The main news last week was the resurgence of the pound, or depending on your perspective the fall in the dollar. The greenback has been sinking steadily against the pound and most other currencies over the past month or so. This unfortunate timing coincides with my move into investing in US stocks and has provided a strong headwind. This is becoming a bit of a baptism of fire – I’ve certainly become a lot more aware of exchange rates as a result.
Fortunately for me though, the US stock market has been rising relentlessly to offset the currency headwinds (at least for most of my US holdings). The lack of volatility in the US stock market is starting to become a bit of a concern – I think it feels like a bubble or at least the start of one. I certainly picked an interesting time to start investing in the US.
I’ve made a few adjustments to my portfolio this week in line with my aim of simplifying my strategy and focusing more directly on momentum. It has occurred to me that there is an obvious element of risk in deciding to focus more on momentum and less on valuation during what could be a bubble! In fact that was my motivation for putting more weight on valuation and less on momentum in recent trades. These trades haven’t turned out so well. I’m still avoiding investing where valuations look excessive, but I’m not going to invest on hopes that undervalued shares with poor momentum will bounce. I think the better risk mitigation strategy for a correction is to use stop losses and get out quickly, rather than to dilute the focus of my strategy from shares with strong momentum.
This week I sold Apple for a 9% loss, RWS for a 5% loss and JD Sports for a 5% profit. Apple was a casualty of the falling dollar and quite a bit of negative sentiment on prospects for sales of iPhone X in its upcoming results. Apparently an anxiety attack of this sort pre-results is pretty common for Apple. Nevertheless the share was losing momentum and the weakness in dollar caused it to hit my stop loss so I sold.
RWS I sold as the momentum weakened. I really like the business but still haven’t managed to make money on my trades in RWS yet. Hopefully next time. JD Sports was also sold as the share seemed to be weak and face consistent selling in spite of some good results last week. Sentiment is pretty negative on physical retail in general and concern is probably mounting about how long JD Sports can keep growing. While I am bullish on JD’s prospects, I don’t like to go against the tide so I sold for a small profit. I’m a bit disappointed that this one didn’t pay off more as it looked very promising at the time I invested.
I bought five new positions in Impax Asset Management, Trex, Moncler, Estée Lauder and CBOE Global Markets.
Impax Asset Management
Impax is a small UK fund management business, which focuses on identifying miss-priced investment opportunities in sectors likely to benefit from a secular shift towards a more sustainable use of resources. This sounds pretty sensible to me as an investment strategy. Importantly, it seems to be resonating with investors at the moment – recently Impax has been benefiting from very large inflows to its funds.
- Business economics: fund management is generally a very profitable business. Impax has reasonable returns on capital and margins. As a fund manager, I imagine it must have a capital light business model. It has quite a bit of net cash.
- Track record: the track record is pretty good for the last 4 to 5 years, with fairly rapidly growing profits. Before that Impax has been through some ups and downs in more difficult market conditions. Impax looks a bit cyclical.
- Competitive advantage: fund management is a very competitive sector as clients can very easily withdraw money to move from fund to fund. This means it is possible to grow quickly but also to shrink quickly if the fund performs poorly or faces increased competition. Impax is attractive as it has a differentiated proposition which should insulate it from competition to some extent. This isn’t the most sustainable of competitive advantages, but should allow Impax to continue to do well for some time.
- Growth prospects: while Impax may not have the most sustainable competitive advantage, this is compensated for by the growth prospects. Impax is still fairly small and looks to be on a roll at the moment. I would imagine that demand for its proposition is likely to continue to grow. It could have quite a long way to go.
The valuation looks pretty reasonable – on the face of it very cheap given the growth prospects, but I don’t think a fund manager should be rated as highly as most of the other businesses I invest in because of the risk from competition. Momentum is excellent, with a big acceleration in profit and revenue growth and in the share price over the past year. However, the timing of my purchase was a little unfortunate and the price has dropped a bit since. I hope it rebounds fairly quickly or I could be forced to sell.
Trex is a manufacturer of wood-alternative decking products, predominantly focused on the US. A theme connecting Trex and Impax is sustainability- as one of the key benefits of wood-alternative products is that they are more sustainable.
- Business economics: The economics look excellent. Trex is extremely profitable with huge margins and returns on capital. While manufacturing wood composite might sound like a capital intensive business, Trex’s capital investments in recent years have been relatively modest. Trex’s high profitability indicates that it is likely to have a significant competitive advantage.
- Track record: Trex has been growing at quite a clip for the last few years, but looking back further reveals it made losses for a few years after the financial crisis. This makes sense as Trex’s business is focussed on US construction, which was hit particularly hard. Sensitivity to the economic cycle is clearly a risk here.
- Competitive advantage: Trex is the biggest supplier of wood-alternative decking products with almost 50% market share in the US. At first glance, the products seem quite commodity-like – this is typically a competitive risk as it is hard for a supplier of a commodity-like product to have pricing power. That said, there are a factors that may give Trex an edge as the largest player in the industry. Trex may have an advantage over competitors from its scale in being able to produce at lower cost. Quality is also important (as the product has to compete with wood on its aesthetics). Trex has a head start in building its brand and a reputation for high quality. Trex has also developed good relationships with its distribution network of lumber yards and DIY retailers, which is also critical to get them to recommend products to customers. Overall, I’d say Trex’s competitive advantage looks likely to be pretty solid.
- Growth prospects: the big growth driver in this market is switching by customers from using wood to wood-alternative composite products. This is currently happening slowly. At the moment, composite is somewhat more expensive than wood but then requires much less maintenance over time and is expected to last much longer. Over time I think it is reasonably likely that composite products will become relatively cheaper. This could provide a huge growth driver for Trex. Trex benefits from a high degree of operational gearing so increases in revenue would translate to propotionally larger increases in profit. On the downside the demand is likely to be quite cyclical.
The valuation is not cheap but I believe reasonable taking account of Trex’s growth prospects. Momentum is excellent. Trex’s last results far surpassed expectations and with next quarter’s results a few weeks away, the share price is consolidating around the highs.
Moncler has been transformed from a predominantly ski-wear brand to a high-end Italian fashion label. It specialises particularly in down jackets.
- Business economics: it is very profitable with high returns on capital and margins. It is vertically integrated and distributes products predominantly through its own retail network of mono-brand stores. Doing this rather than distributing more via wholesale or online is an essential way of managing its brand to maintain its luxury status. However, it would create some risk were it to go out of fashion. The fact is so profitable with its current distribution model is testament to the strength of the brand.
- Track record: the track record is not long, though the last few years have seen some fairly rapid growth.
- Competitive advantage: the competitive advantage comes from the brand. It has many of the characteristics I would look for in a brand likely to endure: it is luxury, has a niche focus and fairly timeless appeal.
- Growth prospects: Moncler has been growing quickly and is unlikely to continue to do so at quite the same rate. However, there does still seem to be quite a bit of scope for continued international expansion. It should also be fairly defensive and I imagine able to grow through all economic conditions.
The valuation seems reasonable given the quality. Momentum is very good, with Moncler performing ahead of expectations this year and the share price currently near the highs.
Estée Lauder makes skincare, makeup and other beauty products. It is a large £30bn business that owns a number of brands. It’s a classic defensive consumer brands business of the sort Warren Buffet would probably approve.
- Business economics: Estée Lauder is very profitable, with consistently high margins, returns on capital and cash generation. I imagine the gross margins on beauty products must be very high, as customers seem prepared to pay sometimes ridiculous price premiums for their favourite brand of seemingly fairly generic cream, moisturiser etc. This arguably excessive brand loyalty reminds me of cigarette brands.
- Track record: Estée Lauder has a good track record of steady growth, with its share price also appreciating steadily over time.
- Competitive advantage: this comes from Estée Lauder’s wide collection of brands. I think these brands are sufficiently high quality to create an enduring competitive advantage.
- Growth prospects: Estée Lauder is already quite a large business and this will limit the of future growth to some extent. However, as the overall market for beauty products benefits from secular growth drivers and Estée Lauder has plenty of opportunities to continue expanding internationally, I am reasonably confident that it can continue to grow at a steady rate for some time yet.
The valuation is fairly expensive, but I believe can be justified on a more long term basis due to the defensiveness of the market and certainty of long term growth. Momentum is excellent with Estée Lauder recently beating expectations and the share price steadily rising. The next quarterly results are on Friday so will have to see how it does then.
CBOE Global Markets
CBOE (the Chicago Board Options Exchange) provides the world’s largest options exchange as well as large stock exchanges in the US and Europe. Its platform is at the cutting edge in terms of the range of derivatives available to trade. For example, most recently it has started a market for Bitcoin futures.
- Business economics: like many other technology platforms, CBOE is exceptionally profitable, with high margins and returns on capital occasionally reaching triple digits. These have fallen in the last year, but my suspicion is that this must be temporary and probably due to its recent acquisition of BATS (another options exchange).
- Track record: CBOE has an excellent track record of consistent profit and revenue growth. The long term share price chart looks very attractive, in line with consistent exponential growth.
- Competitive advantage: as the largest options exchange platform, CBOE benefits from network effects. These are particularly relevant for exchanges, where liquidity increases with the volume of trading on the exchange. There are other options exchanges out there, though I think CBOE’s larger scale will give it a considerable advantage over them in the long term.
- Growth prospects: demand for options and derivatives looks set to continue to grow in the future, and CBOE looks well placed to capitalise on this. It has a lot of opportunity to add new services or functionality to its platform. I am fairly confident that it will be able to continue to grow at a decent rate for
The valuation looks reasonable and the momentum looks great.