Global Equity: A great opportunity for investors
EPIC Global Equity Fund
January 2023
“The market may ignore business success for a while, but eventually will confirm it.”
As I said in my note of 22 November, the current lack of investor confidence has created opportunities for many of the holdings in the EPIC Global Equity Fund.
The wild share price fluctuations and negative investor sentiment brings to mind Mr Market, the analogy of Ben Graham. Mr Market is a manic-depressive business partner known for wildly over and under-estimating the value of your business on a day-to-day basis. As Warren Buffet elaborates in the 1987 Berkshire Hathaway shareholder letter:
“Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favourable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions, he will name a very low price, since he is terrified that you will unload your interest on him.”
Warren Buffet further explains:
“Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game.”
Buffett summarised by stating that:
“An investor will succeed by coupling good business judgement with an ability to insulate his thoughts and behaviour from the super-contagious emotions that swirl about the marketplace.”
Despite all the overwhelming evidence in favour of Buffett’s approach, many investors are simply not wired this way. The Fed, inflationary pressures, geopolitical risks and the recessionary environment have appeared to lead investor decision-making in the past year. Many sought refuge in cash and short dated treasuries, largely ignoring Mr Market who is now offering high-quality long-term secular winners at depressed prices.
Yet in the 1997 Berkshire Hathaway shareholder letter, Buffett makes a pertinent point:
“Smile when you read a headline that says "Investors lose as market falls." Edit it in your mind to "Disinvestors lose as market falls -- but investors gain." Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other. (As they say in golf matches: "Every putt makes someone happy. We gained enormously from the low prices placed on many equities and businesses”
Although it is far easier said than done, investors should question whether by their actions they are, like Buffett, benefiting from market downturns or if they are simply taking the losing side of the trade.
“Charlie and I let our marketable equities tell us by their operating results – not by their daily, or even yearly, price quotations – whether our investments are successful. The market may ignore business success for a while, but eventually will confirm it.”
Reflecting on this final nugget, also taken from the 1997 Berkshire shareholder letter, we turn our focus to some more of the exceptionally well-managed companies held by the EPIC Global Equity Fund.
Roper Technologies is not a household name like Warren Buffet’s Berkshire Hathaway, yet the lesser-known conglomerate has often been compared to Berkshire Hathaway and is one of the very few companies to actually outperform the Oracle of Omaha.
The company is positioned for continued long term shareholder value creation by combining great businesses, a conducive operating environment and process-driven capital redeployment of free cash flow into high quality acquisitions.
Mr Market is still offering shares of Roper at roughly the same price they were trading at back at the beginning of 2022. We believe they are trading at a notable discount to their real worth despite the company increasing guidance for the second time this year. Roper reported strong third quarter results which beat market expectations. Top line revenue grew 10% whilst free cash flow adjusted for taxes paid related to divestitures grew 17% year-on-year.
The firm also raised its dividend by 10%. This was the 30th consecutive annual dividend increase.
Intuitive Surgical increased 12% following the release of its third quarter results which beat expectations. Revenue increased 11% year-on-year. This was due to procedural volume growth of 20%, an acceleration from the 14% growth in the previous quarter. The da Vinci Surgical System installed base grew to 7,364 systems up from 6525, an increase of 13% from a year ago. Intuitive raised its full-year procedure guidance to 17%-18% up from its 11%-15% prior guidance. Management also noted a substantial utilisation increase in the quarter, increasing to 7% versus a more typical 5%. The rate of adoption of robotic assisted surgeries continues to be strong.
Intuitive Surgical tends to be very selective when considering share repurchases but has been acquiring stock throughout the downturn. In October, the company implemented a $1 billion accelerated stock repurchase program.
Visa grew 23% year-on-year in consistent currency or 19% after digesting the dollar headwind. Fuelled by inflation and also double-digit volume growth, the company easily absorbed the drag from exiting Russia. Operating margins remained steady at 65.3%. Guidance for the fourth quarter remains strong.
Mastercard also grew 23% year-on-year in consistent currency or 15% before currency movements. The company generates two thirds of its volumes outside the US so it has a higher exposure to the strengthening dollar. Operating margins grew to 57.7% from 56.7% last year. Mastercard also expects a strong fourth quarter.
MSCI rallied after reporting third quarter results in October which beat analyst expectations. Operating revenues increased 8.4% whilst recurring subscription revenues were up 17.5%. Operating margins increased to 55.2% from 52.4% year on year as operating income increased 10.5%. Despite the macroeconomic headwinds, MSCI posted its highest Index subscription run rate growth in a decade at 12.6%. The company grew its Climate business subscription run rate by a whopping 86.0% and posted its highest Analytics retention rate ever at 95.9%. Due to market turmoil asset-based fees were down 11.4%. The company increased its full year 2022 guidance figures.
Pool reported record third quarter results in October which surpassed market expectations. Net sales increased 14% year-on-year, driven by price increases (c.9%), while operating income grew 11%. For the full year, Pool expects EPS growth of 22% for the full year, despite new swimming pool constructions declining 10% to 15%. However, the average age of a pool in North America is around 25 years with around half of those pools operating with few or no automation or modern features. This is fuelling remodelling activity which has been strong, particularly at the higher end, with Pool heavily weighted towards non-discretionary spending. Pool benefits from structural inflation which has increased the size of the industry by approximately 30% since 2019, and on-going inflation which is expected to continue at 4% to 5% from 2023.
Shares in Pool have been significantly impacted, yet it is a great business with a strong record of shareholder value creation, as is demonstrated by its long-term return relative to the S&P500. We have decided to take Mr Market up on his offer and increase our exposure.
It is our view that a number of EPIC Global Equity Fund’s portfolio of exceptionally run companies are being mispriced, creating a great opportunity for investors.
Malcolm Schembri
Fund Manager, EPIC Global Equity Fund