Taking stock: You’re due an upgrade

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“Even a stopped clock tells the right time twice a day.”

Withnail & I, 1987

We have seen a number of positive profit warnings across the portfolio in recent weeks, which in aggregate, have had a beneficial impact on performance.

As the chart below demonstrates, consensus earnings estimates at the start of a year almost always turn out to be wrong by the end of that year – sometimes by a small amount, sometimes by a very significant amount. Our investment approach aims to exploit these abundant market inefficiencies by identifying situations where the consensus has inaccurately forecasted a company’s future prospects.

Source: Bloomberg as at 31 December 2019.

In uncertain times, the number and extent of these consensus errors becomes amplified. That has clearly been the case this year. In the space of a few weeks, the Covid-19 pandemic prompted a massive collapse in demand globally, which was then followed by a rapid recovery in demand as regional economies attempted to exit their lockdowns. It has been an incredibly difficult task for analysts to maintain accurate forecasts in the context of this rapidly changing economic environment. The stock market has attempted to discount the impact of these changes in real time with some success, particularly for larger businesses. But among small and mid-sized companies, where we tend to focus our attention, there has been a proliferation of mispriced opportunities. These are the ideal conditions for nimble active managers to potenially thrive.

And so, in the last few weeks, we have seen some of the portfolio activity undertaken earlier in the year to take advantage of these uncertain market conditions begin to pay off. Last week alone, we saw positive announcements from Danish jewellery business Pandora, Swedish online gambling operator Kindred, German online fashion company Global Fashion Group, Danish healthcare business Novo Nordisk and British gaming group GVC.

Sometimes the positive trading update itself is less relevant than the share price performance in the weeks leading up to it, and quarterly results need to be seen in the context of our longer term investment approach. We evaluate stocks based on our view of their potential over the next three to five years and how that compares to consensus expectations. Over shorter time periods, these earnings announcements are signposts against which we can check the progress of our investment thesis.

Nevertheless, these stocks, and others like them, have provided a collective boost to performance which we believe can continue. Our investment approach relies on judgements and we won’t always make the right calls, at the right moment, every time. However, our collective experience and disciplined investment approach have combined to deliver a consistently positive hit rate in recent years, which is evidence that we’ve been getting more of these judgements right than we’ve been getting wrong. The RWC Continental European Equity Fund and the RWC European Equity Fund are fast approaching their three-year anniversaries now, and the encouraging performance thus far bears testament to this successful hit rate.

This week’s highlights

As mentioned above, the world’s largest jewellery brand, Pandora, provided a positive contribution to performance last week following a positive update which confirmed that trading remains ahead of expectations. Organic growth rates continue to improve, and the shift towards higher margin online sales is having a positive impact on profitability. Meanwhile, the new management team’s brand initiatives also appear to be bearing fruit, which bodes well for Pandora’s longer-term growth potential across all its key regional territories.

The team held an interesting meeting with sports brand business Puma last week. This is not a current investment but was one of several meetings recently that have provided interesting insights into consumer behaviour during the pandemic. Lockdowns, social distancing measures, and other policy initiatives designed to hinder the spread of the virus, are having a massive impact on spending decisions. Consumers are collectively still consuming, but money that was last year directed towards holidays, trips to the cinema, rock concerts and other forms of social entertainment, has this year been directed towards smaller and more frequent purchases. Sportswear businesses have benefited from this, as have electrical goods manufacturers, fashion retailers and indeed some logistic companies that are responsible for shipping these goods to market. There are many winners and losers in this new dynamic but the key question for us now is, what will happen to these trends next year? More on that another time, perhaps…

Bellway, the UK housebuilder performed well last week following some encouraging data points on the health of the domestic property market. According the Halifax House Price Index, UK house prices were 7.3% higher in September than a year ago. Meanwhile, official property transaction data showed a fourth consecutive monthly rise in UK home sales and mortgage approvals have risen to the highest level since October 2007. The share prices of UK housebuilders remain well below their pre-pandemic highs (in the case of Bellway, the shares are currently more than 35% lower than they were in February), which in our view under appreciates the opportunity for recovery. Recent data from the UK property market appears to support this thesis. 

Source: Bloomberg as at 9 October 2020.

Unless otherwise stated, all opinions within this document are those of the RWC European and UK Equity Team, as at 13th October 2020.

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