many investors. He states in his discussions, "I wouldn't own any international stocks. You get a lot of great companies and great diversification buying the US market."

His research indicates that adding international stocks to a portfolio can sometimes reduce returns while actually increasing risk, especially during economic downturns when correlations tend to rise, and currency effects can magnify losses. The transparency, governance standards, and growth prospects available in the US market often provide superior risk-adjusted returns compared to taking on the additional complexities of international investing.

Finding the GARP sweet spot

While many investors chase high-growth stocks or try to time market swings, David has long advocated a different strategy—Growth at a Reasonable Price (GARP).

"When we look at our proprietary GARP universe, since 2006, it has outperformed the market by 400 basis points per year. Earnings growth has been about 40% higher than the market over that period of time. And in downturns, earnings don't go down for those companies, for the most part. They're not that cyclical," David explains.

Historically, GARP stocks have outperformed by combining steady earnings growth with reasonable valuations, even in bull markets. They represent a sweet spot between speculative high-growth names and stagnant value traps.

GARP investing is particularly effective today because it capitalizes on market inefficiencies created by the rise of passive investing and momentum trading. Many high-quality companies with consistent growth get overlooked because they don't fit neatly into either growth or value categories tracked by major indexes.

AI is exciting, but not yet a game-changer

While AI-driven efficiencies could enhance earnings growth in the future, their impact on investment decision-making remains minimal today.

David notes, "It's really early days for AI having a big impact on the investment process so far, at least for longer-term investors."

However, AI's role in business operations—from automating repetitive tasks to improving software development and customer service—may drive productivity gains that could translate into stronger earnings growth over time.

Charting a course in an unpredictable market

Only disciplined investors who focus on valuation and capital efficiency will thrive in a market shaped by speculation.

Today's environment, where passive investing distorts prices and short-term thinking dominates, demands a return to fundamental investing principles. Understanding proper valuation in context, recognizing quality leadership, and identifying sustainable growth at reasonable prices provide a roadmap to navigate increasingly unpredictable markets.

Rather than chasing the latest narrative, long-term investors should anchor their decisions on fundamental strength, sustainable earnings, and capital discipline.

Ultimately, short-term noise fades, but true value always prevails.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.