What’s the most recent investing mistake you’ve made?
Mistakes are a part of life. But reflecting and learning from them is one of the keys to being a successful investor says Tim Hillier from Allan Gray Australia.
“Self-evaluation is something I don't see a lot of investors talking about and I think it's so important. When you make an investment and it turns out well, it's important to try to make some evaluation as to what extent the outcome was good luck or good analysis. The opposite is also true."
This process of self-reflection is “one of the crucial parts of becoming a better investor over time”, he says. He points to AMP as having provided some hard lessons”, having overestimated its future earnings potential when he first analysed the company. Some unfortunate subsequent events haven’t helped, although the market appears to have more than taken these into account today and Allan Gray remain shareholders.
He warns against over-extrapolating based on a single data point. Just because something turned out well (or poorly) this time, doesn’t necessarily mean the same will happen in future.
In the wire below, we hear why buying great companies and holding them isn’t necessarily a formula for success, he tells us why even perfect economic forecasts may not be useful for investors, and offers three areas of opportunity for contrarian investors.
Two key attributes for contrarian investors
The life of a contrarian investor is a lonely and challenging one. Your positions will be ridiculed (if they’re not, you’re probably not being contrarian) and you’re unlikely to read any glowing stories about your companies in the AFR.
“Most mornings, you open the newspaper and wonder what headlines are going to hit you in the gut… It'd be fun to spend our days building out rosy projections of addressable markets and things like that. But in reality, we spend a lot more time trying to figure out whether some old industrial company still belongs in business or not.”
To be successful as a contrarian investor, he says there are two essential attributes:
- A desire to learn. About industries, how businesses work, and how they make money.
- An appreciation for the psychological side of investing. Watching for euphoria and pessimism, not only in other investors, but also in yourself.
There’s more to investing than just buying great companies
Common investing wisdom would hold that the key to success in markets is simply to buy great businesses and hold them for a very long time. But Hillier says this misses one of the most important aspects of any investment: the price paid.
“Buying great companies and holding them for a long time can be a good strategy, you just need to make sure you understand how much you’re paying, and whether that is a reasonable price to pay for the future earnings stream.”
“A lot of new retail investors entered the market during last year’s downturn, which seems like a good thing. However, I’m not sure I’ve heard many causal investors mention any arithmetic when explaining why they favour an investment, just stories about ‘great companies’. So that is a little concerning.”
He says that the majority of the work they do is simply understanding the potential income stream a business may pay over time, and assessing the range and probability of the potential outcomes.
Would perfect foresight help?
While I’m sure most investors would relish a trip in a Delorean to find out what the world’s macroeconomic data would show in a year or two’s time, Hillier questions whether even this perfect macro foresight would be useful.
“If I told you in late-2019, that we were about to have a pandemic that would disrupt the global economy and lock people at home, and then asked, “Do you want to own discretionary retail stocks over the next year?” Would you have wanted to do that? I think I would have said, "No way." Yet despite this perfect macro foresight, discretionary retail was one of the better areas in which you could have invested in late-2019 and the sector outperformed the ASX by 20% for the 2020 calendar year. It was incredible.”
However, that doesn’t mean sticking your fingers in your ears and ignoring macro altogether. He warns that as investors, we need to “keep our eyes open.” In the context of today’s markets, with interest rates low, asset prices high, and the market’s mood firmly in the optimistic camp, it’s a time to be cautious.
“First, we have to ensure that the businesses we're looking at can handle bad outcomes that might come their way. And then that they're attractively priced, even if operational outcomes aren't great.”
Where to find contrarian opportunities
Hillier says there are three areas they often find contrarian ideas:
- Challenged industries
- Forgotten assets
- Underperforming companies.
One example he shared was the media industry – certainly not a sector lacking in challenges.
When he started as an analyst at Allan Gray, one of the positions he kept an eye on was Allan Gray’s investment in Fairfax, which had faced an unrelenting fall in advertising revenues in the preceding years. When Nine Entertainment (NEC) popped up on the ASX, and had fallen over 50% by 2016, he found himself assessing another challenged media company.
“Nine was facing the same challenges, with falling revenue, but it also had rising costs, and had had a run of poor ratings. Nine fell to about four to five times pre-tax earnings and, at that stage, we had to vet it. Was this a good idea?”
"Now, we've just learned from the Fairfax investment to be very careful with media companies, where advertising dollars are starting to disappear. But on the other hand, we thought, "Well, perhaps Nine is an attractive opportunity at this price?"”
Despite the falling advertising revenue, he felt that it could be a good investment as long as costs were kept under control, or a very good investment if ratings returned to their normal levels (relative to other free-to-air (FTA) networks).
One of the key costs for FTA networks is sports rights. Over the preceding decade, the cost of sports rights had exploded from $300 million to $800 million, as FTA networks outbid each other to secure the content. At the same time, profits for the FTA networks had fallen from $800 million to $400 million. It’s not hard to see the link.
“We thought, "if Nine can just be sensible with its cost base, even if TV advertising revenues fall, it'll probably still be a reasonable investment from here."”
Of course, that’s not how things played out. When the next contract came up for renewal, the rights were bid up by another 30 to 40 percent.
“We just shook our heads in disbelief. It was still happening."
"But then, Nine ended up having amazing ratings successes on some of its shows. The company also started to address its cost base. It ended up being a good investment, but not exactly in the manner we had expected. Subsequently, Nine has merged with Fairfax and it looks like that's been a very good deal for them.”
The lesson here is that if a purchase is made at a great price, good returns can be made even if things don’t play out exactly as expected. This the opposite to the plethora of ‘priced to perfection’ stocks that have proliferated in recent years.
A challenged industry that’s been unfairly sold down
Even before COVID-19, shopping centres had experienced a tough couple of years. The rise of online shopping had been chipping away at foot traffic, and the sustainability of many specialty retailers remained a major question. Then COVID-19 hit.
“That created an opportunity.”
The ungeared yields on retail property trusts spiked to eight or nine percent, which Hillier thought “looked quite attractive.”
“First of all, these businesses have very low operational leverage. If you're operating on thin margins and your revenues fall a bit, you're in trouble. But if you have high margins, like most property assets do, a temporary fall in revenue, due to lockdowns for example, was not necessarily going to be a disaster, as long as they could service their debt. We thought that that provided investors with some downside protection.”
He acknowledges the challenges that retail shopping centres face. With online shopping taking a larger market share than ever, this is affecting the centres’ ability to charge rent. But taking a longer-term view, the situation doesn’t look so dire.
“Owners of shopping centres have shelved almost all of their expansion plans. It’s probably cheaper to buy the space on market now, than to expand.”
This is great for free cashflow generation, as it reduces the amount of capital spending required. It also reduces competition – supply and demand is a two-sided equation after all.
But there is upside to this story. Looking out over the very long term – 20+ years – Hillier believes there will still be plenty of people heading to shopping malls.
“Shopping malls are often in fantastic locations. It's likely there'll be more and more people living around them over time. Also, there are some great ways they can make better use of some of their extra space. They can partner with developers to build offices or residential units on top of, or next to, the centres, where there might only be an open parking lot today.
What's your most recent investing mistake? Tell us in the comments!
Want to learn more?
Contrarian investing is not for everyone, however there can be rewards for the patient investor who embraces Allan Gray’s approach. Visit the Allan Gray Australia Equity Fund profile to find out more.
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Patrick was one of Livewire’s first employees, joining in 2015 after nearly a decade working in insurance, superannuation, and retail banking. He is passionate about investing, with a particular interest in Australian small-caps.
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