Short-Lived Disconnects (reality V price)
All duration has been sold off recently, both in the bond market where yields have increased and in the equity market where growth stocks and in particular growth stocks with negative cash flow have sold off. Whilst many people have recollections of the 2001 Dot Com bubble, this time round there is more to technology stocks than just froth. In fact some of the stocks such as Apple generate extraordinary amount of positive cashflow.
Whilst the sell off of some stocks is justified - think Zip Co, Peleton etc. Many have been caught in the sentiment and now represent good value for long term investors. Below is an interesting read that brings into focus just how far the market has moved in the last six months. Some of the value holdings are now over bought, and the only reason to enter is if you are predicting a prolonged global recession. Per below:
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.
*Quality growth means a business with very high return, returns on invested capital, a high reinvestment rate, and with each dollar reinvested into the business it generates a high incremental rate of return. This is what delivers sustainable compound earnings growth when coupled with megatrends as tail winds whatever the economic situation.
Have a look at the information below. This 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. Its 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?
ESG issues with Company B.
Coming under mounting pressure from governments and campaigners globally for the amount of sugar in their products, some countries are introducing a tax on sugar. Selling coloured water with sugar is not what it used to be in the consumer’s eyes.
Additionally, they sell more than 100 billion plastic bottles every year. This equates to 200,000 bottles a minute. Of these, the unrecoverable majority ends up in the environment and even in the air we breathe.
Company B was ranked the world’s No. 1 plastic polluter by Break Free From Plastic in its annual audit, after its beverage bottles were the most frequently found discarded on beaches, rivers, parks and other litter sites in 51 of 55 nations surveyed. Without tail winds and facing headwinds like this, its future does not seem assured in delivering out-sized financial results.
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.
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Source: Insync Fund Managers April 2022 Update.
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