When will the music stop?

Patrick Poke

Livewire Markets

Around the world there is a speculative mania in unprofitable stocks the likes of which has not been seen for decades. Ned Bell from Bell Asset Management was working in San Francisco during the late 90’s Tech Bubble and can’t help but see the comparison with today’s markets.

“Really high-quality businesses have been lagging a lot, particularly in the last four months, at the expense of these really well-known thematic stocks.”

But with interest rates and inflation on the rise, investors are starting to wonder when the music stops for this speculative mania. The good news for investors is that there are still plenty of high-quality, growing businesses available at reasonable prices.

In this video, Bell discusses the types of companies they’re looking for, the sectors they’re finding opportunities, and shares an outstanding company benefiting from the move away from big cities.

Thematic stocks partying like it's 1999

There are many similarities between today’s boom in unprofitable stocks and the late 90’s tech boom, not the least of which is the wild speculation we’re seeing in various parts of the global equities landscape. The correlation between profitability and share price performance has turned negative, sending loss making stocks skyrocketing, while high-quality businesses that earn excellent returns on capital have been left lagging behind.

Back in ’99, when Bell was working in San Francisco, he witnessed a similar phenomenon.

“These thematic stocks were listing day after day after day. They had almost no business models, no possibility of profitability, but they were being gobbled up day after day. And the frenzy just fed on itself. But eventually the music stopped.”

But unlike the GFC and last year’s market crash, there was no clear trigger that popped the tech bubble. Investors simply got tired of funding business models that didn’t work.

Highly profitable tech stocks like Amazon and Microsoft are unlikely to suffer similar fates to 20 years ago. But the highly thematic stocks such as Tesla, Zoom, and Plug Power, with amazing share price performance and a lack of fundamentals to back them up? Bell says he’d “be staying well clear of those names.”

Avoiding bias and focusing on the fundamentals

Rather than looking for the next big trend, Bell favours an approach that helps to remove bias and ensure they’re focusing only on the highest quality companies. They achieve this by applying a non-negotiable filter over their universe – before any company is considered for inclusion in the portfolio, it must have achieved a return on equity above 15% for three consecutive years. No exceptions.

“If you start excusing companies for, "Well, they only made that one bad acquisition," or, "It was a COVID one-off," then it's a slippery slope.”

A major opportunity in the consumer sector

Today, he’s finding great opportunities in the consumer sector, with a particular focus on the US. With a significant portion of the population having been locked in their home for the better part of the last year, and a huge stimulus recently announced, he says people are “busting to get out and spend”. With the vaccine rollout moving full speed ahead and case numbers beginning to fall, some sense of normality should return to consumers’ lives. All these factors suggest that consumer spending could “spike quite hard” in the second half of 2021, and he believes many investors are underestimating the magnitude of this rebound.

Despite the rebound, life won’t look exactly like it did before. Many consumers have left large cities for smaller communities and rural areas, travel is more localised, and leisure time is increasingly being spent outdoors.

One major beneficiary of this trend is Tractor Supply (NSDQ: TSCO), a “quirky retail concept” with 1,900 stores throughout regional America. They sell everything from tractors to gun safes, and even sold 15 million live chickens in 2020. The recent move to regional living has seen them add 14 million new customers, while changing the store format is helping them extract more value from each of their 1,900 stores. It meets all his requirements for strong management, good ESG characteristics, and a sustainable high return on equity. And with a free cashflow yield of about 6%, Bell says it’s a stock he really likes.

Learn more about Bell Asset Management

Ned believe's that a portfolio of very high quality businesses will deliver above average returns over the medium to long term. For more information on where he is finding the most compelling opportunities, use the contact form below or visit Bell Asset Managements website.

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Patrick Poke
Managing Editor
Livewire Markets

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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