Beautiful and impossible
How easily and lightly the financial industry uses the term quality to define some companies. Quality companies usually refer, in the jargon of markets, to companies that grow steadily, although not at rates of new technology, with a recognized franchise (be this a brand, technology or organization) that allows to maintain solid margins and that, for these reasons, deal at high valuations.
We find that this definition can sometimes be misleading, since it tends to confuse the concept of quality generally understood, that is, a healthy reality that has good long-term prospects, with the trend of society, a trend that today allows it fat margins often thanks to a good competitive positioning. The concept of quality implies stability and reliability over time (a quality bed, quality service, a quality bag, etc.) which on the market can never be guaranteed because here everything can change quickly, especially when everything seems to be going well. Courtesy of capitalism.
For example, Nokia is certainly a quality company in general terms, characterized by good management, high R&D spending, excellent governance, positioning and product. But the fact of going through a phase of strong competition and pressure on the margins does not make it worthy today (as it has been several times in the past) to be part of the category of quality companies.
Apple, on the other hand, is a queen in terms of quality as it has excellent brands and margins, although it passes a regulatory and competitive phase that could, in the not too distant future, present obvious pitfalls. The dynamic component more than static photography, what society could become more than what it is now, represents what those who invest should look at, always considering how much the current possible quality is already incorporated into the prices.
However, from the point of view of marketing to clients it is very convenient to have this type of company in place. When presenting a portfolio with many quality companies to a client, one always falls on one’s feet. The customer, especially the retail customer, understandably feels reassured.
However, the institutional client, who also has to defend his portfolio in front of committees often composed of non-technical individuals, is not disappointed either. The fact that many of these companies occupy prominent places in indices makes them even more attractive. The history of the markets, however, is crowded with quality companies that have fallen into misfortune. And quality stocks that plummet will disappear from portfolios at lightning speed. Such companies are also not infrequently characterised by a poor risk/return profile. The risk exists and is compounded by the general positive consensus on the stock. The return is often capped by the now generous valuations. In short, a fine security but with valuations that are difficult to accept, at least for us. To paraphrase a Gianna Nannini song, Bello e Impossibile (Beautiful and impossible). Wanting to give some hope back to the reader who invests in value and feels deprived of exposure to such an attractive category (because the cool title always looks good…) we must add that there are also many beautiful and possible societies. Clearly, they are beautiful for us but, as they say, beauty is in the eye of the beholder. They may not have stellar margins, but they have plenty of scope for revaluation. The brand is not super-fashionable at the moment, but the product is there. Technology may not be the most popular at the moment, but they invest a lot in research and development. They are diversified and have a solid balance sheet. In short, they are as beautiful as Cinderella and Bridget Jones were if you looked closely. The option of disappointment is always on the table. The Cinderella that remains as such, however, makes less of a
fuss (downside) than Snow White caught with a joint…
Among the good and possible stocks, we would like to give a brief update on Teijin, a company we mentioned a few months ago whose performance has been disappointing so far. The company is one of the world leaders in composite materials and fibres. It also has a drug franchise focused mainly on diabetes and osteoporosis. It is one of Japan’s leaders in domestic medical equipment rental, software for clinics and hospitals, and knee and hip replacements. Finally, it is a major manufacturer of separators for lithium batteries. The company’s diversification allowed it to keep EBITDA unchanged between 2019 and 2020, despite its strong exposure to the aerospace industry heavily impacted by the pandemic. These materials will also increasingly be used in electric cars that need to limit weight to increase range. The prosthetics industry is set to grow due to an ageing population and rising per capita income, as well as demand for diabetes and osteoporosis drugs. The stock trades at 10x earnings and, adjusting debt for its listed holdings and working capital, at 1x tangible equity and 3x EV/EBITDA. Absolutely beautiful and possible.
Teijin is present in the NEF SDG fund, in the Aging Population SDG trend (1.2%), in the Pharus Asian Niches fund, in the Coal Fibres and Steel Recycling Niche (1%) and in the Pharus EMN fund, in the Separators Niche (3%).
Confucius
“Sit on the bank of the river and you will see the corpse of your enemy pass by”, quotes the famous phrase of Confucius. This is what John Deniz, CIO of Paragon, a London-based hedge fund, must have thought when he refused to hand over the Orange Belgium shares in his possession to Orange Telecom. Talking about Telenet with a friend this week, I remembered how much Telenet has benefited from the entry of mobile in Belgium since 2006, to the detriment of Orange Belgium. Three years ago Orange Belgium returned the favour, entering Telenet’s fixed line business and starting to erode its market share. Just when the first signs of growth appear, Orange offers an opportunistic buy-out of the stock at 22 euros per share, or 4.7x EV/EBITDA, which is a bit low for an expanding company with a financial situation as clean as a baby’s eyes. Anyone with a little time and money to invest will find this stock an excellent risk/reward ratio. It is very, very likely that Orange will try again within two to three years (today it has just under 80%). This time not far from 30 euros. The company pays a 3.5/4% dividend (50 cents today, 15 June, at the same time as Orange). The limited free float and lack of interest from institutional investors could lead to weakness in the stock. Accumulating the stock below 20 euros could be a good way to allocate part of the portfolio, with a reasonable probability of achieving an annual return of 20/30% and limited downside (if all goes wrong, it is likely that at 22 euros, Orange will re-offer sooner or later).
Value Investing – Sir John Templeton
Looking back over the lives of great investors, you can see how times change, but situations remain the same. That’s because the market is the product of the human psyche, which remains driven by the usual dynamics. John Templeton’s life is no exception and offers many useful pointers for today’s investor. The young Templeton knew the pitfalls of speculation, greed and euphoria at an early age. His father was one of the pioneers of the cotton futures market. Already wealthy, the explosion of this market made him very rich in a few months, so much so that he told John and his brother that they should never work. A few months later he would lose everything. John worked to support himself at university. This experience helped the young Templeton to stay away, while taking his first steps in the asset management industry, through the electric companies. He recalls in his writings when he and other investors took him into a dark room to show how the switch worked. He describes the investors’ blind
faith in something that would change the world. The point is that those companies were already very expensive and would soon be regulated. This only became clear after their collapse in the following years. Templeton was then extremely curious and, before others, proposed investments outside the American garden, with important returns. In particular, in Japan in the 1950s (which was then, as now, misunderstood) and in Korea in the 1990s, during the Asian crisis. This example should be instructive for today’s investor who, when investing in a global equity product, invests about 60% in the US and only 20% in Asia, even though this region is the most important in terms of economic output, growth, diversity and demography.
Another interesting lesson we can draw from John Templeton’s life is related to the Second World War. In 1939, Nazi Germany invaded Poland. The United States was recovering from the Great Depression, a period of great stress and suffering that demonstrated that, financially speaking, one should not have great confidence in the state’s ability to support the economy (Hoover’s economic radicalism has often been compared to post-2008 German radicalism). However, things change and recent experience shows us that. This was already clear to Templeton, who saw the indexes halved in a few months as a great opportunity. It focused first on the companies that would benefit most from the war, in particular the railway companies. He then borrowed a sum equal to all the assets he had set aside and invested it in a hundred companies trading below the dollar. The idea was that in a war economy everything is thrown away and the risk/benefit profile becomes particularly attractive. When the tide turned, Templeton produced a huge return for himself and for the investors who had the nerve to follow him.
At the age of 46, in 1954, he launched his first fund, the Templeton Growth Fund, which despite its name was a fund with a deep value strategy and great diversification by companies and markets. Despite its good performance, the fund did not really start to grow in terms of assets until several years later, thanks to the arrival of Galbraith and Hansberger who were able to promote it properly. Templeton’s company was bought in 1997 by Franklin, an asset manager that can be described as industrial (as opposed to Templeton’s craftsmanship and active management), which was then renamed Franklin Templeton in the name of the great investor.
Sir John Templeton continued to work 12 hours a day (including Saturdays) until he was 95 years old, shortly before his death in 2008, making incredible returns from 2000 to 2004, during the collapse of the TMT bubble, by heavily shorting leveraged telephone and internet stocks and taking on yen debt.
Very religious, he donated much of his great wealth to charities and his human role model and professional approach stimulated and inspired many talents in the industry. Among the beautiful phrases he left us we quote the one that is probably the most famous “the four most dangerous words in the history of investing are: ‘THIS TIME IS DIFFERENT’.
