Nobody puts value in the corner

Who said value investing means crappy businesses? It’s something we’ve pondered off the back of some questions around our own style. In this episode of Stocks Neat, Gareth and I discuss a bit of the history of value investing, how index funds have reshaped the game, and Forager’s approach.

Before we get to that though, we discuss if the inflation genie is back in the bottle and what we are looking out for when companies report. At the time of recording, we are in the thick of reporting season. This might be one of the reasons we have shaken things up and are tasting … a non-alcoholic beer by Vandestreek Playground IPA.

“Growth has always been an important part of value investing. Buffett’s been buying stocks that are faster growing for 50 years now,” Gareth says, “But it's being pigeonholed to be ‘price to book, price earnings, low PE’. [Growth] is super important to the valuation of any business and it’s been quite frustrating for me in a lot of ways that the term ‘value’ has been commandeered.”

To hear more of our discussion, check out the video below.

Podcast:

Transcript:

Disclaimer:

Just a quick reminder, this podcast may contain general advice, but it doesn’t take into account your personal circumstances, needs, or objectives. The scenarios and stocks mentioned in this podcast are for illustrative purposes only, and do not constitute a recommendation to buy, hold, or sell any financial products. Read the relevant PDS, assess whether that information is appropriate for you, and consider speaking to a financial advisor before making investment decisions. Past performance is no indicator of future performance.

Steve Johnson:

Hello, and welcome to episode nine of Stocks Neat, a Forager Funds podcast, where we talk stock markets and finance, and usually test a scotch. And I’ll explain why usually in a moment. I’m joined by Gareth Brown, Portfolio Manager on our International Fund once again. Welcome Gareth. How are you?

Gareth Brown:

Hi Steve. Hi everyone. I’m well, thank you.

Steve Johnson:

That’s very good to hear. I just said we are going to usually you drink whiskey. Today we’ve got an alcohol free beer. Why are you not drinking whiskey and why are you upsetting all of these thousands of whiskey lovers that we’ve attracted to the podcast?

Gareth Brown:

I take the month of August off every year from alcohol. I’ve been doing it for five or six years now. It often turns into a couple of months that I stay away from it. Yeah, it’s been something I’ve been doing for a while. It’s sort of the dry July, but July’s my birthday month and it’s also I’m a bit contrarian, so I do the month afterwards.

Steve Johnson:

Typically feel better because of that or not?

Gareth Brown:

Oh no, it’s just a reset for me. It’s just sometimes you find yourself opening a bottle of wine on a Wednesday or a Tuesday and you think, “Okay, this just helps me reset.” And my wife and I love to have a bottle of wine. It usually lasts two or three nights. We don’t have any issues with it. But I like the break as well. I think there’s something to most of these things about volume and frequency, right? So it’s a way to break habits that you might otherwise form.

Steve Johnson:

Yeah, absolutely. You brought in a very, very nice scotch for me to try, but I’ve decided we’re going to go with an alcohol free beer to test today. Anyway, I’m in the middle of marathon training for the upcoming Melbourne Marathon. I missed quite a bit of training earlier in the program and I’m very, very busy at work, so just a little help on the sleep front for me makes a big difference. So three or four days a week, try and cut it out, and we’re recording this on a Tuesday, so sorry to the whiskey drinkers, but we’ve got something pretty interesting. We’ll come to it later in the podcast, but it’s called VandeStreek, or ‘Van de Streek’ I’m sure they call it in Holland where it is brewed, and it will be interesting to give that one a taste.

Steve Johnson:

We’re going to talk just past reporting season both in the US, underway here in Australia, move on to a bit of the great inflation debate and finish off with a bit of a chat about whether we can actually still call ourselves value investors after our recent roadshow.

Steve Johnson:

So let’s jump into it. Stock markets are up quite some way from their lows in mid-June, particularly the most heavily sold off of the market. The NASDAQ, probably not as of today but a couple of days ago, was back into bull market territory having had one of its worst six months period in a very long time. And I’m looking at a chart here that is showing performance by sector through this most recent what they call the 2Q or the second quarter reporting season in the US. And it’s lots of sectors, energy a bit of an outlier there, but lots of sectors that had performed quite badly through the first six months of the year, are doing very well. You got commercial services, tech, consumer discretionary in particular, that were heavily beaten up sectors that have performed well. What’s going on there?

Gareth Brown:

And the flip side there, the staples had held up relatively well and has struggled a bit

Steve Johnson:

Staples, health, utilities are three worst performing sectors and they’re probably the three most defensive.

Gareth Brown:

I think they’re probably the three themes that we’ve seen in the selloff in the last bit is, was it crazy overvalued six months ago? That’s part of the reason why some of these things are sold off. That applies to a lot of growth stuff. A lot of tech. Is it economically exposed? People have been concerned about recessions, high oil prices. And then the other thing is, I guess, leverage. REITs is one of the better performing sectors this month. Property trusts because there’s inherently leverage in a lot of that stuff. So I think they’ve sold off with the market and they’ve come back with the stronger market again.

Steve Johnson:

Yeah. And did that have anything to do with what we saw in the actual individual company results? I mean, what was your experience over the past couple of months?

Gareth Brown:

I think we’ve seen that broad pattern with the stocks that we look at. It’s obviously been a really tough six months to 30 June ’22. The reporting season was a point in time that we were really looking forward to because it gives you a chance to test the thesis of the idea that you own. Is everything going to track? Has the market got this wrong, or have I got this wrong? It’s another data point to go through. And I think broadly speaking, most of our stocks have been delivering, even the ones that… There was nothing that was really horrible. There was a few things that were just broadly in line with what we expected and we had a few nice surprises as well.

Steve Johnson:

Yeah, and particularly I think some of those businesses… We own a company called IBP, Installed Building Products. They do insulation for US housing, and that is a sector that everyone is very, very worried about, but not really showing a lot of signs of problems yet. I mean, it may come, but I think that was probably a theme across the market was in the rear view mirror-

Gareth Brown:

The ones you were most concerned about probably outperform the expectations, exactly like you were saying before.

Steve Johnson:

Yeah. And even into August, I’m sort of saying we’re just not seeing a lot of evidence of the consumer, despite the consumer being very pessimistic, actually changing their behavior.

Gareth Brown:

Yeah. So we had Flutter report. That’s the online sports, gambling business. Excellent result, particularly in the US. We had Linamar, they make parts to go into new cars and new trucks. They’ve also made really nice profitability in a tough period. Keysight, it’s a testing and design business, electronic design. They reported some really nice numbers. Harvey’s had a thesis there for quite some time that this is a business that’s more of a structural grower where the market confuses it as a cyclical. And I guess it’s another data point here that Harvey’s on the right track with that one.

Gareth Brown:

As we move into some of the smaller investments, InMode, Norbit. Just really strong results, record results, from a few of our players. And as I said before, even some of the ones that I would say they didn’t particularly disappoint, but they didn’t blow us out of the water. Meta that owns Facebook and Instagram, there’s still no great disasters, which is really nice after the six months we had.

Gareth Brown:

But yeah, you were talking about that, I guess, the economic insights that some of these business have. Everyone asks, “What’s the outlook?” And everyone provides the outlook. And I think we’ve seen some stuff here that everyone’s very closely watching, waiting for a downturn, but a lot of these businesses are not experiencing them yet as at mid-August. Flutter gave that exact sort of insight that they’re sitting there waiting for it, but they’re seeing no change to the consumer experience at the moment.

Steve Johnson:

Yeah. I think one really interesting thing is that these companies are all reporting nominal revenue growth and nominal profits in a very inflationary environment.

Steve Johnson:

And I don’t know that investors are taking too much notice of that yet, but they will, because what we’re talking about is a real recession here and wages are going up. Unemployment is very high. It’s not surprising to me that people are spending more money, it’s just that they’re actually able to buy less things for the more money that they’re spending.

Gareth Brown:

It’s going on things like oil and mortgage and things that you’re not necessarily thinking of.

Steve Johnson:

But they also do still… I mean the starting point here was record levels of excess savings from all the government stimulus period, so the starting point of the consumer balance sheet has been very strong. So this is by no means the end of the story yet. I don’t think most of the pain has yet passed through in full to the consumer. We’re going to see a more difficult environment. But I thought it was surprisingly positive, I think, on the business front and the other thing I think a lot of people forget is that businesses adapt. They think of it as a static thing, your sales are going to go down or your consumer is not going to want to buy.

Gareth Brown:

Maybe we can just touch on some of your Aussie stocks before we get into the general themes.

Steve Johnson:

Yeah, well, I think Seven West Media, it’s the poster child for me of this momentum market that we have been in. The share price was 36 cents, I think, when we first invested in it this time last year. It went into the seventies on the back of two profit upgrades over the past 12 months. I mean, the stock was trading at four times earnings, so a very, very low valuation multiple to start with. Upgraded earnings a couple of times throughout the year and then it was probably March, April after that second downgrade, when everyone started getting obsessed with a recession in Australia. Interest rates are going up, advertising’s going to get absolutely walloped and the share price halved again all the way back to 36 cents. And the result was fine. They’ve said the market seemed fine. We don’t have any more visibility than anyone else, but as far as we can see out two months, it looks fine.

Steve Johnson:

We had oOh!media, which is the outdoor advertising company, reported yesterday pretty much saying the same thing. There’s strength in what advertisers are willing to spend with us at the moment. So that Seven West share price is back to 50 cents again. It has just been a crazy, crazy roller coaster ride around. I’m not arguing whether we’re going to have a more difficult environment out there or not. It’s the magnitude of the price moves we’ve seen around that and I think through reporting season, you’ve seen a little bit of, “Okay, maybe it’s not worth what we thought it was worth a year ago.” But is it worth-

Gareth Brown:

Yeah, what it was two months ago. Yeah. And I think with those general trends, maybe it’s worth getting into them now. We’ve had six months, at least, of people complaining about price of inputs, price of labor, availability of inputs and labor. Some things are just not available at any price. Have you seen that in Australia? I mean, we’ve seen some loosening of that, especially on the products, the input, raw materials, and you’re seeing that in the prices of things as well. Is that something you’re seeing?

Steve Johnson:

Yeah. I don’t know that it was ever quite as acute here in Australia in terms of availability and my gut feel is we’re still three months behind in terms of it loosening up in terms of product getting here. My brother’s a civil engineer. They still have huge amounts of problems getting cement and product for building roads and that type of thing into the country. And even just domestic production capacity issues, we’re still dealing with labor is probably the biggest issue that I’m hearing across the board, not just finding new people, but getting your current staff to turn up. Or not getting them to turn up, but everything going around is causing enormous problems, so-

Gareth Brown:

So that’s a very global story. It seems to be most acute here in Australia and in the US. I think Europe, it doesn’t seem to be as extreme, probably because it’s a less dynamic place. So, into the up turns, they’re not necessarily looking to add big staff numbers, but, yeah, just the availability labor at any price and then the price of it you do have to pay particularly at the bottom of the wage, which I mean it’s probably good for society after years of having to worry about inequalities. Unfortunately, a lot of that pay packet’s going to have to go on higher oil prices and higher mortgage costs for people.

Steve Johnson:

Yeah, absolutely. Just really quickly, I think it has been a more important reporting season than usual, just because there is so much uncertainty around how businesses are going, but it is a complete circus every three months with all these companies. I mean, what do you actually use it for from an analytical perspective when it comes to your investments?

Gareth Brown:

Well, the main point for us is to test our thesis for a stock or thesis for multiple different stocks. How is this traveling versus how I expected it to be traveling? Did I get it wrong or did the market get it wrong? And it’s never the be all and end all, but it’s an additional data point, which is important to test the thesis of the ideas that are in our portfolio. I think more broadly, it’s a chance to take an economic pulse. That sounds a bit wanky, but you read about the results from 100 different companies. You start to see, okay, the labor shortages, they’re still a problem over most of the globe, but products are getting easier to get, raw materials are getting cheaper. The computer chip shortage is easing. There’s fewer problems with freight. And I may be looking at a completely different company, but it gives me some insight into the companies I own or the companies that I want to own and then I guess more broadly, it gives you a chance to refresh your watch list and your hit list. You’re getting exposed to results from a lot of different businesses. You’re looking for change. Is there a reason why I didn’t look at this in the past? I might now want to because the market might misunderstand. Am I seeing something the world isn’t seeing? Is it more likely I might want to buy this in future because of what’s being put on the table this quarter?

Steve Johnson:

Yeah. And one space where I think that is particularly interesting at the moment is some of these loss making tech or even SPAC companies that are burning a lot of cash. You can buy… There’s quite a collection of them out there trading out their net cash backing or a discount too, but they’re burning that cash pretty quickly, so is there any sign here that they’ve recognized that the party’s over and they need to stop or change something? And I think, and I’ve got this view that the first year to 18 months that you own a stock is really, really important in terms of having that differentiated thesis. You’re going to be wrong fairly regularly saying, “I’ve got a view that’s different from the market and recognizing that as early as possible.” And I think Flutter that you touched on earlier is a really good example of that. We have this view that this US business is worth dramatically more than the market is attributing to it. And even the people that are bullish are looking at their competitor, DraftKings, and saying, “We’re going to apply the same valuation metrics to this business.” And you’ve had a view there that is crazy, absolutely nuts, because they are clearly winning. And I think in that result, the share price jumped a lot on the back of it, but it was a really important one from that perspective.

Gareth Brown:

Yeah, for sure. So I mean, to give you an insight, we put my first research piece together in November, December 2021. I had a number in there for revenue for the US business for 2023 that they’re going to eclipse in 2022. So this is a rapidly, rapidly growing industry in America and they’ll grow in one year what I expected out of them in two years. They were profitable in Q2 in America. Profitable. They have quite high margins in the States that they’ve been established in for more than two years. So New Jersey, they’re now 17% EBITDA margins in New Jersey, even though they’re still spending to attract new customers in that state. There’s a lot of things falling into line. Then we look at the results of someone like DraftKings, they’re bleeding cash. They’re still giving away a crap ton in stock based comp. I can see a world where they become a more solid competitor, mostly via takeover, but so far everything’s just flowing the way we laid out in our bull case. So when we put the case together in late 2021, we said, “Here’s three potential paths.” Well, it’s looking like the better, more profitable path and we’ve got a lot more confidence in it than we did even three months ago.

Steve Johnson:

Yeah. So this whole reporting season caper in the US where it’s every quarter, it is a circus and it is generally less important than it’s made out to be in terms of the stock price moves around quarterly results can be dramatic, but it is important and it’s difficult to know which is which.

Gareth Brown:

Especially when we have seismic shifts in prices, right? That’s also the other thing that I just wanted to touch on. We’ve sort of gone a bit out of order here. But this is not necessarily good for the world, but it’s good for some of the companies we own. Companies that would historically be price takers that are expressing increasing confidence in their ability to set prices for their customers, so I’m thinking of Linamar here, also Norbit to an extent. They both sell to the automotive space and in the global automotive business, you tend to make a product and you have a long run and the price goes down every year and you make your money because you get more efficient at making it. So you do more volume and you make more money, but your charging price goes down.

Gareth Brown:

They are passing through actually. They’re not only not going down in price, they are passing through cost increases to their customer at the moment. So the ecosystem has recognized the world is different. Now, whether that changes or not, we go back to the old environment. But what I was worried about six months ago is the inability to pass through the cost increases and there’s sort of a confidence there that I didn’t expect and it’s quite nice and reassuring to see it.

Steve Johnson:

I was on a call with a company this morning with our colleague, Harvey. I won’t actually name their names because they might not want me talking about what they said. But they’re in a position of some market power and they’ve done a very good job of passing on the costs as quickly as they possibly could. Steel being one of their main inputs. And he said to us on the call, “We’ve never given anyone the price back that we took when we had to put the prices up.” So I think they’re another cohort of businesses to look out for, the prices for steel and those sorts of things come down here. He said, “The magnitude of what we’ve seen over the past 12 months has been so extreme that I think we will want to give some back, just as a gesture of goodwill.” But those companies that have that pricing power are going to be really interesting out the other side of this in terms of just keeping extra margin and being more profitable.

Gareth Brown:

I mean, what I’m sort of getting at here though, is that even big powerful customers are accepting of price increases in this environment. They recognize what’s happened. And maybe that says something about the intractability of inflation. I don’t know. Your guess is as good as mine.

Steve Johnson:

All right, let’s move on. I mean, it’s been actually quite pleasing for me to see some stocks moving around on their actual results rather than just macro issues. But the big thing that’s driven markets overall has been a change in perception about risks of rising interest rates and that has changed because people’s views around-

Gareth Brown:

Inflation.

Steve Johnson:

- how bad inflation is going to be have waned somewhat, and you can almost… If you get the US 10 year bond rate, its peak was the stock market’s bottom, certainly in terms of the NASDAQ index, and they’ve traded very, very correlated with each other ever since. What is causing people to get, I guess, more relaxed about the risk of higher and higher rates here?

Gareth Brown:

Well, I think people are seeing the damage to the economy that too higher rates can cause, so there’s a sort of a game theory going on, right? There’s how high the rates have to go to slow things down, but then if you expect high rates to really cause a lot of damage, you’re going to be a little bit more cautious around it and some of that damage gets brought forward. Yeah, I mean, it’s all a game of expectations, isn’t it?

Steve Johnson:

Yeah. I mean, in terms of the real world out there, you’ve got oil prices down quite substantially from their peaks.

Gareth Brown:

20% from June, yeah.

Steve Johnson:

That’s passed through to gasoline prices that, I think, are now the lowest since Russia’s invasion of the Ukraine back in February. That took a month or whatever it was to get passed through to petrol prices, but per gallon in the US down to under $4 again at the moment. And this was something that people talked about a lot through reporting season, supply chain issues are still there, but they’re trended in a way that is getting better and I’ve got a chart here in front of me that’s that Baltic Dry Shipping Index. It’s a pretty good barometer of how difficult it is to move things around the world. That is, what, probably down 40% over the past couple of months? And everyone is saying it’s getting easier.

Gareth Brown:

So it’s all down. It’s still high, it’s still elevated versus a pre-COVID world, but it’s definitely easier than it was a few months ago.

Steve Johnson:

So some of those things that everyone was saying were transitory, maybe are transitory, taking longer to pass through than people expected, but still transitory. And then offsetting that, I think that’s made people more comfortable. That all happened before the latest data came out of the US, but then that latest data did suggest that that’s actually also turning up in the headline numbers as well. But labor still a massive, massive issue out there in terms of A, just finding it and B, that translated into higher prices as well.

Gareth Brown:

I mean you can think of a couple of fundamental reasons for the labor issue, so it seems like we’ve had a fairly big brought forward in people retiring. People that had planned to retire around 2025, some of them have brought that forward. And then of course the massive cut in immigration to most of the countries that are fairly reliant on it, including Australia. Is labor just behind the curve of physical and they’re going to look somewhat similar in six months or more? I don’t know. I don’t have a definitive answer there.

Steve Johnson:

I do think it’s a pretty balanced argument. I think there are good arguments on both sides. We went from, what was that, January 2021? I wrote that cover letter saying nobody’s worrying about inflation here at all and if it’s ever going to come, it’s going to come in this sort of environment to what I would say almost panic about how high rates needed to go. Particularly here in Australia, we at one point had, by the end of this calendar year, the market was pricing in an RBA cash rate of 4.5% and then higher further out than that.

Gareth Brown:

What’s it down to now?

Steve Johnson:

3.2, so it’s come down really substantially here in terms of people’s expectations. There’s this view that it’s expectations. I mean, these are markets, right? And I think things move so far that there were a lot of financial institutions, fund managers, that because it had happened, were forced to liquidate positions. I don’t think it necessarily means someone is sitting there thinking, “This is where the cash rate’s going to go,” particularly in dysfunctional markets. But that’s what the implied rate was by the end of the year. I thought that was nuts in terms of the impact that would have on the Australian economy. They won’t need to be worrying about inflation. They’ve got a lot more problems if they go that far.

Gareth Brown:

We’ve talked a lot about this in house for years, but I don’t know if we’ve talked about it publicly. But something that John Hempton brought up in one of his recent letters was how the Australian economy is particularly sensitive to changes in interest rates because most of our mortgages are either variable or in recent years, sort of fairly short term fixed. Whereas you want to move the needle in America, you take out the new home buyer, because they’re all getting fixed rate life for the mortgage stuff, so you kind of take them out by raising rates.

Gareth Brown:

Whereas you raise rates here and it instantly hits the pockets of, what is it, 35% of people that have a mortgage? It takes money straight out of their pocket straight away. And so a 2% jump in interest rates in America is a different kettle of fish than a 2% jump in rates here in Australia because we’ve got ourselves in this position where we’ve got variable loans and a lot of debt, we’re quite sensitive to it.

Steve Johnson:

Yeah, that debt to disposable income ratio here in Australia’s about 40% higher than it is in the US, so even just that sensitivity in terms of spending capacity. No, it’s still a very crazy world out there and I don’t think anyone should be anticipating that we’re going back to a really stable environment of prices. I think you were posting some interesting stuff about Europe and the UK are a mess with energy prices at the moment and some extraordinary things happening there.

Gareth Brown:

Yeah. So I mean, everyone in Europe is looking at a massive jump in gas prices. Most of the home heating, especially in the urban areas in central Europe at least, is driven by gas that drives your heating systems. And they are looking at 10, 13, 15 times the bills of what they were paying last window. I can’t remember the exact specifics. But one of our mates there, they were told to plan on a, I think, it was 9,000 or 7,000 Euro bill over the course of a year for heating, whereas it was measured dramatically lower even just last year.

Gareth Brown:

And I saw some data on this, that the Google searches in Germany for brennholz, for firewood, have dramatically jumped up. Everyone’s getting ready for winter. Everyone’s concerned. Anyone that’s got a fireplace is thinking, “At least I can load up the garage filled with wood and have some heat that way.” And it’s quite a sad state of affairs, but I think, I hope, that some of these price changes that we’re seeing will ultimately lead to supply but at the moment, it’s not really a price issue for places like Germany. They’re reliant on Russian gas.

Steve Johnson:

And when it comes to those issues, interest rates are going to be very ineffective, which sort of leads me to my last point here. We had 10, 15 years of extremely, extremely loose monetary policy that didn’t turn up in a lot of inflation.

Gareth Brown:

It all just went into assets.

Steve Johnson:

It did. And then we have COVID and huge fiscal stimulus, basically the government just handing money out to people. And what do you know? It turns up in crazy inflation and yet we’re sitting here today and everyone’s talking about how interest rates, monetary policy, are being used to deal with getting inflation out of the system. And I think fiscal policy seems to have completely been taken out of the debate. And I love this. Last week or two weeks ago, America passed a piece of legislation called the Inflation Reduction Act, which involves spending about 500 billion US dollars on a whole bunch of things.

Gareth Brown:

Of borrowed money, yeah. It’s Vogon-ish [reference from The Hitchhiker’s Guide to the Galaxy] isn’t it? Yeah.

Steve Johnson:

All right. We will crack open a beer and move on to the next topic. So I’ve got this can. It’s a very, very interesting can itself. If anyone’s familiar with the Australian artist, Del Kathryn Barton, or if you’re not go and Google it. These cans are sort of designed in a similar style to her artwork.

Gareth Brown:

Looks like a Mamburg.

Steve Johnson:

And yeah, as I said, we both quite like the Heaps Normal. [BLEEP] We’ll have to bleep that out, but Gareth’s just spilled his beer all over the recording studio. Does that mean I should be very careful?

Gareth Brown:

And I cursed. Yes, I would. Sorry. I got non-alcoholic beer all over myself.

Steve Johnson:

So piece of advice number one, open the can very carefully.

Gareth Brown:

You must have been shaking them up.

Steve Johnson:

I’ve really enjoyed this. This is good. So it’s an IPA, for anyone who’s a beer drinker will know that’s a fairly hoppy beer. Usually high alcohol strength, but this one’s non-alcoholic and like the Heaps Normal, it actually tastes like a beer. I find most non-alcoholic beer tastes more like water than beer.

Gareth Brown:

So that’s the brand that we drink most often at home, Heaps Normal, which is an Aussie brand. I think the guy might be from Canberra originally. And what’s interesting is the first time we had, in my house, had non-alcoholic beers was in Austria when my wife was pregnant with our first child. They’ve got a quite well established, no alcohol beer system over there. They don’t have the low alcohol one so much, but they have alcohol free.

Steve Johnson:

They gave me an ‘alkoholfrei’ beer at the end of the Berlin Marathon. It was absolutely the last thing that I possibly felt like.

Gareth Brown:

And they’re pretty good and I find that it’s interestingly, it’s the wheat beers that work better than the lagers. And that’s where I think Heaps Normal’s really tapped into something interesting here. The IPA seems to be an easier thing to recreate than just the simple lager or ale. And most of those non-alcoholic ones that I’ve tried, Carlton and Great Northern. I don’t like them much. I get this caramelly taste. It’s a bit off-putting. Whereas with the very flavorful beers, it’s actually easier to recreate it.

Steve Johnson:

Yeah, definitely worth a try for anyone who’s drinking the non-alcoholic beers. It’s, once again, VandeStreek or ‘van de Streek’. V-A-N-D-E-S-T-R-E-E-K. Really, really enjoyable.

Steve Johnson:

We’ve just wrapped up our roadshow for 2022, Gareth. It was a difficult one. We had a message to tell after having a cracking year about how bad things have been in 2022. But very enjoyable, lots of long term clients came along and watched the online one as well. It’s up on our YouTube channel if you haven’t seen it and want to watch it, you can jump on and watch that webinar.

Steve Johnson:

But I got quite a few questions after part of our Australian fund presentation was that one third of that portfolio is now invested in tech stocks. We have, for some time now, owned quite a few growing businesses. Maybe less tech, but definitely smaller growing businesses in the international fund and people questioning whether we can actually still call ourselves value investors, owning businesses like this. What do you say to that comment?

Gareth Brown:

I mean, historically I’m like, “How do you get to decide what a value investor is?” I think growth has been an important thing for us since the beginning. As we talked about before this recording, Buffet’s been buying stocks that are faster growing for 50 years now. I mean, I think I first read Phil Fisher’s book, Common Stocks and Uncommon Profits, which is very much a growth focused book. I think I first read that in 1996 or 1997. I mean, it’s been part of the-

Steve Johnson:

Peter Lynch’s One Up On Wall Street, all about finding businesses that are growing much faster than people anticipate.

Gareth Brown:

And I think, to me, that’s always been part of value investing, that it’s sort of, “No, it needs to be pigeonholed. It needs to be price to book, price earnings, low PE.” And so I think we’ve all come to the conclusion that it’s just the terminology we’ve moved away from, but it hasn’t changed the process at all.

Steve Johnson:

Yeah. I think it’s difficult because there are a lot of ETFs these days, low cost funds. And even I think the asset consultant industry wants to put people in a pigeonhole and say, “You’re going to invest with a certain style and we want to be able to define that by the metrics of the companies that you’re buying.” And actually, you know I’m a really big fan of the low cost index funds. They do a very, very good job, I think, of getting people access to equity markets at an attractive price. But when it comes to value investing, it has certainly captured a specific form of it around buying very low PE, stocks at big discounts to assets.

Gareth Brown:

Something that a computer can work out.

Steve Johnson:

Which was probably the original Ben Graham Security Analysis way of valuing businesses out there which was just go and buy things that are screamingly, screamingly cheap relative to their replacement costs.

Gareth Brown:

Liquidation values.

Steve Johnson:

It is a good 50 years now of people realising that there are many good businesses that come along at really cheap prices from time to time. And for me, that is the real key. When you say we have a value of a business, how do you think about growth in that context?

Gareth Brown:

Well, it’s an important metric, right? We sit here and say, “How much cash can I get out of this business between now and judgment day?” And the answer is growth is going to be a part of that. It doesn’t have to be much more complicated than that. I mean, looking back at my history, two of my best performing stocks ever were ARB and Flight Centre. I bought Flight Centre first in 1998 and I think I paid 16, 17 times for both those stocks when I bought them. Flight Centre was growing a 30 plus at the time. I made a fortune. I made five times my money in two years or three years. ARB’s been a slower thing but growing in the teens.

Gareth Brown:

That growth has been essential. If the growth didn’t turn up, I would regret having paid that much for those stocks, but they were in both cases, very clearly worth buying. But we’ve also bought things at four times earnings on 10% dividend yields that have worked very well as well. And I think they’re both the same. We need to try and equalise those things and work out which one’s cheaper and they’re different metrics.

Steve Johnson:

With hindsight, it has almost been a prerequisite of all of my successes as well. There’s one really noticeable exception to that in RHG, but that is illustrative in its rareness rather than…

Gareth Brown:

Exception that proved the rule.

Steve Johnson:

Yeah, I think that’s exactly right. And lots of the businesses, my successes I would say, grew more than even I was expecting sometimes. Sometimes they weren’t businesses that were growing into that. You sometimes get lucky and I’d take a business like Enero here in Australia. We definitely got lucky there. They ended up owning a US business. But often that happens to businesses that you buy at cheap enough prices and some of our biggest mistakes were quite obviously businesses that shrank that I wasn’t anticipating them shrinking at the time I bought them, thinking they were going to grow. So it’s always easy to say your successes were ones that grew, but it is for me a really important factor and I think as we’ve gotten bigger, we’ve had more money to manage. Another thing, when you talk about those stocks like Flight Centre and ARB, they’ve been such wonderful investments over a really long period of time because they have been able to compound your wealth. They’ve kept their earnings, they’ve reinvested in the business.

Steve Johnson:

And you have made a lot of money from them keeping your money and using it. If you get it back all of the time, you need to go and find another one and you need to redeploy that capital. And in the case of those stocks that have been what a 15 year… Well ARB are a 15 year investment for you, is it?

Gareth Brown:

20. A bit over 20.

Steve Johnson:

That’s probably in lower quality businesses where you’re getting dividends or you’re getting taken over, that’s 10 different ideas that you need to work out.

Gareth Brown:

Which is fine. That’s our job, right? It’s nice having at least some one decision stocks in there.

Steve Johnson:

Yeah and I think just recognising how powerful that can be from valuation perspective. It’s super important to the valuation of any business and it’s been quite frustrating for me in a lot of ways that the term has been commandeered because we have had to come up with a different way of explaining it. And if you jump on our website today, I hope you get a much better feel for that. And I think we do need to be careful because to the extent that the world changes and the perception of it changes, if people are thinking they’re getting something different from us than what we’re actually doing, then that is a problem as well.

Gareth Brown:

And I think hopefully we made that clear today but if you think you’re going to get exclusively low price to book, low PE, we’re not the fund for you. And I think that’s part of the reason why we’re increasingly using that term valuations based rather than value investors. We are always focused on the valuation and we believe growth is a part of that and I don’t think that should be controversial, but it’s something that people should be aware of.

Steve Johnson:

Yeah. And the other thing is, there’s a term in the industry called style drift, when someone who’s been running a fund in a certain way starts running it in a different way and owning different types of stocks. And I would say the thing to expect with us is a lot of drift if we’re doing our job well. And I would say, when I look back at the past few years-

Gareth Brown:

Our problem last year was not style drift. It was a lack of style drift.

Steve Johnson:

Yeah, I think that’s right. We want to go where the market is mispricing things, is most pessimistic and we want to have bigger allocations to the things that people are most pessimistic about at any point in time. The past three months, it’s already changed reasonably meaningfully in terms of how much some things have bounced off the bottom. But mid-June, that was almost certainly small cap-tech stocks here in Australia that were down 70 and 80% and starting to trade at levels that you didn’t even need them to grow to justify the price.

Steve Johnson:

There’s some accounting nuances in terms of people will look at them and say that they’re losing money. We won’t get into the detail about that today. So it’s not as straightforward as, “I was buying this tech company on 10 times earnings,” but wow it was a pretty serious selloff in that part of the market. And that’s what people should expect from us when there’s a part of the market that is under extreme pressure, where people are being irrationally pessimistic about it, then you should expect us to be drifting as hard as we possibly can into that space.

Gareth Brown:

We won’t always get it right, but that’s always the aim.

Steve Johnson:

All right. We will wrap up our alcohol free whiskey podcast, Gareth. It’s been a pleasure. Thank you very much. We’ll be back next month and yeah, and enjoy your alcohol free August.

Gareth Brown:

Thanks Steve. Thanks everyone.

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Steve Johnson
Founder & Chief Investment Officer
Forager

Steve began Forager Funds in 2009, and now manages approximately $350m across two funds. Offering a listed Australian Shares Fund (FOR) and an unlisted International Shares Fund, Steve focuses on long-term investing in undervalued companies.

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