All quality is not created equal
Some investors believe that if you buy quality companies and hold on to them for a long time, you are bound to make money. This is not entirely true, as this simplification ignores a cardinal piece of the puzzle – the starting price of the investment. We believe investors are far more likely to achieve investment success when they combine the quality consideration (as enshrined as moat and management in our 3M process) with the final critical component of the equation: margin of safety.
It may be true that great ideas and great management make great companies, but we have argued time and again that the starting price investors pay has a material impact on the long- term return they achieve. The availability of the first two Ms may be relatively evenly distributed through time – we must always be discerning, but someone always has a good idea and you can almost always find good management teams. However, the final M, margin, is not always equally abundant.
There are times when the market offers us the opportunity to invest in companies at exceptionally attractive valuations, like now. The last M – margin – is the true scarce commodity. The first two Ms (moat and management) for many companies have stayed largely the same, despite a weak post-pandemic economy. Yet it is most often movement in the final M (margin) that typically sends investors running for the hills. However, we would argue that investors are running in the wrong direction. If all other factors have been accounted for and if you remain convinced of your assessment of above-average quality, then an increase in the margin of safety (typically via falling share prices) signals an opportunity to buy. So why do investors not view it as such?
Markets follow their own logic. They diverge from both rational expectations and tangible economic outcomes in the real world for extended periods of time. This causes many investors to capitulate at precisely the wrong time, when their expectations have been dashed yet again and the market persists on its course to exacerbate this. The level of discomfort this causes simply becomes unbearable for many investors.
The courage of conviction is hard won through bitter experience, and by the disciplined setting-aside of emotion through a proven investment philosophy and process. As custodians of our clients’ capital we keep our eyes firmly fixed on the third M. When all the indicators align for us in terms of our process, we know that we must act to secure the best long-term outcomes for our clients – even when a pandemic has much of the world in a tailspin and discomfort levels are high. Because above all else, we know great returns are often made in times of great discomfort, by those who have the courage to act when others fall prey to their emotions.
In the first article Looking beyond the corona crisis, Fund Manager Justin Floor outlines developments over the past six months and the extent to which the combination of monetary and fiscal stimulus has driven the recovery of risk assets. In our outlook on asset classes, he explains why we remain positive on the outlook for South African equities despite the extreme negativity that surrounds this asset class.
Fund Manager Shaun le Roux outlines Why it is a bad timeto give up on contrarian investing in the second article. He delves into the extraordinary market conditions that have seen investors crowding into a narrow selection of shares, both here and abroad. With investors focusing on earnings growth almost at the exclusion of valuations, we have to ask if the market has completely forgotten the importance of the third M.
Lastly, Fund Manager Philipp Wörz explains why we believe the markets are offering great opportunities in Obscured quality – the market is pitching classic 3M opportunities. He offers three case studies that help to explain why we argue that the current market conditions are heavily stacked in favour of building a classic PSG portfolio.
We trust that you will find these articles insightful, and that they offer you some guidance in these turbulent times.
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Click here to read the next article: Looking beyond the corona crisis by Justin Floor