SINGAPORE (Mar 5): The past 2½ months since the Global Portfolio started have been eventful, to say the least, coinciding with the first meaningful market correction after two years of historic calm.
Our basket of stocks started off very well, with total portfolio returns reaching as high as 10.6% right before the market correction. The portfolio underperformed the benchmark index during the turbulent two weeks, but has since rebounded, in line with global markets.
Notably, throughout this period, the portfolio continues to outperform the benchmark index in terms of total returns (including non-income-generating cash in hand), which now stand at 6.3%.
On a week-on-week basis, the portfolio did better than the MSCI World index in six out of the last 11 weeks since inception.
Individually, Facebook and The Walt Disney Co are slightly underperforming the index, while Towa Corp is our worst-performing stock. The gainers, on the other hand, are outperforming by double digits. They include China Sunsine Chemical Holdings (+32.6%), DIP Corp (+19.7%) and BYD Co (+10.6%). We have written about most of these stocks in the past and believe they still have room to grow.
Facebook has lagged the tech sector rebound. The stock is facing headwinds, starting with the announcement that it will tweak its News Feed algorithm, which will result in less time spent on the platform and therefore less ad inventory in the near term.
Sentiment was further buffeted by the current backlash against fake news and inappropriate content. Major advertisers such as Unilever have threatened to pull their ads. In fact, Facebook’s algorithm change is partially in response to the fake news issue. The company has pledged to spend more to boost security, which will raise expenses this year.
Nonetheless, we like Facebook. The stock is cheap, given its growth profile — it has the highest Ebitda growth yet low EV/Ebitda multiples (see Chart 1). Facebook has the most “pure” business model, focused on social media, and has not ventured into high-cost physical assets. Consequently, its gross margin is high (low marginal costs) and will likely remain so (see Chart 4).
The challenge is when revenue growth levels off (the S-curve). We believe that is still some way off — Facebook has yet to monetise other popular platforms in its stable, including WhatsApp, Instagram and Messenger, and has only recently launched a video platform called Watch.
Plus, its business model leverages the human need for social interaction and not for material goods, which diminishes over time. Delivery does not require the high cost of logistics or other frictional costs.
Another tech company with high Ebitda growth and reasonable EV/Ebitda is Alibaba Group Holding. Like Facebook, we expect the company to sustain high revenue growth for years to come, on the back of the fast-expanding digital market in Asia, which has a large, digitally connected population.
Alibaba’s business strategy resembles that of Amazon.com. It has been aggressively expanding into every sphere of digital commerce as well as physical stores, logistics, mobile payments (through a recently acquired stake in Ant Financial), cloud computing and so on.
Its investments in brick-and-mortar stores and logistics will, inevitably, raise marginal costs. Furthermore, many of its new investments are still lagging in profits. These will be a drag on overall gross margin, as seen in Chart 6, but notably, it is still high relative to the other tech stocks. We are content as long as revenue continues to grow at a faster-than-average clip.
We disposed of our stake in General Motors Co (GM) a few weeks back (making a marginal profit) and raised our holdings in China Sunsine and Shanghai Haohai Biological Technology Co, taking advantage of the selloff, which we predicted to be short.
Shares in GM have fallen below the price at which we sold, while the prices of both China Sunsine and Shanghai Haohai have risen. So, our decisions were quite well timed in hindsight.
We were attracted to GM mainly because of its low valuations. The carmaker has done very well since emerging from bankruptcy in 2009. Its shares are currently priced at only 5.6 times earnings and 2.3 times EV/Ebitda. Upon further reflection, though, we are less certain of GM’s future prospects.
If it is not already self-evident, our key considerations when selecting stocks are the underlying secular trend and the business itself. We are not so concerned with short-term earnings or share price fluctuations.
The car industry is facing its biggest revolution since Henry Ford gave the world the Model T (all the way back in 1908). The future of mobility, we believe, will not only be electric but also autonomous and on demand.
Electric car prices will drop sharply, mirroring the falling cost (and improving technology) of batteries over the next five years. And when you cut out labour cost from the equation, autonomous, ride-hailing services will become so cheap that you will think three times before buying a car. Or just one — the self-driving car can ferry your family members around after dropping you off at work.
All these things entail wholesale changes in what we know now of the freight, delivery and transportation landscape as well as car ownership.
It also pits traditional automakers against the tech companies. GM and Ford Motor Co will be taking on the likes of Waymo (owned by Alphabet), Lyft and Uber. Not forgetting, Tesla, which is a vertically integrated carmaker that hails from Silicon Valley. Who will be the eventual winner?
GM is, without doubt, one of the leaders in electric and autonomous vehicles — it has the scale and a product that could be commercially available by next year. But traditional carmakers also have a lot more market share to defend — bearing in mind that we may be on the cusp of a secular downtrend in car volume sales.
Crucially, there is significant network effect in dynamic mapping, AI and driving data that might just tip the scale towards the tech companies.
Waymo is way ahead in terms of mapping and on-the-road testing miles, while Tesla already sells semi-autonomous electric cars that people also love. Even though the latter has repeatedly missed production targets, the wait list for its Model 3 — targeted at the mass market — remains long.
In the future, cars might become almost commoditised, just like the PC and smartphone — and carmakers will simply be the original equipment manufacturers, while the network value accrues to tech companies that own the software platforms.
Another company affected by secular trend, in this case cord-cutting and the switch to over-the-top media services, is Disney. Its share price has underperformed both the broader market as well as disruptors such as Netflix in the past two to three years.
The company was slow off the block in responding to changing customer preferences. Nevertheless, we maintain a high conviction that Disney’s intellectual property library remains formidable and should begin to offset falling media network sales once the company rolls out its own streaming services in 2018 and 2019.
Meanwhile, Disney will continue to dominate the box office this year, starting with the critically acclaimed Black Panther, a lead-in to its summer blockbuster Avengers: Infinity War. Its parks and resorts are also doing very well, with no shortage of new themed attractions, given the franchises under its umbrella.
We disposed of our entire shareholding in Towa the week of Feb 26, at a loss. Its share price dropped after the company reported sharply weaker earnings for 4Q2017. Even though revenue was down just 4.3% y-o-y, Ebitda fell nearly 53%.
We learn from our successes and, more so, our failures. In this case, our mistake was relying too heavily on data analytics and investing in a low-profile company in which financials are in a foreign language. To be honest, we do not yet fully comprehend its latest earnings results, owing to the language barrier. Its share price is recovering, but we decided to cut our losses, given the resulting uncertainties. We will not make this mistake again.
Following the disposal of Towa, our cash holding increased to US$107,923, or about 20% of the current portfolio value. We are evaluating prospective stocks to add to the portfolio. But as we articulated a couple of weeks ago, valuations for non-tech stocks are, by and large, not cheap, no thanks to the growth in exchange-traded funds (ETFs).
This remains a concern. A sharp rise in interest rates will have a huge negative impact on bonds. That, in turn, will have a cascading effect on equities, owing to redemptions, and especially since ETFs have taken large stakes in many companies.
There is no question that interest rates will rise, driven by a combination of reverse quantitative easing, monetary policy normalisation, rising commodity prices and falling unemployment. But, we believe the rise will be gradual as long as inflation — including wage growth — remains subdued.
This is the most probable scenario, owing primarily to the real benefits of digitalisation that are lowering costs for consumers. Pricing pressure is evident throughout the ecosystem. For now, this secular downward pressure is more than offsetting the upward push from cyclical economic growth.
In short, we will remain invested, based on the positive outlook for equities, but will keep a close watch on interest rates.
In any case, value investing is about finding specific stocks that offer value rather than timing the market. Thus, as long as we find value, we will invest.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
