3 stocks that could become the next great compounders of the coming decade

The US dollar has been extraordinarily strong this year, with most currencies weak against it. So if you're a US company or a US-listed multinational, it's a huge headwind. In most cases, however, this is mostly just a translation issue and less of a fundamental headwind. Of course, to the extent that there are US-based costs or manufacturing, there is also a more fundamental headwind as these companies lose relative competitiveness. These factors can be transitory and just as easily reverse if currencies move the other way.

Nevertheless, at current spot rates, FX will likely still be a significant earnings headwind for most of the US market at the moment, and probably still somewhat underestimated as a drag for next year. But all of this is reversed for non-US companies, where FX is mostly an earnings tailwind at the moment.

Is Alphinity pricing in a global recession? 

The outlook for global growth remains challenging and consequently, we are still cautious. As Jamie Dimon’s famously said, the chance of recession is 100%, we are just debating the timing and severity. 

Of course, he was being somewhat facetious, but he's also alluding to an important underlying truth. I mean recessions are very painful and can have significant negative social consequences, but they're also a natural and unfortunately a somewhat inevitable part of the free market economy.

But it's not all doom and gloom, and a softer landing for the US remains a possibility for several reasons. Firstly, consumer spending has been surprisingly resilient so far, underpinned by personal savings which are still relatively high, as well as a strong labour market. People still have their jobs. Of course, we would be surprised if unemployment doesn’t rise next year, but we don’t expect a significant unemployment-driven recession at this point. So that’s an important mitigating factor. Furthermore, while there are pockets of concern as there always are, generally speaking, corporates are relatively well positioned for this from both a liquidity and a leverage perspective.

And finally, the financial system is well-capitalised and resilient, which is critical. This is not a systemic financial crisis like we experienced during the GFC. US banks are generally in good shape - meaning, they are well capitalised, with liquid and well-funded balance sheets.

So there are some good reasons to expect a softer landing in the US. In contrast, we are more concerned about the outlook for the Eurozone and the UK, where the impact of higher interest rates and energy costs is more acute.

One area where we are beginning to see opportunity is within some of the high-quality growth stocks, which have performed badly so far this year. Many of these simply became too expensive over the last few years and were also not immune to cost inflation pressures or COVID normalisation. 

It’s not that surprising that they have had a tough time recently, but many of these companies are now trading at far more reasonable valuations and in some cases, earnings are also beginning to inflect positively again.

One example that we have just recently added is Intuitive Surgical (NASDAQ: ISRG). It's one of the world's leaders in robotic surgery. This is an exciting and dynamic industry, underpinned by structural growth trends. The stock has fallen quite significantly this year alongside the general market. Earning expectations have been under pressure as a result of various issues including supply chain pressures and hospital productivity. For example, it has been challenging for hospitals to find nursing staff to support patient volumes. These issues are beginning to normalise and we are optimistic about the outlook for 2023.

Another significant change we have made is within some of the large technology stocks, where we have recently sold out of Microsoft (NASDAQ: MSFT) and Alphabet (NASDAQ: GOOGL), as well as reduced exposure to Apple (NASDAQ: AAPL). These are high-quality businesses, but generally reported third-quarter earnings which disappointed market expectations on both revenues and margins. These businesses are clearly not immune to overall macro growth and inflation headwinds.

At Alphinity, we believe there is a right and wrong time to own a company. This is core to our investment philosophy. While we always seek to invest in high-quality businesses (companies with strong management teams, in good industries with wide competitive moats, with high and rising returns, strong cashflows and robust balance sheets), we also always look for businesses where the outlook for earnings is fundamentally underappreciated by the market.

In our view, it’s the positive earnings surprise that drives outperformance more than anything. Furthermore, we believe these surprises are often serially correlated. For various behavioural reasons, analysts and the market are often slow to fully appreciate the full scope of positive change, and the same is true on the downside. One profit warning or disappointment is often followed by several more. So at Alphinity we always want to invest in positive upgrade cycles and at the same time be very disciplined about avoiding the latter.

From our perspective, analyst estimates for many of these large technology companies remain too optimistic. While we continue to be great admirers of many of these businesses, and I would be surprised if we didn’t own some of them again in the years to come when earnings expectations inflect positively, for now, we are out.

Finding the next great compounder