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Investment Strategy
Wednesday, May 1, 2013
Then and now

“At Cannon Asset Managers, we have always believed that the price you pay for an investment is the most important determinant of your investment return,” explains the company’s Geoff Blount. “Buying a good firm at a high price means that excellent subsequent company performance will result in only a mediocre investment result.”

As our stock market continues to rise, investors appear to be increasingly ignoring valuation risks, he observes. “One area in which this is evident is the cash retail sector of South Africa.” An example of how stretched this has become, is the observation that the market capitalisation of Mr Price (at R34.2 billion) is nearly the same size as the six largest construction firms on the Johannesburg Stock Exchange combined (at R35.9 billion).

“While we believe that Mr Price is a high quality business, we question whether it is worth the same as the entire construction sector on the JSE,” says Blount.
But let us rewind and consider what we can learn from history. “In 2007 we witnessed a similar story, although the roles were switched. At the time, the market was euphoric over the prospects for construction stocks, with perceptions that they would grow at rapid rates for many, many years. By contrast, Mr Price was worth a mere 6.7% of a very expensive construction sector’s market cap of R79.7 billion.”

With the tables turned in 2012, investors are behaving as though Mr Price can do no wrong, while Construction can do no right. Although Mr Price currently shows earnings and dividends ahead of that of the Construction industry, we believe that investors are vastly overpaying for the future prospects for Mr Price, while regarding the construction as if it were on its death bed. Of interest, the current Net Asset Value of the construction sector is R30 billion versus that of Mr Price of R2.7 billion and annual revenue of Mr Price is R12 billion versus that of the construction sector of R122 billion.
Blount says that most investors seem to have very short memories. “But if we are to learn from history, unloved construction is likely to be the outperformer in the future, and the much loved cash retailers, the underperformers.”
Another example of emotional asset pricing is the market cap of all Euro-zone Financial stocks ($361 billion) which is currently less than that of the Canadian Financial Sector ($377 billion). While Europe’s Financials are, no doubt, under severe stress, is the financial sector of the largest economic region in the world worth less than that of Canada?
“Perhaps the most intriguing example of the emotional pricing of an asset is Apple versus Southern Europe.” Apple’s market cap is currently some $660 billion. The market cap of all the listed shares in Spain, Italy, Portugal and Greece is about $640 billion. An investor can essentially buy all of Southern Europe’s stocks for less than the cost of Apple. “While Apple is certainly a great business with excellent products, it is the valuation accorded to the share which we question and the sense of investors paying top dollar for them.”
Looking at investing over a five-year period, one must as: which has the potential to surprise on the downside, and which has the potential to surprise on the upside? “Cannon’s money is on construction stocks and Southern Europe performing better.” The surest way to a great investment is buy assets that are irrationally unloved and under-priced, and avoid those that are irrationally loved and overpriced.

Copyright © Insurance Times and Investments® Vol:26.5 1st May, 2013
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