What to expect in Q2, dividend strategies, 100 baggers with Chris Mayer, and quality/value with John Rosier
The best investment research, blogs and podcasts this week
With the first three months of the year already gone, there has been an avalanche of Q2 previews in the past couple of weeks. Details vary but the main themes are crystal clear: how quickly can central banks get inflation under control, and what impact will their rate-hiking efforts have on the economy (or to put that another way, when will recession eventually hit us?)
I wrote about this a bit in my interactive investor column this week, but the main barometers of the near-term outlook are sending interesting messages. The first - the stock market - got off to a solid start in 2023. And despite a turbulent month in March, April has picked up again. So far.
Given that equity markets are ultimately driven by the outlook for corporate earnings, it suggests that investors are sanguine on the prospect of any recession.
A second barometer - the bond market - had a tough year in 2022. Central bank action caused government bonds to fall sharply, which caused a reset. The yields on these bonds are now much more appealing to longer-term investors. And while the US fed has been keen to insist that it won’t lower rates this year, the bond market in pricing cuts in, nonetheless.
In summary: it’s a very mixed picture.
Paul O’Connor, Head of Multi-Asset at Janus Henderson, wrote that uncertainty about future rate moves is at its highest since the financial crisis:
“Investors have clearly struggled to decide how the conflicting influences shaping interest rates will balance out in the quarters ahead. Options prices show that the level of uncertainty surrounding US interest rates has recently touched heights last seen during the Global Financial Crisis.”
His view is that taking defensive positioning is the optimal strategy for the time being:
“…we are at the stage of the economic cycle in which investors should prioritise defensive investment strategies, higher asset quality and diversification over more cyclical and higher-risk investment exposures.”
A neat summary of equity market moves this year comes from Fabiana Fedeli, the CIO at M&G Investments:
“In all of this, equity markets – which looked less attractive than their fixed income equivalents earlier this year, after a glorious January, a torrid February (and first half of March), and a decisive recoup in late March – took the gold medal for resilience.”
Here’s a chart that shows what she means:
Note that the US Nasdaq has had a very solid start to 2023, with a 17% rise, after such a miserable year in 2022. All said, equities were generally upbeat everywhere in Q1.
Less than half of global dividend stocks have a yield over 2%
On the subject of rising bond yields, the shifting fortunes for fixed income over the past year could lead to a rethink about the viability of some equity income strategies.
Company dividends have really been the only game in town on a consistent basis for investors wanting cash yields over the past decade or so. That all changed last year, and this note from AllianceBernstein: Dividend Investing: Broader Is Better for Multi-Asset Strategies raises the point that traditional dividend strategies are in some ways surprisingly narrow.
First, the good news: dividends certainly do propel equity returns over time - see the chart on the left. However, they aren’t reliable year-in, year-out - see the table on the right.
Here are the main points:
Traditional dividend strategies tend to gravitate to defensive sectors, which can mean they lag in bull markets
Dividend-payers tend to have value traits, which makes them competitors to high-growth companies that reinvest profits to expand
Recent market trends (massive re-rating of growth/tech stocks) means less than half of the global universe has a dividend yield over 2%
Income seekers should expand into other areas of the equity market - take a systematic approach to harvest yield across countries, styles and sectors
Investors should assess stocks on dividend yield as well as factors like price momentum, quality and earnings strength, to build a more well-rounded portfolio
A more systematic approach to dividend-investing can help to reduce sector differences (by embracing sectors that aren’t just defensive)
Chris Mayer: in search of high returns over the long term
We Study Billionaires Podcast 100 Baggers: Stocks that Return 100-1 w/ Chris Mayer
Chris Mayer is an interesting guy. For a long time he wrote an investment newsletter that was under the umbrella of Bill Bonner’s Agora group. Then he started managing some of Bonner’s family money, which he still does, but these days as the manager of Woodlock House Family Capital. A few years ago, Mayer wrote 100 Baggers.
A 100 bagger is a stock you put a dollar into and get a hundred back
His book 100 Baggers is based on updating a book called 100 to 1 in the Stock Market by Thomas Phelps
Key characteristics of 100 baggers
Mayer stripped out nano-cap extremes (which were unpredictable). He was hoping to find a statistical profile of winning stocks, but didn’t really find one “because the paths up the mountain are so varied”. But there were some common characteristics:
All of them took a long time (20-25 years) to get there
The maths of 100 baggers is that you have to compound capital at 20-25% a year for 20-25 years. That means you have to find companies that grow a lot. It was companies that had the world as their market - the McDonald’s and Home Depots of the world - that grow, grow, grow and deliver high returns on capital over a long period of time
Most companies had some kind of moat. There was something that they did that was difficult to copy
Often there was an entrepreneur who was a driving force behind it
Most of the time great companies carry premium valuations - but it can still work out. If you’re investing for the long haul, there will be times down the line when the companies you’re invested in become cheap and you can continue to buy them. If you’re right about the business, you probably have more room on valuation than you probably think.
On assessing the durability of a company moat…
Usually it means avoiding things that are very cyclical (for example, oil and gas companies can earn great returns, but only at certain times in the oil cycle).
Winners tend to keep winning because they have some competitive advantage that makes them special. There are different types of competitive advantages and you really have to look at it on a case-by-case basis to figure out whether a business can generate high returns over a long period of time.
On the subject of insider ownership…
The more Mayer studied businesses the more he realised that businesses are about people… Some are so great that they can survive having lousy management but he thinks skin in the game is important. The behaviour of people who own a lot of stock in their businesses comes out especially in times of crisis. They will continue to invest during downturns, whereas a hired-hand CEO might pull back and preserve his job.
It’s the same with family-owned businesses. They have certain behavioural patterns. They don’t play that quarterly earnings game, they tend not to give guidance, they tend to use less financial leverage. The incentives are more aligned and they are on the same side as you.
On conviction and diversification…
Chris runs a concentrated portfolio with around 10 holdings. How does he get comfortable with that focus?
Wouldn’t recommend it for everyone
He doesn’t go near anything that is too leveraged, he stay away from businesses that are too cyclical and all the stocks he owns produce a lot of cash
They have entrenched competitive advantages
Odds of a permanent impairment in any one of them is quite low
He says there is a good case for concentration. The advantages of diversification roll off pretty quickly on the way up to 20. “I get to know the businesses well and understand them deeply.”
Companies mentioned…
Copart - good capital allocator that outmanoeuvred its main competitor
Constellation Software - outstanding M&A approach
John Rosier - a small-cap quality / value strategy
Here’s an interesting video interview with UK investor and blogger, John Rosier: Private Investor Diary: Introducing John Rosier.
John started John’s Investment Chronicle back in January 2012 and used it as a public place to run some of his own money in the stock market, with funds and equities. The idea is to make money over the medium to long term and not lose too much.
In 11 years and three months up to the end of March, his annualised performance was 13.2%. Over the same period the FTSE All Share annualised was 7.2% (dividends included)
The portfolio hit a peak 21 months ago, which has meant the intervening period has been tricky
John also runs an all-funds portfolio, which he started in July 2020 (it’s his wife’s SIPP). He did that because there was a demand from readers who didn’t have time or desire to pick stocks. He mainly uses investment trusts and doesn’t do much chopping and changing with that portfolio.
In there, the main UK exposure is through Chelverton UK Equity Growth. In that case it’s a fund rather than an investment trust, so John can’t take advantage of discounts (IT share prices can sometimes trade at a discount to the IT’s net asset value) but the performance “has been fantastic”.
John’s investment style…
Prefers to be a bottom-up stock-picker
Value approach (more relaxed about buying stocks on 12x, 13x, 14x earning that stocks on 24x or 25x
Start with a reasonable valuation and look for earning that are growing quicker than the market (ideally earning forecast upgrades)
John looks at half-year on half-year company reports as a way of detecting the likelihood of earnings forecast upgrades
People take notice and you get a revaluation on higher earnings
He likes companies with a lot of free cash flow
On the subject of dividends…
“At the moment they are really important to me. We’re going through a stage where ‘value’ is going to do better. A bit like the early 2000s, where we came off the dotcom boom. From March 2000 everyone piled into value, and it had a good run for four or five years.
“I think it’s best to stick with stuff where the balance sheets are pretty strong, they have net cash, paying decent dividends and you can feel reasonably comfortable about the earnings outlook. So at the moment, I’m big into dividends.”
On commodities exposure…
He has a substantial exposure to commodities. Interesting supply and demand dynamics where the drive for clean energy is driving demand for certain metals, but ESG priorities are making it harder to open new mines. This strategy worked well for him last year but not in Q1 2023 (presumably on economic concerns).
On deciding when to sell…
“It’s so difficult.” Some people have automatic rules and just cut, say, when a stock falls 20%. But I don’t like doing that because unless something has changed then the stock’s just 20% cheaper, so you should actually be buying more… You have to look at everything on its merits.
Companies mentioned…
ME Group (Photo-Me) - a classic compounder
Serica Energy - his second largest position
Bloomsbury Publishing - great financial results
Bioventix - held for eight years
Shoe Zone - a retail winner
IG Design - impressive management
Man Group - on the watchlist but needs more research
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