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From March 2000 to January 2007, the MSCI World Value Index returned nearly twice that of the MSCI World Growth Index. Since then, it has under-performed by 52%. Has the pendulum swung too far once again? Is now the best time to take some profit on growth and quality strategies and switch to value investing? Or, has the world changed so much that the value strategy is no longer relevant? BizNews founder Alec Hogg found out more by chatting to Sean Peche, director and portfolio manager at UK-based Ranmore Fund Management, during this intriguing webinar. – Claire Badenhorst
Alec Hogg: Lovely to be with you, Sean, today on this special podcast. Sean is based, not here in South Africa, but you spent, well, much of your life in South Africa.
Sean Peche: Yes. Good morning, Alec, and thanks very much for the opportunity. It’s good to be here. A thumbnail sketch. I grew up in Cape Town and went to Deloitte where I qualified as a Chartered Accountant. Went to Old Mutual; spent a few years at Old Mutual and then joined a company called Decillion where we started a hedge fund, one of the early hedge funds in South Africa – the Big Rock Fund – ran that for a few years, then came over to the UK with a good friend and ex-colleague, Richard Pitt, where we set up a hedge fund over here. That was in 2001.
Then I left and joined Orbis where I spent a wonderful five years with some fantastic people, including the late great Simon Marais. I had the privilege and pleasure of working with Simon and also the late great Mr Allan Gray, and then left and started Ranmore in 2008. So that’s a whistle-stop tour.
Fantastic. Sean will be guiding us through his views and he’s got some very interesting charts to share with us. But it’s all about value investing. Today, value investing is kind of out of fashion. So just maybe tell us a bit more about that – what is value investing, maybe, to start off with, and why is it relevant today?
Well, Alec, if you look at value investing, I mean, essentially it’s just buying something for less than it’s worth. I’d argue we’re all really value investors. Everybody likes a bargain. If there’s a special on holidays, you might want to take advantage of that and go on holiday, or buy a car close to quarter-end and get the same car, but just at a better price.
So that is really what value investing is all about – just trying to buy something for less than it’s worth. And the reason being: well-bought is half-sold. If you buy something at a good price, you’re basically halfway to having sold it, whereas, if you buy something at the top of the market, things have got to go really well for you to get your money back.
So if you compare them, growth investors are focused primarily on earnings growth and sometimes, at any price, and quality investors are focused on the quality of businesses – return on equity, cash flow, margins – those types of things. Of course, they’re not mutually exclusive. I mean, we as value investors, of course, we want to buy quality. Who wouldn’t want to buy quality? Who wouldn’t want to buy something that’s growing? We just don’t want to do it at any price, and the reason we don’t want to do it at any price is, that is how we try and minimise the risk of a permanent loss of capital. So that’s all value investing is. It’s nothing esoteric. It’s a timeless concept. So that’s what we do.
So it is really common sense. Warren Buffett has always told us that we have a margin of safety in anything that we purchase because we might be getting our calculations on the value of the company wrong. So give yourself a 20% margin of safety and then when it comes to time to sell the investment that you made, you’re at least going in at a low level. So you’ve got a presentation for us over the next few minutes. Let’s kick off.
Well, I think the reason we want a margin of safety is because things change. Let’s just think in terms of Covid – what’s happened in the last six months. Arguably, shopping centres are worth a lot less today than they were at the beginning of the year. You could say the same thing for airlines and cruise ships. So business has changed and the price and value of things also changed, but that is not only for value stocks. It is the same thing for growth stocks. We have seen that forecasts and conditions can change very rapidly, and for that reason, one has to be very careful about how much you pay for future growth, because likewise, things can change for those companies, too. There’s lots of examples of those.
Brilliant. So let’s talk to those forecasts. You’ve got a lovely story there about BlackBerry.
What you’re looking at here is the blue line is the share price of BlackBerry and the orange line, which is a bit stepped, is the earnings per share for BlackBerry, and that’s on the right hand side. If you go back to the early 2000s, I mean, BlackBerry really came into its own during 9/11 when everybody was using their BlackBerry to message people at the top of the towers. Then in 2009, BlackBerry had half of the US smartphone market – you can see that in the lower left chart – 55% of the market compared to Apple. They were growing subscribers. People were getting very excited about the total addressable market. At the time, only business people used Blackberries but it could expand that.
So earnings grew and then, right at the peak, they launched the BlackBerry Storm and that was the first touch phone. So everything was going well for BlackBerry, and people at the top, if you had the misfortune of buying BlackBerry, you were paying 42 times forward earnings. Earnings continue to grow, but wow, you’ve lost most of your money – 95% – because along came Apple. Just when everybody thought BlackBerry was impenetrable. It had the touch screen, had the security, and the control, etc. Along comes Apple with a slightly better product and 12 years later, BlackBerry is nowhere to be seen.
So that is the first challenge – one has to be very careful about being so wedded to your forecast because forecasts change, and they certainly change when there’s competition. People looked at BlackBerry, saw how well they were doing and thought, we can do that and we can do it better.
Great. You have Microsoft on the screen now?
Well, I mean, Microsoft – is there a better quality company, if you think about it? Annuity income, wonderful cash flow, embedded in businesses around the world, and if you go back to 1999 to the tech bubble, back then earnings were growing and you paid $40 for Microsoft. It was a forward multiple of 34 times and your forecasts of growth would have been right. Ever since then, Microsoft, over the long term, has grown earnings substantially and earnings per share have grown from around 80 cents to $6.
The problem is, for 14 years, Microsoft’s share price did nothing. In fact, at one point in 2009, the company was in seven times earnings and you’d lost more than 50% of your purchase price had you bought it at the wrong time. So here’s an example of a company that is just of impeccable quality, and was forecast to grow, and had market share dominance, etc. Yet because you overpaid, it took you a long time to get your money back.
So that’s the lesson here. I mean, who doesn’t want quality? Of course, we all want quality, but don’t overpay for it because it might take you a long time to get your money back.
If you’d held on for the whole period, even though you bought it at the peak in 1999, you’d still be looking pretty today.
You certainly would but we only know that with hindsight because if you’d held on with BlackBerry, with the same thought in mind, you would have been looking pretty terrible. One only knows who the winners really are with hindsight. We can think that they’re going to be winners, and they might end up being winners but that doesn’t always play out.
There’s your next graph.
We’ve obviously seen there’s lots of articles doing the rounds in recent months and years about, well, value is finished; it’s an outdated philosophy, etc. I might point out that those same arguments were made at the peak of the tech bubble in 1999. What you’re looking at here is the green line is, had you invested in the MSCI World Value Index in October 1980, your $100 would be worth $3,100, and had you invested in the growth index back then, your $100 would be worth $3,263. So pretty much neck and neck, and you’ve returned 9% and 9.1% respectively, compounded through that time, well above inflation. So the problem is not that value strategy has destroyed wealth – it hasn’t. It is just that, in recent years, it has substantially underperformed.
If you stop the clock along the way at various points in time, you’ll see that post the 2000 correction, value substantially outperformed – far more than growth. If you look at the vertical red line, at the end of 2017, had you invested in those strategies in 1980, value strategy would’ve been 10% and 8.7% for growth. So, as with these performance charts, it always depends on where you stop the line, where you start, etc.
The key thing for me is just invest in a strategy that you think makes sound fundamental sense, rather than trying to back the horse that won the last race.
Don’t miss out on the full webinar, where Sean shares more about his views on value investing, available on the BizNews YouTube channel here.
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