Rudi’s View: Traditional Value Is A Flawed Narrative

This story features PINNACLE INVESTMENT MANAGEMENT GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: PNI

The decade past has challenged the narrative that buying ‘cheaply’ priced equities are a starting point for guaranteed success. Why would the decade ahead be any different?

By Rudi Filapek-Vandyck, Editor

We don’t need to read Yuval Noah Harari’s ‘Sapiens‘ to understand how people unite behind narratives.

It happens in financial markets all the time.

Not that popular narratives are also required to be accurate or able to withstand the test of time. The US has been on the verge of going bankrupt for multiple decades now, and the end of the US dollar as the world’s reserve currency has been “imminent” for all this time.

Another popular prediction sees a replay of the stagflation 1970s, with bond yields reverting back into the double-digit percentages as the price of crude oil jumps to US$200/bbl and those mean-spirited central bankers can no longer contain inflation.

Not all narratives are equally flawed. If they were, we’d probably be no longer treating them as gospel, though maybe I am now putting too much faith in the intelligence of my peers and contemporaries. Certainly, social media has been a genuine eye-opener.

The most dominant narrative in the world of investing is that, in order to achieve the best return in the long run, we must buy assets at a discount. Buy something that’s worth a dollar for less, preferably a lot less, so the adage goes, and you cannot go wrong.

It’s what a smart investor does, as opposed to those who simply chase market momentum.

So ingrained is this narrative in the share market’s psyche that many will never, ever question it. It’s like religion. You believe. You don’t doubt. It’s simply the way it is.

The problem is, however, a ‘cheap’ valuation is not the same as a low PE. Never has been. Even more important: sometimes the world changes so dramatically, it makes a mockery out of old ways and habits that used to work well during the Halcion days.

The past ten years have been such a time. One need not look any further than the latest marketing campaign by investors in ‘growth’ stories at Hyperion, part of the Pinnacle Investment Management Group ((PNI)), which is proudly showing off the 17.1% per annum average return from the Hyperion Global Growth Companies Fund since 2014.

Let’s not beat around the bush, your average ‘value’ investor fails to beat the local index which has done a little better than half that return over the period (circa 9%). By anyone’s measurement, that’s a significant difference.

A quick glance over the individual stock performances for the decade past easily explains why buying cheap & undervalued stocks has failed to keep up: many of the familiar household names have significantly underperformed, including all the banks (ex-dividends), energy retailers, small industrials, and large swathes of the energy and metals sectors.

While many a local investor might argue total return for banks and other market segments has kept up with the index, broadly, when taking into account the large dividends and franking attached, the gap with those stocks that have performed over the period is nevertheless mindbogglingly large.

We are talking three-four times the average index return without taking into account any dividends on top. Those are merely broad averages; many ‘Growth’ stocks have done significantly better.

You all know the names too: Altium ((ALU)), Aristocrat Leisure ((ALL)), ARB Corp ((ARB)), Cochlear ((COH)), Fisher & Paykel Healthcare ((FPH)), Pro Medicus ((PME)), REA Group ((REA)), WiseTech Global ((WTC)), et cetera.

Even CSL ((CSL)) and ResMed ((RMD)), whose share prices have encountered more headwinds in recent years, have still outperformed the ASX200 accumulation index by a factor three and four respectively.

For good measure: the select list of significant outperformers also includes a number of commodities-related companies, including BlueScope Steel ((BSL)), Fortescue ((FMG)), Mineral Resources ((MIN)) and smaller peers like Chalice Mining ((CHN)), Evolution Mining ((EVN)) and Paladin Resources ((PDN)), but this segment always generates a few Heros among many more Zeros.

Making the observation is an eye-opener, for sure, but how will we respond to this?

On my observation, most people, whether they are in Finance or otherwise, find it incredibly difficult to deal with ‘change’. We rather stick with what we know from the past, and wait for things to revert back to how they were. For many, that’s the easiest path to choose.

But what if there’s no quick reversion on the horizon?

When the world changes, it doesn’t happen overnight. These are long, elongated processes. The past ten years have not been without major events and markets violently swinging in either direction. We’ve seen Europe in crisis, oil prices slump and rise, a global pandemic, wars in the Ukraine and in Gaza, negative real bond yields, and the steepest tightening from central banks ever… and yet, there is a gigantonormous gap in performances between those who benefit from change and those who don’t.

Most importantly, ‘Growth’ and ‘Quality’ have been out of favour multiple times -think the second half of 2016 and the whole of 2022- but those stocks still come out on top when the long-term calculations are made.

Frustrating as it may be for your dyed-in-the-wool value investors, solely looking out for low PEs and companies trading at intrinsic discount may not be the most appropriate strategy in a time when new technology, disrupters, innovators, ‘Quality Growth’ and ‘structural growth’ rule the financial landscape.

Time to highlight one of the market observations that have coloured the decade past (it is repeated by all kinds of investment experts regularly across my social media forum): a stock trading on a low PE is not by definition ‘cheap’ or even ‘attractive’, while a stock trading on a high PE can still be ‘cheap’ and ‘attractive’.

The counter narrative thus becomes: don’t look for the one dollar stock to buy at 70c or 60c, look for the stock that will go to one hundred dollars and you can buy it at $10, at $20, at $40, even at $80, still. And when you arrive at $100, consider it might yet have a lot more upside in store, still. The past ten years (and beyond) have offered plenty of examples to make that strategy work.

I can report the FNArena-Vested Equities All-Weather Model Portfolio has used this strategy successfully, most recently when shares in Audinate Group ((AD8)) sold off from above $21 to below $15.

Ironically, confidence in the future growth path of this high quality small cap emerging conqueror of the global wireless AV market has been backed up by an initiation of coverage by Morningstar, which tends not to lead when attempting to value such emerging strong growth stories.

This time, however, Morningstar’s $23 fair value estimate (whitelabelled by Ord Minnett) is even higher than your traditional technology enthusiasts at Morgan Stanley (target $22).

Now that I am thinking about it, the All-Weather Portfolio’s exposures to successful and strong growth achievers such as Hub24 ((HUB)), REA Group ((REA)), and WiseTech Global ((WTC)) have all been purchased following a pull-back in the share price.

It always raises the question: how deep should the pullback be?

There’s no golden rule when it comes to playing the share market. One has to deal with what the market offers. I am an avid user of the data and tools on the FNArena service. I look at price targets and where the share price trades. I try not to be too greedy, but I am equally aware investing is not about being perfect.

I always remember anecdotes like that investor who’d only buy CSL below $90 or Wesfarmers ((WES)) below $30. In both cases the price didn’t quite get there, and thus no purchases were made. Now look at where those share prices are trading, and make sure next time it won’t happen to you.

Goes without saying: trends from the past do not continue into eternity. There is equally a valid argument to be made that GenAi has the power to significantly re-shape the world in the years ahead, and that process has only just started.

GenAi won’t be the only source for growth (and disruption) either.

****

Paying subscribers have 24/7 access to my research into All-Weather Performers: https://fnarena.com/index.php/analysis-data/all-weather-stocks/

Recent updates on GenAi and the era of technological advancements:

-VIDEO: https://www.youtube.com/watch?v=yDD3CKlZTM4

–https://fnarena.com/index.php/2024/06/19/rudis-view-genai-the-super-megatrend-part-1/

–https://fnarena.com/index.php/2024/06/20/rudis-view-genai-the-super-megatrend-part-2/

FNArena Subscription

A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (20 since 2006); examples below.

(This story was written on Monday, 24th June, 2024. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena’s see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: contact us via the direct messaging system on the website).

Click to view our Glossary of Financial Terms