The discussion began with the panel acknowledging that disruption continues to be the key issue. Everyone agreed that there are two key sources of excess competition on which analysts focus research, regardless of the specific stock opportunity: the internet and China. This has divided the market to a certain extent – into stocks considered at low risk from disruption, and those deemed high risk – and valuations have reacted accordingly. Many of the “high risk” stocks are trading at what appear on the surface to be very reasonable valuations. For example, clothes retailers (who face internet disruption in abundance). Those without a sufficient internet presence are seeing like for like revenue comps eroding rapidly, and it feels like a genuine game changer. The Gap is a good example of a company facing these issues. As a result, it is trading at a meagre 10x earnings. At the other end of the spectrum are companies like Nestle, who have sufficient brand strength to combat cheaper alternatives from China. This is reflected in its valuations of 23x 2015 earnings.
We are naturally sceptical when told “this time it’s different” – but, with respect to these two particularly disruptive risks, perhaps it could it be.
The key (as always) is to find resilient stocks trading at reasonable valuations, where the market has over-estimated the risks. At Kennox, we hold the view that risks are never low enough to justify earnings multiples of close to 25x.
Value versus growth
Following on from this, there was a consensus that value managers globally (and perhaps even more so in the US where value is a more mainstream style than it is in the UK) are seeing performance suffer. This has resulted in outflows from their strategies. Current sentiment towards value investing is reminiscent of 2000 when those that did not invest heavily in the tech boom were vilified. That is, until things reversed.
Warren Buffet’s portfolio is an interesting case study (when is it not?) on the fortunes of value investing then and now. Currently, American Express is off 25% in 2015. Coke first traded above $40 in 2012, and trades at just $42 today. Walmart is off over 35% in 2015. Burlington Northern is no longer listed, but the intrinsic value is unlikely to have increased this year (Union Pac, CSX and Norfolk Southern are all off around 30%).
When a particular style comes under this much pressure, the question has to be asked: is now the time to look seriously at listed fund managers who are seeing their own share price creaking?
We couldn’t avoid a discussion of commodities. In the 12 months to 30 September 2015, the MSCI energy index was off 30% (in GBP) and materials were of 20% versus an overall MSCI index up 2%. Whether it be oil (where the phrase “lower for longer” is ubiquitous), copper, steel or gold, can an investor be comfortable investing in these sectors? The answer will lie in supply and demand, and the panel focussed on supply and capital discipline: whilst production has not come off-line as quickly as some predicted in late 2014, it is also true that nobody is talking about increasing capital expenditure, rather talk is of shelving products that are not viable at current commodity prices. The reason commodities are so cyclical is that capital decisions take so long to feed through. There was no clear consensus from the panel, but it is always worth investigating when world-class companies come under pressure. Of course, investors have to be careful about waiting too long as the market will anticipate the recovery.
Peter Hollis, Russell Napier, Angus Tulloch and the Kennox investment team.