Much has been written about the FAANGs – Facebook, Amazon, Apple, Netflix and Google (Alphabet)1 . With a combined weighting of almost 5% in the MSCI World Index, and an average return of 43.3% over the year they have largely driven US and global indices2, 3 . Not so much has been said about the lesser known WAMITs. This group of three stocks: Wabash, Michelin and Transcontinental posted a higher return of 55.5%. But in no way did these companies drive index returns – their combined weight in the MSCI World Index, for example, is less than 10 basis points (0.1%).
Consistent with most of the Fund’s holdings, the WAMITs operate quite “boring” businesses – manufacturing trailers for trucks, producing tyres, and making boxes/printing pamphlets. Not real sexy industries compared to the FAANGs. But they still managed to grow earnings per share (EPS) by an average 18.7% per year over the last three years (yes, we concede the FAANGs growth was superior at 43.7%)2 . And they still achieved a 22.9% return on their invested capital (which was even better than the FAANGs 18.0%)2 . And what about pricing? At June’s end, according to our analysis the WAMITs were trading at an average unlevered earnings yield of 11.8% and an average free cash flow yield of 8.9%. Quite a lot higher than the comparable FAANG’s yields which were 2.8% and 2.6% respectively2 .
But the real difference between the WAMITs and the FAANGs is market expectations of their future earnings. To provide an indication of this, with some hesitation and for the first time in years we referred to broker estimates (don’t be too concerned – we only looked at the “consensus” level). And they are suggesting that the WAMITs average EPS will remain relatively stable over the next two years, whereas the FAANGs EPS will increase by an average of 25%2 . (We have not wasted our energy delving into the details to try and understand how these forecasts account for employee stock issuance in both the earnings and share count – but our suspicion is that it is unlikely to be conservative).
We admire the “tech visionaries” and we readily acknowledge there is value inherent in the FAANGs businesses. After all, with the exception of Facebook we both use their products/services. However, we are not visionaries, nor are we tech gurus. We are not even active on social media. We certainly do not see ourselves as having any edge in analysing these enterprises and perhaps even more importantly, we are sceptical of anyone’s ability to accurately foresee business plans, growth options, consumer tastes, new competitors…the list goes on. There’s only one sure thing when it comes to forecasts: they will be wrong. And we believe the degree to which they will be wrong is greater when the forecasts involve these types of businesses compared to businesses with a more steady stream of past earnings.
In our view, the inherent assumption that a business will merely maintain earnings or grow them at a slow and steady rate, is more reliable than an explicit assumption of strongly growing earnings. So we have a preference for the double digit earnings return presently available via investing in the WAMITs over the similar level of earnings return which may potentially be provided by investing in the FAANGs at some point in the distant future. Will this be five years time (assuming 25% earnings growth over that period), or ten years time (if we were to assume earnings growth of 25% per annum for two years, 15% for the next five years and 10% thereafter), or some other timeframe? To us, the more certain and imminent earnings return available by investing in the WAMITs is simply less risky than the less certain (but admittedly potentially greater) earnings return possibly provided some time in the future by investing in the FAANGs.
“Analysis is concerned primarily with values which are supported by the facts and not with those which depend largely upon expectations.” – Benjamin Graham
And, aside from pricing, our analysis of the FAANGs financials suggests to us that they are generally a more risky investment proposition than the WAMITs. In fact, at present three of the five FAANGs presently fail to meet our financial strength rules (mainly due to either their cash flows relative to their earnings or their ever increasing shares on issue).
So despite the WAMITs providing a higher investment return than the FAANGs over the year, in our view, the investment risks associated with holding them was lower.
We would like to make an important additional point here. Our view, even in hindsight, of how risky it was to hold interests in those businesses is independent of the investment outcome. So although we were fortunate to have experienced healthy share price increases, had the WAMITs performed poorly, then provided the business fundamentals were the same, our view in regard to risk taken would be indifferent – to us they would still have been sensible investments at the time they were made and therefore a good investment decision. We again stress the importance of viewing risk from the perspective of process, rather than outcomes (refer Musings with mates).
May your forecasts come true,
Stuart and Alexis
1 Company names have been abbreviated throughout this document in the interests of readability. Should readers wish for more detailed information, please feel free to contact Alluvium.
2 Factset Research Systems Inc.
3 MSCI Inc.
This article has been prepared solely for the purpose of providing general information about Alluvium Asset Management Pty Ltd (ABN 69 143 914 930) which holds an Australian Financial Services Licence Number 476067 (“Alluvium”), and the Alluvium Global Fund, which is managed by Alluvium. The article has been compiled in good faith in relation to the activities of Alluvium. Alluvium believes the statements contained are reliable, however no representation is made as to the completeness or accuracy of the information it contains. In particular, you should be aware that this information may be incomplete, may contain errors or may have become out of date. Use of this article is entirely at your sole risk. Reproduction or distribution of this article without written permission is prohibited. The information is general in nature and does not take into account your personal circumstances, financial needs or objectives. Statements contained are not general advice or personal advice and should not be considered as a recommendation in relation to an investment in the Fund or any company referred to, or that an investment in the Fund or any company named in the article is a suitable investment for any specific person. Further, it is likely that at the time this article is published, Alluvium’s and/or the Fund’s position or opinion in any identified company may well be different to that at the time of writing. You should seek independent financial advice and read the relevant disclosure document prior to acquiring a financial product. Alluvium, its directors and employees do not accept any liability for the results of any actions taken or not taken on the basis of information contained in this article, or for any negligent misstatements, errors or omissions.
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