Upload
others
View
0
Download
0
Embed Size (px)
Citation preview
Uruguay – April 2019
Quality Equities and the Power of Compounding
2
8.0
10.0
12.0
14.0
16.0
18.0
20.0
50.0
72.0
94.0
116.0
138.0
160.0
De
c-0
4
Ma
y-0
5
Oct-
05
Ma
r-0
6
Aug-0
6
Jan-0
7
Jun-0
7
No
v-0
7
Apr-
08
Sep-0
8
Feb
-09
Jul-0
9
De
c-0
9
Ma
y-1
0
Oct-
10
Ma
r-1
1
Aug-1
1
Jan-1
2
Jun-1
2
No
v-1
2
Apr-
13
Sep-1
3
Feb
-14
Jul-1
4
De
c-1
4
Ma
y-1
5
Oct-
15
Ma
r-1
6
Aug-1
6
Jan-1
7
Jun-1
7
No
v-1
7
Apr-
18
Sep-1
8
Feb
-19
Jul-1
9
De
c-1
9
12M forward EPS (LHS) 12M forward PE ratio (RHS)
We are in phase four of the cycle – will earnings implode?
MSCI World EPS Expectations 12M Forward and PE 12M Forward MSCI World EPS NTM Percent
MSCI World PE ratio NTM Multiple
Source: FactSet, Data as of 31/12/2018
PE down –
EPS to follow?
Phase 1
EPS up/PE down
Phase 2
EPS flat/PE up (a lot)
Phase 3
EPS up/PE flat
Phase 0
PE down
then EPS
3
Forward PE back within historic ranges
MSCI World Index PE 12M forward (broker estimates)
Multiple
9
13
17
21
25
Jan-9
9
Jul-9
9
Jan-0
0
Jul-0
0
Jan-0
1
Jul-0
1
Jan-0
2
Jul-0
2
Jan-0
3
Jul-0
3
Jan-0
4
Jul-0
4
Jan-0
5
Jul-0
5
Jan-0
6
Jul-0
6
Jan-0
7
Jul-0
7
Jan-0
8
Jul-0
8
Jan-0
9
Jul-0
9
Jan-1
0
Jul-1
0
Jan-1
1
Jul-1
1
Jan-1
2
Jul-1
2
Jan-1
3
Jul-1
3
Jan-1
4
Jul-1
4
Jan-1
5
Jul-1
5
Jan-1
6
Jul-1
6
Jan-1
7
Jul-1
7
Jan-1
8
Jul-1
8
-6%
below
average
Source: FactSet, Data as of 31/12/2018
4
Adjusting for leverage, buy backs and tax, EV to EBITDA +1 STDEV
above average
MSCI World – EV to EBITDA 12M forward EV to EBITDA (broker estimates) Ratio
6
7
8
9
10
11
12
Jan-9
9
Jul-9
9
Jan-0
0
Jul-0
0
Jan-0
1
Jul-0
1
Jan-0
2
Jul-0
2
Jan-0
3
Jul-0
3
Jan-0
4
Jul-0
4
Jan-0
5
Jul-0
5
Jan-0
6
Jul-0
6
Jan-0
7
Jul-0
7
Jan-0
8
Jul-0
8
Jan-0
9
Jul-0
9
Jan-1
0
Jul-1
0
Jan-1
1
Jul-1
1
Jan-1
2
Jul-1
2
Jan-1
3
Jul-1
3
Jan-1
4
Jul-1
4
Jan-1
5
Jul-1
5
Jan-1
6
Jul-1
6
Jan-1
7
Jul-1
7
Jan-1
8
Jul-1
8
+9%
above
average
Source: FactSet, Data as of 31/12/2018
5
…Looking at EV to sales, valuations down a bit, but still ~19%
above historic averages
MSCI World EV to Sales EV to 12M forward sales (broker estimates) Ratio
1.00
1.20
1.40
1.60
1.80
2.00
2.20
Jan-9
9
Jul-9
9
Jan-0
0
Jul-0
0
Jan-0
1
Jul-0
1
Jan-0
2
Jul-0
2
Jan-0
3
Jul-0
3
Jan-0
4
Jul-0
4
Jan-0
5
Jul-0
5
Jan-0
6
Jul-0
6
Jan-0
7
Jul-0
7
Jan-0
8
Jul-0
8
Jan-0
9
Jul-0
9
Jan-1
0
Jul-1
0
Jan-1
1
Jul-1
1
Jan-1
2
Jul-1
2
Jan-1
3
Jul-1
3
Jan-1
4
Jul-1
4
Jan-1
5
Jul-1
5
Jan-1
6
Jul-1
6
Jan-1
7
Jul-1
7
Jan-1
8
Jul-1
8
+19%
above
average
Source: FactSet, Data as of 31/12/2018
6
15%
16%
17%
18%
19%
20%
De
c-9
8
Jun-9
9
De
c-9
9
Jun-0
0
De
c-0
0
Jun-0
1
De
c-0
1
Jun-0
2
De
c-0
2
Jun-0
3
De
c-0
3
Jun-0
4
De
c-0
4
Jun-0
5
De
c-0
5
Jun-0
6
De
c-0
6
Jun-0
7
De
c-0
7
Jun-0
8
De
c-0
8
Jun-0
9
De
c-0
9
Jun-1
0
De
c-1
0
Jun-1
1
De
c-1
1
Jun-1
2
De
c-1
2
Jun-1
3
De
c-1
3
Jun-1
4
De
c-1
4
Jun-1
5
De
c-1
5
Jun-1
6
De
c-1
6
Jun-1
7
De
c-1
7
Jun-1
8
…as the market still believes margins will continue to improve…
and earnings won’t implode
MSCI World EBITDA Margin 12M forward, broker Percent
+348bp
Source: FactSet, Data as of 31/12/2018
7
MSCI World Index
Energy
Materials
Industrials
Cons. Disc.
Staples
Health
Financials
IT
Communications
Utilities
R² = 0.9631
0%
4%
8%
12%
16%
-4% -2% 0% 2% 4% 6% 8% 10% 12% 14%
Pri
ce C
AG
R
EPS CAGR
Earnings growth explains price movements in the medium term
10 Years EPS and Price CAGR by MSCI World Sector
Percent
MORE RERATING
LESS RERATING
Source: FactSet, Data as per 31/12/2018
8
The share price outperformance of US markets versus Europe is
predominantly a function of stronger earnings
MSCI USA Price and EPS relative to MSCI Europe over the last 20 years Index
US relative EPS and price outperformance
55
75
95
115
135
155
Price EPS
Source: FactSet, Data as per 31/12/2018
9
Two major threats to earnings
Corporate Profits/GDP
0%
2%
4%
6%
8%
10%
12%
14%
Political headwinds
The global political consensus
of the last 40 years is
unravelling:
• China shifting focus
• Trade wars
• Fragility of the Eurozone
• Rise of Populism
• Higher labour cost
• Tech regulation
Tightening is here
After nearly 10 years of
unlimited liquidity, we now
have:
• US tightening into a potential
slowdown
• Rising debt cost weighs on
net profit margins and
increases credit risk
• Growing government budget
deficits sap corporate
liquidity
• Renminbi devaluation?
10
Two major threats to earnings
Corporate Profits/GDP
0%
2%
4%
6%
8%
10%
12%
14%
Political headwinds
The global political consensus
of the last 40 years is
unravelling:
• China shifting focus
• Trade wars
• Fragility of the Eurozone
• Rise of Populism
• Higher labour cost
• Tech regulation
Tightening is here
After nearly 10 years of
unlimited liquidity, we now
have:
• US tightening into a potential
slowdown
• Rising debt cost weighs on
net profit margins and
increases credit risk
• Growing government budget
deficits sap corporate
liquidity
• Renminbi devaluation?
11
QE has been great for asset prices, but now QT is here
Central Bank Assets vs. MSCI World $ Trillions Index (Dec1998=100)
Source: FactSet
282
100
600
5
10
15
20
Fed (LHS) PBoC (LHS) BOJ (LHS) ECB (LHS) MSCI World Total Return (RHS)
12
Tightening is here: US corporate leverage is close to all time highs
when adjusting for excessive EBITDA margin
Total Debt to EBITDA Ratio
1.50
2.00
2.50
3.00
3.50
Ma
r-9
0
No
v-9
0
Jul-9
1
Ma
r-9
2
No
v-9
2
Jul-9
3
Ma
r-9
4
No
v-9
4
Jul-9
5
Ma
r-9
6
No
v-9
6
Jul-9
7
Ma
r-9
8
No
v-9
8
Jul-9
9
Ma
r-0
0
No
v-0
0
Jul-0
1
Ma
r-0
2
No
v-0
2
Jul-0
3
Ma
r-0
4
No
v-0
4
Jul-0
5
Ma
r-0
6
No
v-0
6
Jul-0
7
Ma
r-0
8
No
v-0
8
Jul-0
9
Ma
r-1
0
No
v-1
0
Jul-1
1
Ma
r-1
2
No
v-1
2
Jul-1
3
Ma
r-1
4
No
v-1
4
Jul-1
5
Ma
r-1
6
No
v-1
6
Jul-1
7
Ma
r-1
8
No
v-1
8
Total Debt/EBITDA Normalised total debt to EBITDA
Source: FactSet, data as of 31/12/2018 Note: EBITDA adjustment assume average EBITDA margin 1990 – 2017.
13
Two major threats to earnings
Corporate Profits/GDP
0%
2%
4%
6%
8%
10%
12%
14%
Political headwinds
The global political consensus
of the last 40 years is
unravelling:
• China shifting focus
• Trade wars
• Fragility of the Eurozone
• Rise of Populism
• Higher labour cost
• Tech regulation
Tightening is here
After nearly 10 years of
unlimited liquidity, we now
have:
• US tightening into a potential
slowdown
• Rising debt cost weighs on
net profit margins and
increases credit risk
• Growing government budget
deficits sap corporate
liquidity
• Renminbi devaluation?
14
The Eurozone fragility is a recurring feature that dampened
business and consumer confidence in the upturn
Eurozone Economic Confidence Indicator
Index
50
62
74
86
98
110
122
Euro sovereign
debt crisis
Brexit
Italy election
and budget
Source: Bloomberg, Data as of 31/12/2018
15
Populism is on the rise
Democrat Populist Autocrat
= In post since 2017
= Already agreed to step down
16
Populism could increase labor costs, and hit corporate profitability
US Wages and Corporate Profits as Percent of National Income
Percent
Source: BEA. Data last updated December 31, 2017
7%
9%
11%
13%
15%
58%
61%
64%
67%
70%
Ma
r-4
7
No
v-4
8
Jul-5
0
Ma
r-5
2
No
v-5
3
Jul-5
5
Ma
r-5
7
No
v-5
8
Jul-6
0
Ma
r-6
2
No
v-6
3
Jul-6
5
Ma
r-6
7
No
v-6
8
Jul-7
0
Ma
r-7
2
No
v-7
3
Jul-7
5
Ma
r-7
7
No
v-7
8
Jul-8
0
Ma
r-8
2
No
v-8
3
Jul-8
5
Ma
r-8
7
No
v-8
8
Jul-9
0
Ma
r-9
2
No
v-9
3
Jul-9
5
Ma
r-9
7
No
v-9
8
Jul-0
0
Ma
r-0
2
No
v-0
3
Jul-0
5
Ma
r-0
7
No
v-0
8
Jul-1
0
Ma
r-1
2
No
v-1
3
Jul-1
5
Ma
r-1
7
Wages as % of national income (excl. government) (LHS) Corporate Profits before tax as % of National Income (RHS)
17
Tech regulation is on its way – as well as a more robust approach
to anti-trust
US Federal regulation by sector Thousands
215
128
124
99
85
47
45
37
27
Manufacturing
Finance
Transportation
Media & telecom
Natural resources
Utilities
Education
Health care
Technology & E-commerce
Source: BofAML Global Investment Strategy, Data as of 31/12/2018
18
How to navigate challenging markets?
19
Characteristics of quality earnings
High return on
unlevered operating
capital employed
Resilient earnings
and free cash flow
Recurring Revenues
Pricing Power
Strong Intangible
Assets
…pricing power should help
preserve margins
…low capital intensity drives higher
free cash flow conversion
…recurring revenues should protect
the top line
In uncertain times….
20
(120%)
(100%)
(80%)
(60%)
(40%)
(20%)
0%
20%
HealthCare
ConsumerStaples
Utilities Telecoms Energy IT Overall Industrials MSCIWorld
Materials Financials ConsumerDiscretionary
IT Soft& Serv
ITHardware
ITSemis
Quality earnings are the most robust in a downturn
NTM Forward EPS Change During Financial Crisis Drawdown (Oct 2007 – Feb 2009)
Chart Source: FactSet. Data as of July 31, 2018
21
What is a quality compounder
Distribution of wealth
to shareholders
22
Compounding at work: Reckitt Benckiser
Organic Sales Growth (1)
(%) (%)
Attractive Total Returns (1)
Indexed, USD
10
15
20
25
30
0
4
8
12
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017Organic Sales Growth EBITA Margin
0300600900
1,2001,5001,800
2000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2011 2012 2013 2014 2015 2016 2017
Reckitt Benckiser MSCI World Index
Reckitt Benckiser CAGR 16.8%
MSCI World Index CAGR 4.7% $1,638
$227
28.1%
Earnings per share CAGR 12.9%
Dividend per share CAGR 9.9% Category Kings:
• ROOCE (2): 123%
• Gross Margin (2): 59%
• CAPEX/Sales (2): 2.7%
• Margin Stability (2): 95%
• Organic Sales Growth (1): 6.0%
Source: FactSet & annual company report. 1. Data from January 1, 2000 to December 31, 2017. Updated Annually (from company report circ. March). 2. ROOCE (Return on Operating Capital Employed) = Ebita (Earnings Before Interest, Taxes and Amortization) / PPE (Property, Plant, Equipment) + Trade working capital (excludes goodwill). Ex-Financials. ROOCE, Gross Margin and Capex/Sales are last reported and ex-Financials. EBIT margin stability is (1-(std deviation)/mean)). Five year averages to December 31, 2017. This example is provided for illustrative purposes only. This should not be construed as a recommendation, but as an illustration of a broader theme. Past performance is not a reliable indicator of future results. Within an investment portfolio, this security could be one of many holdings and is not representative of how all holdings in portfolio would have, or will, perform. The portfolio management team did not hold this security during the entire time period reflected above and may have bought and sold the security (at a gain or loss) at various points through this period. There is no guarantee securities will perform well and compound shareholder returns over time. MSCI World index shown for comparative purposes only. It is not possible to invest directly in an index. CAGR = Compound annual growth rate as of December 31, 2017. Group EBITA Margin ex Reckitt Pharma division. Holdings shown based on equities within the Top 10 Holdings for the quarter which have a return on operating capital employed of over 30% and gross margins over 30%. Logos reprinted with permission of Reckitt Benckiser
A superb innovator and brand extender
Flat
23
Capital intensive companies do not generally compound
Where to find quality compounders
• Consumer staples
• Information technology
• Consumer discretionary
• Health care
• Materials
• Telecom
• Utilities
• Energy
• Real estate
Companies with pricing power and resilience are excellent sources
of quality compounders
TAKEAWAY
A search for quality compounders leads to a portfolio heavy in consumer and the softer side of tech
COMPOUNDER RICH COMPOUNDER LIGHT
24
• Average returns are
not the same as
compounded
returns.
The example shown is for illustrative purposes only. The data have been chosen to convey the concept of compounding and the
erosive effects of volatility on returns.
YEAR LESS VOLATILE RETURNS
Alternating years of 7% and 9% gains
MORE VOLATILE RETURNS Alternating years of 32% gains, 16% losses
$1,000,000 $1,000,000
1 7% 1,070,000 32% 1,320,000
2 9% 1,166,300 -16% 1,108,800
3 7% 1,247,941 32% 1,463,616
4 9% 1,360,256 -16% 1,229,437
5 7% 1,455,474 32% 1,622,857
6 9% 1,586,466 -16% 1,363,200
7 7% 1,697,519 32% 1,799,424
8 9% 1,850,296 -16% 1,511,516
9 7% 1,979,816 32% 1,995,202
10 9% $2,158,000 -16% $1,675,969
Average annual return 8.0% 8.0%
Compound annualized return 8.0% 5.3%
TAKEAWAY
Quality stocks tend to have relatively low volatility of returns, which powers compounding
Compounding: How it works
25
Compounding at work
-
100
200
300
400
500
600
700
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
To
tal R
etu
rn o
f $
10
0
Years
$612
$395
10% CAGR
7.5% CAGR
$195
$380
$206
7.5% AVG
$209
Average returns are not the same as compounded returns
26
• Historically, quality has
delivered lower volatility
and higher return than
traditional broad
equity benchmarks
Quality investing offers attractive risk return profile
Source: Morgan Stanley Investment Management 1. Past performance is not a reliable indicator of future results. Performance returns reflect the average annual rates of return.
The comparison indices are the MSCI World Index, the MSCI EAFE Index, the S&P 500 with Income Index, the MSCI World Consumer Staples Index, the FTSE All Share Total Return Index, MSCI AC World Free Blend (ACWI) Index and the MSCI World Quality Index. The period start date is March 31, 1996. Data updated quarterly.
2. The MSCI World Quality Index was launched on December 18, 2012. Data prior to the launch date is back-tested data (i.e. calculations of how the index might have performed over that time period had the index existed). There are frequently material differences between back-tested performance and actual results.
Volatility vs. Return – March 31, 1996 to December 31, 2018
Annualized Return (%)
MSCI World
MSCI EAFE
S&P 500 MSCI World Consumer
Staples
FTSE All Share
MSCI ACWI
MSCI World Quality
2
3
4
5
6
7
8
9
10
10 11 12 13 14 15 16 17 18
Volatility (Standard Deviation %)
(2)
27
The key to compounding wealth
Think in
Absolute
Rather Than
Relative Terms
Strive to
Avoid the
Permanent
Destruction
of Capital
RULE 1: DON’T LOSE MONEY
RULE 2: DON’T FORGET RULE 1 – Benjamin Graham
28
Appendix: Building a Quality Portfolio
29
Source: Factset MSCI Indices February 2019
United States 609 Developed markets (ex US) 990 Emerging markets
Over 2,400
865
There are a lot of companies out there….
30
What approach?
• Passive or Active
• Top-down
• Bottom up What markets?
• Developed markets
• Emerging markets
• Regional
What style?
• Growth
• Value
• Large cap
• Mid cap
• Small cap
…And many ways to approach the market
31
• The ‘management’ choice > Active or Passive?
• The ‘style’ choice > Growth or Value?
• The ‘market’ choice > Developed or Emerging?
• The ‘investment approach’ choice > Top Down or Bottom Up?
Where do you start?
32
ACTIVE MANAGEMENT PASSIVE MANAGEMENT
Objectives • Alpha
Deliver alpha relative to a representative benchmark or
index
• Absolute return-orientation
Generate a positive return regardless of market conditions
• Seeks to replicate a benchmark
Aims for “market” or “index” returns
Strategy • High conviction strategy
Portfolio based on research and a defined philosophy &
process for implementation
• Replication strategy
Portfolio is constructed to closely mirror that of the index
Risk management • Defined in absolute terms (loss of capital)
• Cares about price and quality
• Defined by the index (loss vs index)
• Doesn’t care about price or quality
Cost • Higher cost
Management fees are generally higher to compensate for
time and expertise to manage strategy
• Lower cost
Management fees are generally lower than those of active
managers
Behavior • Returns may vary significantly vs index • Returns closely track index
minus fees
The ‘management’ choice
33
Average
market
valuation
Growth investors purchase stocks with high and rising
earnings expectations
• Growth stocks’ growth rates are
projected to be above the market
average
• Often do not pay dividends
• Returns often based solely on
capital gains
• Popular growth stocks include
Amazon, Tesla and Square
Challenge overpaying for growth
The ‘style’ choice
Value investors
purchase stocks at depressed prices,
with the expectation they will recover
• Often described as under-valued
or mispriced
• Typically generate a high dividend
yield
• Popular value stocks include Bank
of America, AT&T and Walmart
VALUE
TRAP
Challenge avoiding ‘value traps’
34
The ‘markets’ choice
DEVELOPED MARKETS EMERGING MARKETS
Characteristics • Ease of capital movement
• Efficiency of market institutions
• Developed infrastructure
• More consumption driven
• Increasing economic freedom
• Gradual integration with global marketplace
• Expanding middle class; improving living standards
• More capital driven
Risk-return profile • Relatively stable economies
• GDP growth generally lower with less volatility
• High quality of governance
• Less stable economies
• GDP growth generally higher with higher volatility
• Lower quality of governance
Ten largest (per GDP2)
1. U.S.
2. Japan
3. Germany
4. United Kingdom
5. France
6. Italy
7. Canada
8. Australia
9. Spain
10. Netherlands
1. China
2. India
3. Brazil
4. Russia
5. South Korea
6. Mexico
7. Indonesia
8. Turkey
9. Saudi Arabia
10. Argentina
1 As defined by per capita income 2 Source: Wikipedia
as of 2015-2018
35
The ‘investment approach’ choice
TOP-DOWN
portfolio construction focuses on macro factors:
• GDP
• Trade balances
• Inflation
• Interest rates
• Government
• Market risk
BOTTOM-UP
stock selection focuses on company specifics:
• Business model
• Competitive advantages
• Margins, cash flow, leverage
• Capital requirements
• Management
• Company risk
36
The Quality Choice . . .
High Quality
Active
Global
Fundamental
37
Growth stocks Value stocks
Growth
investors
Value
investors
Quality
Management Good capital allocators
Powerful Intangible
assets - Brands and networks
Pricing power
- high gross margins
Strong free
cash flow
Sustainable profits - high rooce*
FILTER FOR QUALITY ATTRIBUTES
*ROOCE (Return on Operating Capital Employed) = Ebita (Earnings Before Interest, Taxes and Amortization) / PPE (Property, Plant, Equipment) + Trade working capital (excludes goodwill).
Choose quality rather than a growth or value style box
38
PASSIVE MANAGEMENT ACTIVE MANAGEMENT
Objectives Seeks to replicate a benchmark Sustainable compounding of long term returns
Absolute return-orientation
Strategy Replication strategy High conviction strategy
Risk management ???
Absolute
Behavior Returns closely track index Returns may vary vs index
Choose active, high-conviction
39
Choose to invest globally….
Revenue
from
emerging
markets
….Given the scarcity of high quality companies
There are so few high quality compounding companies even when you
search everywhere in the world.
A disciplined investment process results in a portfolio of companies
listed in developed markets – multi nationals generating revenues
throughout the world
The result is a portfolio of companies with strong governance practices
(often a by-product of developed markets exposure) while accessing the
growth of the EM consumer indirectly
1 Economic Exposure in Global Investing; 2014 MSCI Inc.
21%
MSCI World Index
Average % of revenue of developed companies
derived from emerging markets. 1
40
Buy businesses, not macro
TOP-DOWN BOTTOM-UP BUY BUSINESSES FOR
THE LONG TERM
Portfolio construction focuses on macro
factors:
• GDP
• Trade balances
• Inflation
• Interest rates
• Currency swings
• Sector outlooks
• Other ‘factor’ exposures
Stock selection focuses on company
specifics:
• Business model
• Competitive advantages
• Margins, cash flow, leverage
• Capital requirements
• Material ESG factors
• Company management
• Intangible assets
• Other stock-specific attributes
Owning a stock means owning a business
• Make investments for the long term, to allow seeds of
compounding to bear fruit
• Avoid the distraction of top-down, short-term market noise
Examine stock-specific attributes
• Franchise Quality
• Management Quality
• Financial Strength
Avoid unnecessary constraints
• No benchmark constraints
• No geographical constraints
• No style box constraints
• No sector constraints