Quality street [Members]

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• 

  Mogul

  1 Mirror Man January 30, 2024, 8:51 pm

  Good evening, I’ll kick things off on this one if no-one else wants to take up the mantle. (Long-term reader, but first ever comment!)

  I’d be interested to get your take on small- and mid-cap “quality” stocks. I have a hunch (and it’s really nothing more than a hunch) that small and mid caps stocks could outperform large cap stocks and I’m trying to position accordingly. You mention Fundsmith in this piece, but I’d like to know your thoughts on Smithson IT, Terry Smith’s SMID-focussed offering. I think SSON could well do better than Fundsmith over the coming decade and I also like the fact that it can be bought on a double-digit discount at the moment, something that’s obviously not possible with the open-ended structure of Fundsmith. Do you hold Smithson and do you have any thoughts on its prospects versus the bigger brother? The top holdings in Smithson are certainly less well known than the more obvious “quality” selections in Fundsmith.
• 

  Mogul

  2 Owl January 30, 2024, 9:09 pm

  I suppose I should comment, given that I invest in individual stocks with a `long quality’ strategy. It’s the only strategy that really makes sense to me (other than its opposite of `short s***’, but shorting is too much work for me).

  I try to buy companies that I can hold indefinitely. In practice, my longest continuously held position was initiated in 2013. I only started investing in 2012, and by 2013 had yet to settle on the quality strategy. My median position by time initiated was only bought in September 2021, but about two out of five of my holdings I’ve held for more than five years.

  Yes, there has been a recent cheapening of quality, but I still find it overall expensive these days compared to the 2010s. In his first (2010) letter to shareholders for the Fundsmith Equity Fund, Terry Smith reports a 7% free cash flow yield for his portfolio. So, despite having recently ticked up to 3.2%, it is still less than half of what it was when he started.

  But I still think it offers value versus alternatives.
• 3 The Investor January 31, 2024, 12:51 pm

  @Owl @Mirror Man — Thanks so much for commenting! I was getting a bit of a ‘he who dealt it smelt it’ vibe off this post, lacking as I do the sort of dominate ego that presumes I must have said everything to be said on the matter and nobody has anything to add… 😉

  You make a good point @Owl on the relative expensiveness of quality. While the drink companies in the main do seem to have de-rated back quite a bit, for example, some other quality companies have only gone back to the pre-Covid bump (or not even to that level). We are definitely at risk of recency bias.

  I’m also slightly concerned of being misled by mistaking industry-level factors for a multiple re/de-rating story. Again, for the drinks makers did their businesses really get better, did investors come to appreciate this, did they just re-rate versus lower yields, or was there low-hanging fruit from a one-time industry consolidation phase (say 1995 to 2015) that won’t be repeated? I hope to have a ponder of this in a future post, though we might have to focus in on just one company, probably either Pernod Ricard or Diageo (disclosure: I hold both as I type) to keep the investigation manageable.

  Talking of what I hold, I do indeed have a small position in Smithson @Mirror Man. My reasoning is similar to yours.

  US small caps (‘small’ being relative in the US market!) and those elsewhere are at historically wide discounts to large cap. Some of this incorporates value versus growth too (US large growth being all conquering for the past few years) but nevertheless, the size factor has been notable by its absence for a long-time.

  On balance I think SSON seems to translate the Fundsmith philosophy down reasonably well. The cautionary counter is FEET — the Fundsmith EM fund — where that didn’t seem to be the case. It reminds us to be wary of a cookie cutter approach to alpha. Terry Smith’s basket of factors / nose for a good company may be able to earn an edge when applied to the largest companies in a way that doesn’t hold true for smaller ones.

  For example, large companies are invariably dominant — that’s how they got to be large. You can argue that smaller companies may not be large because of some kind of constraining factors in their business model, addressable market, or whatnot.

  This is esoteric but it’s worth bearing in mind. ‘Small value’ has from memory beaten the market whereas ‘small growth’ has not.

  Now ‘small growth’ in that academic sense is not what SSON is investing in (it will include a lot of blue sky jam tomorrow earnings-less type companies) but nevertheless, something to keep in mind.

  Perhaps I’ll cover SSON in the future too. Just wary of Moguls becoming Investment Trust Monthly! 😉
• 

  Mogul

  4 Mirror Man January 31, 2024, 9:40 pm

  Thanks very much for sharing your thoughts, I guess in the end only time will tell as to whether the size factor makes a comeback and smaller cap stocks have their day in the (smith)sun again. I’m still at the beginning of my investment journey so I have time on my side and I’m willing to place that bet…and hope my patience doesn’t run out!

  Your Mogul articles have been truly excellent and well worth the subscription. Please don’t be discouraged by lower numbers of comments on any of these pieces. It probably reflects the fact that the articles are extremely comprehensive and typically quite niche. I’ve enjoyed every single one so far even though this is the first I’ve commented on.
• 

  Mogul

  5 Owl January 31, 2024, 9:55 pm

  @The Investor: I would be keen to read your thoughts on Pernod Ricard. Diageo I hold: I first bought in towards the end of its 2013-15 doldrums; I added more in the dip that was mostly in 2020; and then … I added some more a few weeks before the big lurch down in November last year. It seems I can’t always be a̶ t̶i̶m̶i̶n̶g̶ g̶e̶n̶i̶u̶s̶ lucky!

  (As an interesting aside, some money I got back from a misselling thing (not PPI) helped fund the initial investment; and the most recent top-up was funded by some above average luck Premium Bonds prizes.)

  @Mirror Man and @The Investor: Overall, I don’t think the companies in SSON are as high quality as those in the main Fundsmith fund. I do own a few of them, but I have a greater overlap with the main fund. The discount on SSON does interest me. But, ultimately, owning exactly what I actually want to own tends to trump owning not exactly what I want to own even though it is on a discount.

  The median market cap of Smithson’s holdings is about £7 billion — so we’re are very far from penny-dreadful territory — but I do always think of smaller companies, “if this were such a great company, it would already be big”. Obviously every big, great company started small, but probably not for long, and often only before listing.

  I did invest in FEET, not personally being able to buy individual stocks on most emerging market exchanges. A big problem for FEET, being heavily weighted to India, was:

  https://finance.yahoo.com/quote/INRGBP=X/ .

  My own little story about FEET: I wanted to top up my position during what happened to be the run-up to the Brexit referendum. I thought that after the inevitable `remain’ verdict came in that Sterling would strengthen a little, and thus FEET would get a little cheaper. So I waited …

  When the result came in and the pound instead went down the pan, FEET’s share price did not immediately adjust accordingly. So I made my top-up on the Friday at the still unadjusted price; a nice little trade! Longer term, not such a happy experience, though I did overall make money (not selling any until after the wind-up announcement).
• 

  Mogul

  6 KISS February 1, 2024, 10:16 am

  Commenting to acknowledge the post was read, enjoyed, appreciated and gave some interesting ideas! Your blog is all green triangles.

  I recently listened to “Value Stock Geek” talk his approach on the Many Happy Returns podcast. An interesting, similar-ish approach, to find stocks that offer value, quality and hopefully better returns. I thought the guy got really unstuck when they talked about criteria to sell – It didn’t come across as a clear strategy at all, just someone applying random ideas and hoping for the best. I can’t claim to do better though.
  https://pensioncraft.com/captivate-podcast/value-stock-geek/
• 

  Mogul

  7 Cantseethewoodforthetrees February 1, 2024, 9:46 pm

  Hi thanks for writing the article and sharing your thinking. I’d read the article when it was posted, for me though there is an awful lot to consider in there and I hadn’t had time to think it through thoroughly enough to comment (still largely the case!).

  You mention you are guided much more by the business fundamentals than the share price. Would you mind sharing how you consider a few areas where I’d be interested to know more on your approach.

  How do you take into account “adjusted” measures in your analysis or do you base your assessment of the business fundamentals on “reported” figures and build from there? Given some subjectivity around adjustments made by many companies and a lack of consistency even by companies in the same industry, I find it challenging to establish an initial base.

  In terms of rising interest rates and their impact on the financing costs of debt (and higher claim on a businesses capital allocation to service financing costs after refinancing), is this something you consider in your process? Unilever’s debt profile for example they have roughly 1/3rd of their bonds (10bn euros) maturing over the next 4 years. This will need to be refinanced in a much higher interest environment now, increasing interest charge and demand on capital to service. These costs either get passed on to the consumer, pushing affordability and possibly impacting sales or reduce availability for other capital allocation priorities (investment, debt repayment, dividends, buyback).

  For me, there is so much difficulty in determining value, I think I’m better off sticking to index investing, but I’m enjoying the analysis and learning about approaches and considerations. Your writing is therefore much appreciated. Thanks
• 8 The Investor February 2, 2024, 11:58 pm

  @Owl — One of the interesting things about Moguls is that there are certain members who know much more than me about any particular thing I write. It’s kind of daunting!

  There are specific members who know far more than me about quantitative investing and market structure, for example. There is a member who has forgotten more by breakfast than I’ll ever know about financial products, fees, regulation and so on. And now I think I’ve found the member who knows more than me about Pernod Ricard… 😉

  I’ll see if I can choose it to cover over Diageo when the time comes, but honestly I don’t really have any sort of bold out-of-consensus thesis on it. It’s just classic quality from my POV. Perhaps I am less bothered (or even more animated) by the family ownership / semi-control than an institutional investor would be, but that’s about it. Still, the devil is in the detail I suppose. We’ll see! Enjoyed your other details (on FEET) too.

  @KISS — Selling is by far the harder part of investing if you’re even half good at the first part (buying). My favourite book on this is The Art of Execution. I was going to write ‘criminally under-read’ before that, but I’ve just noticed it now has 773 reviews on Amazon so I guess the word got out

  You can find it here:

  https://amzn.to/49jLEl1

  @CSTWFTT — I am much more relaxed about looking at adjusted figures than some investors are. Perhaps that’s because I don’t have a very quantitative investing method — in that I’m not screening or testing the balance or P/L against a model or even making sector comparisons very much (though of course I do a little). Generally I think as long as management is clear why it is using alternative metrics, then they’re often helpful to understanding the business. Sometimes the unadjusted figures are far more misleading that the adjusted (a very clear and obvious example would be how Berkshire Hathaway is now reporting wild swings from profit to loss and back due to how it has to report changes to the value of its investments quarter to quarter).

  The other key of course is that nobody is obfuscating the ‘real’ numbers, so you can always see what’s going on in the pure accounting sense too if you want to.

  Yes, debt is a much bigger deal than two years ago with all companies. (Look at REITs or alternative energy trusts if you want to see real pain from such). Most if not all the high-quality companies people tend to look at aren’t going to come unstuck due to debt IMHO provided interest rates don’t go bonkers, it’s more a curb on other uses of capital such as reinvestment or (more likely) it’s going to mean lower returns to shareholders via dividends and buybacks. Unilever will have no problem rolling over its debt; the same is not true of a £50m property developer perhaps. The snag is how heavily it will lean on cashflow, but as you state these companies have lots of levers to respond to rates/inflation by jacking up prices too (it’s partly how inflation manifests!)

  I mostly look at companies on a case by case basis nowadays, but I suppose it could be interesting to say consider debt for 3-4 companies from a particular sector one month, or free cashflow, or amortisation or whatnot. The key will be keeping things interesting versus becoming a textbook. Such information is widely available; if I bring value here it will be more in seeing such stuff ‘live’ in real life examples (even I’m wrong or off, we’ll see a process in action and hopefully learn together).

  Thanks again for the comments. While Moguls membership is still ticking upwards, naturally the articles only get a small percentage of readers versus free site articles (like 1% or so!) and hence it’s not surprising comments are low I suppose, but I do hope to see continued discussions.

  As I said above this membership base is ridiculously bright, so I hope we can all learn things together! 🙂
• 

  Mogul

  9 KISS February 9, 2024, 10:45 pm

  Thanks @TI for the great book tip, have raced through most of The Art of Execution tonight, what a fantastic read. Interesting to see a case study of selling Novo Nordisk prematurely in 2009, in a book released in 2015. Will be setting stop loss alerts and documenting my decisions more clearly from now.
• 

  Mogul

  10 Mirror Man February 10, 2024, 10:27 pm

  I’d also like to give a virtual thumbs up for The Art of Execution. It’s the book that I would recommend to anyone who is picking individual stocks and trying their hand at beating the market. It’s definitely my favourite book on investing. It really makes you realise that investing success is down to psychology and temperament. Execution is everything!
• 

  Mogul

  11 Delta Hedge March 9, 2024, 1:07 pm

  Noteworthy 11 stocks in Euro. equivalent of US Mag. 7, the GRANOLAS (GSK, Roche, ASML, Nestle, Novartis, Novo Nordisk, L’Oreal, LVMH, AZ, SAP & Sanofi), trade @31x forward PE compared to a). 13-14x for Euro. markets, b). 34x for Mag. 7, and c). 20x for US market. All 11 are rated wide moat. Divi yield 2.5% for GRANOLAS v 1.5% for US market v 0.3% for Mag. 7. If you want Quality, you pay a premium. But premia (and relative premia) differ, and no 2 versions of Quality are made alike.
• 

  Mogul

  12 Delta Hedge March 25, 2024, 8:58 pm

  Joachim Klement now writing in Market Watch and beginning by covering Quality growth through a US v Euro lens. He notes that the “average expected earnings growth over the next 12 months for the Magnificent 7 is 41%” and “The average price/earnings ratio is 32.4” (i.e. a Price Earnings Growth, or PEG, ratio of ~0.8). He then looks at 7 broadly equivalent high quality Euro large caps with an aggregate 12 month earnings growth forecast of 40%, but which are trading at an average P/E of just 16, i e. a PEG ratio of ~0.4. He largely attributes valuation differences between the US and Europe to the Magnificent 7 having one quality and growth narrative common to them all (i.e. a transformative wide moat tech narrative), thereby making them easier to understand, whereas the seven Euro comparators each have their own story to try to take in.
• 13 The Investor March 26, 2024, 10:44 am

  @Delta Hedge — Thanks for the pointer (members should feel free to share links to sources btw if not excessive 🙂 ) and I hope he’s not abandoned his often interesting blog in the move.

  My quality drink stocks continue to… encourage me to pour one out 😐
• 

  Mogul

  14 Delta Hedge April 2, 2024, 8:41 pm

  Bestinvest have listed both Terry Smith’s £23.4bn Fundsmith Equity and the £3.9bn WS Lindsell Train UK Equity fund in its Spot the Dog twice-yearly rank of under performing equity funds. Extraordinary.
• 

  Mogul

  15 Delta Hedge August 15, 2024, 12:33 pm

  Good analysis (respectively published last week and yesterday) of what makes for Quality investing by Jamie Ward of ShareScope and on the ‘School of Quality’ investing from David Stevenson (at around halfway through Mr Stevenson’s piece, under his Investment Idea):

  https://knowledge.sharescope.co.uk/2024/08/07/quality-investing-is-not-what-it-was/

  https://open.substack.com/pub/davidstevenson/p/weekly-note-will-it-and-it-recession