As March’s conditions and fears spill into April (including the Ukraine war), it should come as no surprise that Insync funds underperformed the benchmark for the 4 weeks of April. Markets tend to wrong-foot many investors, regardless of investment style, with 2022 becoming a year of extremes. Central banks are dealing with the prospect of stagflation, an environment that bankers do not have experience in, as this last occurred in the early 70’s. Investors trading with a short-term time horizon have rushed into expensive defensive plays boosting their price further such as utilities, consumer staples and energy. They’re attempting a ‘momentum play’. To succeed, their timing will need to be impeccable at both ends. Later on, we will explain by example why this is contradictory to common sense and how you can avoid this risk. History consistently shows that investing on the basis of the short term economic outlook leads to poor outcomes. In 2021 the consensus was that 22’ will be a period of reasonable economic growth and low inflation. That narrative changed quickly to a year where inflation is rising and concerns over recession looms. It is very likely that consensus will be wrong again.
Insync’s focus is always on longer term outcomes. Thus, we invest only in businesses that have the capacity to generate sustainable earnings growth through the cycle and over multiple cycles. Whilst recent fund returns have been disappointing, the businesses in our portfolio continue to deliver strong growth in their revenues and their profits despite the current market backdrop. The consistently longer term strong share price rises of highly profitable growth companies like these, over many decades, supports this approach to investing. In last month’s edition we showed how stock prices over time tracks to this result. For now, the Insync portfolio is trading at a discount well in excess of 50% of our proprietary based DCF methodology.
As an investor this is worth reflecting upon: after the pull back in the markets of some of the most profitable secular growth companies in our portfolio that typically trade on higher P/Es, they are now perversely trading on much lower P/Es, as markets presently ignore their superior financial metrics and earnings power! This will not continue beyond the short term as we explain later on. We strongly believe that for long-term investors, quality growth stocks are now available at bargain prices.
Short-Lived Disconnects (reality V price)
Investors have flocked into defensive sectors to hide in the short-term. Fears of markets falling further has resulted in quality growth stocks becoming attractively valued. In times of volatility, investors are presented with an outstanding opportunity to invest in these enduring businesses.
Here is a real example today of investors losing sight of business realities versus current prices.
Company A - A well-known technology company. It’s recently been aggressively sold down. Yet it’s continuing to be one of the most profitable global businesses, with over 90% market share and compounding revenues at 20+% p.a. for the past 5 years. Despite this investors are attributing a low price to earnings ratio to the business.
Company B – The leading soft drinks company. One which investors have flocked to for safety in the current market clime. It's significantly less profitable than Company A. Revenue growth has been negative over the past 5 years with total revenues today sitting at -19% below 10 years ago in 2012. Despite poor operating performance with no revenue growth for 10 years and no prospects of such, investors are attributing a high price to earnings ratio to the business. Which would you own?
A quirk of markets today that is worth knowing
For now, most investors have flocked to industries and businesses that resemble Company B. Go figure? Interestingly many of the sectors that capital is pouring into since February – and pushing up their prices will likely suffer far more financially than those like Company A and its industry; especially if the dire economic forecasts for the years ahead come true. Again, go figure?
By now you would have worked out that Company A is Alphabet and Company B is Coca-Cola. Clearly there is today a temporary disconnect between fundamentals and share prices! Over the long term the share price of a company follows its earnings growth. Broad indiscriminate market corrections often provide investors a once in a cycle opportunity to invest in the most profitable companies such as Alphabet. This will set them up nicely to achieve strong returns in the future.
How price follows earnings once again
Whilst short term volatility may persist, Insync’s concentrated portfolio of quality stocks across 16 global megatrends is well positioned to perform strongly over the long term. Why? The consistent strong earnings growth these companies are set to deliver should result in much higher share prices over time once markets adjust after the initial shift- as they always do.
Whilst headlines and prices across all tech stocks have been hit hard, only some deserved it. Markets don’t care initially; they just treat all growth stocks the same, quality or not. Only after this period is over the market separates the wheat from the chaff. This table highlights examples of those probably deserving of such a negative move. It depicts their price declines from their all-time recent highs. None of these companies exhibit the financial abilities we at Insync require.
