There seem to be some signs of danger in the market at the moment. I’ve seen some reports of very high levels of optimism and low investor cash balances (mostly relating to the US). While markets are still near all time highs, quite a bit of sector rotation has been happening away from growth and technology stocks towards value. These are possible signs that a correction is imminent. I’ve read quite a few predictions that 2018 will be the year for a correction after the long bull run we’ve had.

While these signs are making me a bit more wary, I’m almost fully invested at the moment. Predicting the overall markets is not part of my strategy – too hard – and the opportunity cost of holding a large cash balance is very high. The valuations (and prospects) of most of the companies on my watchlist still seem pretty reasonable. So for now I don’t see reason not to be fully invested but will be cautious and vigilant.

My portfolio has bounced back a bit over the last two weeks, since I restricted myself to buying once a month. While I’m taking this opportunity to reshuffle my portfolio and make some new investments, I’m going to continue the once a month buying restriction into next month (20 Jan). If share prices continue to be volatile and hit my stop losses, in the current market I want to give myself time to assess whether and where to reinvest and discipline myself against doing so straight away.

I sold out of Burford Capital for a 10% loss on weakness following a broker downgrade. I also sold out of Bioventix for a 75% profit. I’m still a big fan of the business longer term, but have decided there’s too much uncertainty at the moment with the timing of the rollout of the high-sensitivity troponin test. The shares are very illiquid so would be hit hard by bad news.

In deciding what to buy, I’ve placed a bit more weight on valuation this time by reweighting the value factor in my watchlist spreadsheet. This factor scores shares (very roughly) according to whether the current price undervalues the business relative to its expected growth over the next few years – this therefore picks up shares where I expect higher growth as well as those on lower current profit multiples. A theme I’ve picked up from doing this is fashion brands. These are looking attractive at the moment with decent valuations and improving momentum. Michael Kors, JD Sports, Supergroup, Ted Baker and Moncler are all near the top of the watchlist.

With all that in mind, I have bought new positions in Supergroup, JD Sports, Arista Networks and Fevertree. I’ve held and written about Supergroup, JD Sports, and Fevertree previously, but apart from JD Sports, these assessments could do with updating.

Briefly on JD Sports the main reason for buying right now is that the valuation looks absurdly cheap, given the track record of growth and continued good prospects. I expect news in early January and if it is good I anticipate scaling up this position fast.

Supergroup

Supergroup own the Superdry fashion brand, selling clothes both through its own retail business and wholesale.

Quality

• Business economics: from the figures the business economics look OK. Supergroup has a premium brand and can sell its clothes at high prices. It is consequently fairly profitable, with decent but not spectacular returns on capital in the high teens and an operating margin of 12%.
• Track record: Supergroup has a good track record of fairly rapid expansion over the last few years. There have been a couple of blips – notably some supply chain issues a few years ago but these seem to be behind it now.
• Competitive advantage: Its competitive advantage obviously comes from its Superdry brand. The Superdry brand is definitely ‘hot right now’ and confers a lot of pricing power. It is a pretty strange combination of a British brand using American vintage with Japanese characters. Almost like it was designed by a computer algorithm statistically combining different factors for maximum overall ‘coolness’. I suspect it will endure for some time and be able to evolve and grow, though I do have some nagging doubts that it could be a bit faddy.
• Growth prospects: the growth prospects are probably the main draw here. The brand has international appeal and there is a lot of scope for further international expansion. This has been progressing pretty successfully so far, particularly in Europe.

Price

Current momentum is very good, with the share price recently breaking out to new highs from an extended two-year base. Recent news has generally been in line with expectations. The current valuation seems cheap since medium term steady growth seems highly likely and there is a reasonable prospect that it will accelerate.

Fevertree

Fevertree is a premium soft drinks and mixer brand. It spotted premium mixers as a big gap in the market and has hardly put a foot wrong so far in taking over this niche.

Quality

I think Fevertree is an exceptionally high quality business:

• Business economics: Fevertree’s brand allows it to charge high prices and earn high margins. Its business model involves outsourcing the bottling while managing the brand and recipes itself. These factors result in a highly profitable business with huge returns on capital and operating margins. It hardly makes any capital expenditure and generates a lot of free cash flow.
• Track record: Fevertree has a relatively short track record but has grown revenues and profits at an extraordinary rate over the past few years.
• Competitive advantage: Fevertree’s competitive advantage comes from the strength of its brand. The brand seems very strong to me, with a reputation for high quality and the clear leader of its niche.
• Growth prospects: Fevetree has continued to grow at a phenomenal rate in the UK, riding the gin boom. For continued growth in the future Fevertree is looking to expand internationally and into mixers for dark spirits. It has had some success in these areas but is yet to really take off. Overall, I think the potential addressable markets are huge and Fevertree with its very differentiated brand is likely to have some success.

Price

The valuation does not obviously appear cheap at first glance, but when its likely continued high rate of growth is taken into account, I think it could be. The last trading update was ‘materially ahead of expectations’ (again), though the share price has not responded positively so far. Share price momentum is not great, though I bought after the price seemed to have found some support and started to bounce back.

 

Arista Networks

Arista Networks makes cloud networking software and Ethernet switches. Arista is a disruptive business and on the back of its technological innovations has grown to become the number two player in its market in a relatively short period. Arista’s products are very technical and I don’t pretend to fully understand how they work. However, I feel I have got a high level understanding of the business and main risks.

Quality

• Business economics: Arista is a profitable capital-light business and makes very high returns on capital and margins.
• Track record: Arista has a short track record but has grown very rapidly in that time.
• Competitive advantage: Arista describes its competitive advantage as arising from two main sources. The first is from its network operating system, which apparently has an innovative modern architecture. The second is from its use of merchant silicon and open-source software to create a more open networking platform that can perform and innovate faster than legacy proprietary systems. While I don’t understand exactly why its products are better, it does appear to be the current technological leader with a rapidly growing market share. My main concern is that Arista’s competitive advantage could be short-lived in a market characterised by rapid technological change.
• Growth prospects: the growth prospects are excellent. Arista is a technological leader with a rapidly growing market share of a rapidly growing market.

Price

Momentum is very good with Arista recently beating expectations. The share price has been a little volatile recently following the sector rotation out of technology shares in the US, but is currently still in a strong uptrend. Arista seems reasonably valued given growth prospects.