Oriental Focus: A Highly Profitable Portfolio

EPIC Oriental Focus Fund
February 2023

A Highly Profitable Portfolio

My colleague, Malcolm Schembri, recently published an excellent article explaining in great detail why understanding a company’s return on invested capital should be a key starting point for any investor.  This is recommended reading.

In this paper I highlight the underlying profitability of the EPIC Oriental Focus Fund (“EOFF”) in chart form looking at a wide range of metrics. All charts and data were sourced from Bloomberg and MSCI on 16 February 2023. We start with the return on capital, which does not differ greatly from return on invested capital.

EOFF Return on Capital vs MSCI AC Asia ex Japan Index Return on Capital (%)

The MSCI AC Asia ex Japan Index has a weighted average return on capital of 5.02%. The weighted average return on capital of the EPIC Oriental Focus Fund stands at 18.34% which is three and a half times better than our underlying index.

We also show a simple (unweighted) average in the chart which, while still an impressive outcome at nearly three times the index return, is somewhat lower at 14.90%.  This tells us that our larger portfolio positions are more profitable than our smaller holdings. Our larger positions are, as one would expect, higher conviction stocks such as Taiwan’s TSMC and eMemory.

Margins

Companies with relatively high operating profit margins and net profit margins must, by definition, be doing something right. They may have a leading (or dominant) market share in the industry they operate in, they may have a more efficient cost structure than the competition or their products may have key advantages over the competition. They will almost certainly have a higher quality management team.

Not only are such companies more profitable but, with the cushion of relatively high margins, they are likely to be able to navigate negative industry or economic events better than companies or competitors with lower margins. They are much more likely to be able to continue to invest in downturns and thus be able to further consolidate their leading industry positions.

This is particularly relevant in an industry such as information technology where longer-term structural growth trends are regularly offset by shorter term cyclical headwinds. We can see this today in the semi-conductor industry where rapid capacity expansion has collided with a downturn in end user demand leading to rising inventories and falling prices.

The EPIC Oriental Focus Fund has a weighted average operating profit margin of 27.74%, 2.3 times higher than the MSCI AC Asia ex Japan Index. The fund’s weighted average net profit margin is 2.5 times higher than that of the MSCI AC Asia ex Japan Index at 23.20%.

EOFF Operating Profit Margin vs MSCI AC Asia ex Japan Index Operating Profit Margin (%)

Return on Assets

The weighted average return on assets of the EPIC Oriental Focus Fund of 12.92% is six times higher than that of the MSCI AC Asia ex Japan Index at 2.08%. This means that the assets in the EPIC Oriental Focus Fund pay for themselves in just over eight years versus nearly fifty years for the assets in the index!

EOFF Return on Assets vs MSCI AC Asia ex Japan Index Return on Assets (%)

Return on Equity 

The EPIC Oriental Focus Fund’s return on equity is more than twice as high as that of the MSCI AC Asia ex Japan Index. This would allow the fund to distribute over 50% of its net profit in dividends and still grow the book value faster than the index.

EOFF Return on Equity vs MSCI AC Asia ex Japan Index Return on Equity (%)

Moreover, the outsized returns of the EPIC Oriental Focus Fund are not the result of the debt position of the portfolio. While leverage data for the MSCI AC Asia ex Japan Index is not available, the EPIC Oriental Focus Fund is running a net cash position on a weighted average debt to equity ratio basis (-21.52%).

Conclusions

The EPIC Oriental Focus Fund trades on 24.7x current year earnings, 5.1x book value and yields 2.2% as per our internal calculations as at 14 February 2023. The portfolio is not ‘cheap’ in comparison with the MSCI Asia ex Japan Index, which trades on 14.3x earnings, 1.6x book value and yields 2.6%.

The difference is that our portfolio is compounding at a rate which is far superior to that of the MSCI AC Asia ex Japan Index and is highly likely to continue to do so for all the reasons outlined above.      

To quote Albert Einstein “compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn't… pays it.”

Henry Thornton
Fund Manager, EPIC Oriental Focus Fund