2020: Put a Cork In It
The investment backdrop of 2020 might best be described as a champagne market—dizzying, expensive, full of bubbles and destined to lead to a painful hangover for many. Much like champagne, the bubbles in many asset classes crept up slowly, knocking out common sense and encouraging the impulsive.
The following are just a few examples where excessive exuberance has led to inflated asset prices ripe for popping.
- DoorDash, Inc. (Dash), the money-losing food delivery company became public in December at $102 per share (raised from $75). DASH catapulted 80% the first day of trading to $182.
Valuation: $56 Billion market cap priced at 63X Sales. Earnings? Maybe some day.
- Tesla, Inc. (TSLA) shares jumped 70% in five weeks not because of any news on profits or sales but because it was being added to the S&P 500 Index. Its $669 billion market value is greater than nine major carmakers—including GM, Ford, Fiat-Chrysler, Volkswagen, Hyundai and Honda—combined. Priced at a stunning 300X estimated earnings, 23X sales!
- Feeling lightheaded yet? If not, don’t worry, more bubbly is on the way.
Estimates suggest another 500 unicorns valued at $1 billion each are lining up to go public in 2021.
During this speculative frenzy, reminiscent of the 1999 internet craze, we are pleased to note that our investment approach resulted in the Small Cap Strategy posting double-digit gains, beating the Russell 2000® Value Index for the year.
Who’s Pouring?
What’s driving these pervasive capital market excesses and the chase to overpay?
In our view, “investors” fear of missing out, momentum investing, historically low interest rates plus a growing glut of cash all contribute.
The Federal Reserve’s money printing has been a strong elixir. As the chart below details, the U.S money supply has boomed at record double-digit levels. To finance the deficit and support our economy, the Fed is printing money at incredible rates.
A Flood of Money
Source: Board of Governors of the Federal Reserve System (US), M2 Money Stock [M2], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/M2. 11/2/1981 to 12/21/2020 weekly. M2 includes a broader set of financial assets held principally by households. Seasonally adjusted M2 is computed by summing savings deposits, small-denomination time deposits, and retail MMMFs, each seasonally adjusted separately, and adding this result to seasonally adjusted M1. Past Performance does not guarantee future results.
The result of the Fed’s monetary policy of accelerating the supply of money has been to weaken the U.S. dollar and heighten speculative activity.
Yes, the aforementioned momentum/growth stocks have benefited. Also, due to the loss of the dollar’s value, investors keen on maintaining their purchasing power, have sought refuge in inflation hedges including commodities, cryptocurrencies, precious metals, selective real estate and other “hard” assets.
Seeing Straight
Instead of joining in the chase of overpaying for potential growth based on excessive optimism, we’ve stuck with our principles to search out small, well-managed businesses, priced at a considerable discount to our determination of their intrinsic worth. Simply put, our goal is to pay 50 cents for a dollar of real value.
The price paid is of utmost importance requiring significant due diligence to dig deep to unearth underappreciated assets and earnings power.
It requires discipline and the willingness to go against conventional wisdom, avoid crowd psychology, while maintaining a deep reservoir of patience.
Here are some examples of this effort held in your portfolio.
Value Vindicated
A recently announced acquisition of one of our holdings appears to confirm our investment thesis.
Early this year we took a stake in an Industrial REIT that specializes in warehouses and distribution centers as the sector was still recovering from the steep COVID-19 sell-off.
Our confidence came from management’s history of prudent capital allocation, a growing list of Fortune 500 customers and focus on warehouse properties to meet the growing needs of online retailers. Perhaps due to its smaller market cap, the business was priced at a significant discount to larger competitors while sporting a handsome cap rate and well financed dividend.
In mid-December, others recognized the company’s value as well and offered to buy the REIT at a substantial premium to our cost.
With interest rates near all-time lows, we believe the search for under-appreciated assets and sustainable dividends will intensify.
The portfolio should be a beneficiary.
Smiles for Miles
We recently initiated a position in Thor Industries Inc. (THO), the largest recreational vehicle (RV) manufacturer in the world. The company owns iconic brands including Airstream, Dutchmen, Jayco and Keystone, among others. Interestingly, this market leader was valued as a small cap and at only .5X of sales.
We believe the market continues to underappreciate the staying power of the resurgence in RV-ing. Recent data for the industry points to double-digit growth in demand, including strong interest in entry-level vehicles—a sweet spot for Thor.
The renewed excitement around open-road traveling resulted in roughly a 18% jump in Thor’s sales and low inventory on dealer lots should translate to further sales growth. We are encouraged by Thor using its robust free cash flow to reduce debt. Despite the positive developments, the business is priced at only 7X our estimate of normalized earnings, almost a 50% discount to historical levels. The current valuations, in our view, represent a compelling opportunity to own a market-leader with meaningful upside potential.
Supplier to the In-Crowd?
While investors are clamoring to pay top dollar for a chance to ride along on money-losing tech juggernauts, we’ve been busy looking for beneficiaries from the booming Tech sector but at prices we believe will help mitigate downside risk. nVent Electric PLC (NVT), a manufacturer of parts used for electrical connections and enclosures designed to protect equipment in high heat environments, fits this profile.
Since nVent’s spin off several years ago, management has been nimble in targeting cost savings, as well as bringing new products to market, including 24 new offerings launched in the first half of 2020 alone.
This progress has positioned nVent, in our view, to capitalize on booming data center demand as well as an inventory restocking cycle. Despite its attractive mix of a steady pipeline of sales with significant growth opportunity ties to the IT sector, shares are trading at just 11X our estimate of 2021 earnings.
A Golden Goose?
Deficit spending continues unabated with the Federal Reserve pulling out all the stops to finance it. Thus, by stimulating the economy, the money supply has ballooned–historically a boon for the price of hard assets such as gold.
Fortunately, we’ve been able to identify well-managed participants in the space. One is Centerra Gold Inc. (CAGDF) $11.59*, a gold miner and long-term holding. We’ve been attracted to Centerra due to management’s conservative capital allocation, immense free cash flow and geographic diversification strategies.
After opening their newest low-cost mine, on time and on budget, Centerra now has mines on three continents: North America, Eastern Europe and Asia. We like this diversification and its rock-solid balance sheet with minimal debt and impressive cash hoard.
Centerra recently announced it was selling two non-core assets which could boost cash to $900 million, or about $3 per share. At current gold prices, the company throws off immense cash flow: its FCF yield approaches 20%, supportive of a growing dividend.
Priced at a 6.8X this year’s EPS and only 5X next, the business is remarkably undervalued.
A Rare Opportunity?
The gap in performance and valuations between Value and Growth has only been this striking two other times in the past 50 years—during the Nifty Fifty bubble of the early 1970s and during the Internet craze of the late 1990s-2000. In both instances, the growth bubble burst and it was a rewarding time to be a value investor.
If, as we suspect, the growth-at-any-price delirium of the past decade is on the verge of fizzling, we believe the valuations and strong balance sheets held in your portfolio and shown below will go a long way in helping investors capitalize on what we view as a third-in-a-lifetime opportunity.
With that, we’ll leave you with a toast for a healthy and prosperous 2021 and the return of a bull market in common sense.
Thank you for your continued trust and confidence.