In the current environment of low interest rates and massive fiscal support alongside an improving economy, there has been a significant amount of speculative activity. This has been evident in many areas, but one, in particular, is the increased participation in equity markets by "retail" day traders.
This is reflected in the huge increase in call options over the past 12 months - particularly short-dated call options. Here the investor is simply deploying capital to achieve an expected gain based on their prediction of how future prices will differ from the market’s expectations. Or to put another way taking a punt on the value of an asset going up or down.
In stark contrast to this, at Talaria we are patient, bottom-up, value investors. As part of our fundamental analysis of companies, we assess the individual components of long-term share price returns. We show this breakdown visually to highlight stocks we think are sustainable compared to stocks possibly subject to reversion. We start at revenue and go right down to changes in P/E multiples to see what has really driven shareholder value creation (and whether it looks reasonable!).
So, we thought we’d share a comparison of 3 stocks to show how sometimes you can justify the price and sometimes you can’t.
If you bought a share in Microsoft in 2015, you would be a very happy investor today! The share price of this mega-cap business has increased 32% per year, going from $55 in 2015 to $222 in December 2020. Roughly $88 of this uplift can be attributed to higher margins and $43 to lower taxes. These two factors have been the dominant driver of EPS which has also grown ~32% p.a. since 2015. Put another way, the increase in Microsoft shares has been entirely driven by the company delivering strong profit growth and not much in the way of a re-rating in the stock.
Source: Talaria, Bloomberg
Roche, the Swiss Pharmaceutical company that we hold, has faced a different set of circumstances over this period. Since 2015, Roche has managed to deliver EPS growth of ~11% p.a. A respectful number in any sense, with growth driven by many factors (higher sales, margins, lower tax, finance costs). Despite this, the market has seen fit to de-rate Roche’s stock since 2015, and in the process wiping off a potential ~€160 in the share price.
Source: Talaria, Bloomberg
These are the types of companies we like. The ones that have consistently delivered growth for investors (and where we think can continue to deliver) and are currently out of favour with the market. They are offering good value, and so are the opportunities we look for.
Then there are share price journeys like Walmart’s. Like the previous investor who bought Microsoft in 2015, the investor who bought Walmart in 2015 would also be a very happy individual today.
Source: Talaria, Bloomberg
However, the reasons why are completely different. Unlike Microsoft, Walmart has failed to grow its business since 2015. EBIT has fallen ~5% per year and EPS has been flat. Despite this, the share price has gone from $61 to $144 (or growth of 19% p.a.)
The key driver, you ask? A huge expansion in the P/E multiple driven by the market’s desire to pay up for the potential that Walmart’s business fortunes improve over the next few years. As value investors we don’t tend to want to pay up a lot for the potential growth of companies!
There is plenty of risk out there in the market, from inflation to concentration and duration, and so understanding the true fundamental drivers of a company’s performance helps us reduce investment risk. In doing so, it improves the chances of successfully navigating periods of uncertainty to deliver for investors.
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The information in this article is general information only and is not based on the objectives, financial situation or needs of any particular investor. In deciding whether to acquire, hold or dispose of the product you should obtain a copy of the current Product Disclosure Statement (PDS) for the Fund and consider whether the product is appropriate for you.
Wholesale Units in the Talaria Global Equity Fund (the Fund) are issued by Australian Unity Funds Management Limited ABN 60 071 497 115, AFS Licence No. 234454. Talaria Asset Management Pty Ltd ABN 67 130 534 342, AFS Licence No, 333732 is the investment manager and distributor of the Fund. References to “we” means Talaria Asset Management Pty Ltd, the investment manager. A copy of the PDS is available at australianunity.com.au/wealth or by calling Australian Unity Wealth Investor Services team on 13 29 39. Investment decisions should not be made upon the basis of the Fund’s past performance or distribution rate, or any ratings given by a rating agency, since each of these can vary. In addition, ratings need to be understood in the context of the full report issued by the rating agency itself. The information provided in the document is current at the time of publication.
Chad is the Co-Chief Investment Officer and co-founder of Talaria Asset Management. He has more than 20 years’ experience in the financial services industry in the UK, South Africa and Australia. Talaria's investment strategy seeks to increase the...