Renowned value investor Alastair Mundy provides insight into how he and his team categorise the companies they select for their value portfolios.
Before buying a share, it is often a good thought exercise to try and understand why another investor is happy to sell it to you. After all, it is very likely that person is a professional investor with access to the same information as you, but has reached a diametrically opposed view. Sometimes the reason may have nothing to do with the underlying company – for example – the seller might be desperate to raise cash. More often, there is something else at play.
Over the years we have found we can put these more meaningful reasons into five separate pots. And each pot has a classic investment cliché we can attach to it.
Firstly, we like to invest in fallen angels. These are stocks which were previously adored by investors and viewed as having pre-eminent business models. However, at some point something happened – a large but non-fatal blow – which damaged investors' perceptions to such an extent that they lose hope in the business ever regaining its prime position, 'It used to be a good company, but now the competition's caught it up'. We often conclude that the company has temporarily lost its way but, despite a share price fall, that its longer-term prospects are fine…and just as importantly that investors will return and pay a higher price when the company is back on track.
Secondly, we invest in cyclical winners. These companies have perfectly respectable business models but can find themselves buffeted about by issues beyond their control. Perhaps supply has grown significantly ahead of demand in their industry or an economic recession has badly affected demand for their product. In this case, we hear comments such as, 'Why would I buy ahead of a recession'. The point here is that if the shares have already fallen heavily they may well already discount such a recession.
Thirdly, we look for special situation recoveries. A company may have disappointed because of unsuccessful acquisitions or poor strategic decisions. New management may have been appointed but have made it clear that the issues are complex and even if solvable, will take some time to correct. 'This stock's dead money. I can't see a catalyst' say the naysayers.
Fourthly, we try and find hidden assets; those parts of an underperforming business that are still doing well or are simply more valuable in another company's hands. This provides us with some confidence that much of the value of the company is under-written by the good parts and will hopefully be supported by the more troubled areas if they can be brought back to good health. Many investors have at this point given up hope and are more likely to believe the last shoe is about to drop, 'I'm selling before it gets too embarrassing for me'.
Finally, there are some companies which are simply deeply unloved because investors can see no future – only obstacles for the company. 'It's a poor business' or worse 'It's in structural decline'. We need to take these claims seriously, but often find companies have been driven into the ground by poor management and that a new set of eyes can provide a new perspective for a struggling business.
We hold companies from all these buckets within the portfolios in our Value capability. They will not all prosper and some may sorely test our patience before recovering, but historically we have found that stocks perhaps too eagerly discarded by other investors can potentially produce good long-term returns.
The value of investments and any income generated from them can fall as well as rise. Past performance is not a reliable indicator of future results. Investment objectives and performance targets may not necessarily be achieve, losses may be made.
Investec Asset Management is authorised and regulated by the Financial Conduct Authority. May 2019.