The exchange rate headwind I’ve been facing from a strengthening Pound and weakening dollar is starting to show signs of changing to a tailwind. This is providing a welcome boost to my portfolio, which is bouncing around near its highs but still failing to make real progress. I made one opportunistic purchase this week, buying AB Dynamics after it reported some excellent results and a bullish outlook.
Investing in foreign-listed shares has made me much more conscious of exchange rates. With around half of my portfolio invested abroad, mostly in the US, moves in the Pound to Dollar exchange rate have quite a significant impact. So far I’ve viewed exchange rates as entirely unpredictable and so haven’t let them affect my investment decisions. Six months of loosely monitoring hasn’t led me to change that view very much, though I have noticed that the exchange rate has been on an uptrend for about a year. Over the past week or so that trend has broken.
The main immediate catalyst seems to be poorer than expected UK economic growth data, reducing expectations for further interest rate rises. There doesn’t seem to be particularly strong evidence that this will persist and I doubt the break in trend has much predictive power. However, I am hopeful that it may signal some respite to the exchange rate headwind that has been holding back the performance of my US investments.
My experience of investing in the US has been fairly mixed so far, with quite a few abortive investments. This is partly due to the exchange rate headwind, but probably more because I’m still familiarising myself with the market and individual opportunities available there.
I have noticed a few differences between the UK and US markets that may affect how I should implement my strategy. One of the most notable is that the US market appears much more efficient in responding to news. In the UK, I’ve found it often takes some time for share prices to appreciate after good news, providing some reward for those who respond quickly. This has not been the case for the US stocks on my watchlist, where the immediate share price reaction has typically been much faster and more extreme and subsequent movements harder to predict. This may be a reflection of the greater market capitalisation and liquidity of the US stocks on my watchlist. Perhaps I’d be better off focusing on smaller businesses – I may slowly skew my watchlist more this way. The greater short term efficiency (and higher trading costs) may also mean that I’d be better off holding US positions for longer and riding out more short term volatility – this fits with how I want to adapt my strategy more generally.
I’ve also noticed that US shares, well at least those on my watchlist, seem to have share price movements that are more correlated to one another than the UK shares on my watchlist. Either everything is going up or everything is going down, whereas in the UK there seem to be more mixed days. This may partly be because the US market has much larger concentration of passive ownership. It might also just be a recent phenomenon because macroeconomic concerns have been heavily affecting markets recently.
On the plus side, the US markets are home to a huge number of high quality businesses compared to the UK. There are a lot of US contenders vying for a place on my watchlist. Valuations of shares in the US are not as expensive compared to the UK as the headline valuation multiples would suggest. When I look at the share prices of individual high quality businesses, the valuations look comparable to the UK. The US market is simply much higher quality overall, skewed much more towards technology than lower quality cyclicals.
Anyway, on to this week’s purchase:
AB Dynamics is an engineer that makes vehicle testing systems for the automotive industry. It sells its testing systems internationally to the main car manufacturers. Its two main products are driving robots and Guided Soft Targets (soft dummy remote controlled vehicles that other cars can crash into without damaging themselves). It’s a long term favourite and I’ve traded the shares a couple of times before.
- Business economics: AB Dynamics is highly profitable with an operating margin of around 20% and returns on capital regularly in excess of 20%. In the last couple of years it has been investing heavily in its growth, depleting its cash, though it still has net cash on the balance sheet.
- Track record: it has a recent track record of fairly rapid growth in revenues and profits. The share price has steadily appreciates over the past few years.
- Competitive advantage: AB Dynamics is a market leader in a small competitive niche. It’s not quite a monopolist but almost. Its products require very high precision and its reputation benefits from years of experience and technical know-how. It has close relationships with the car manufacturers.
- Growth prospects: its market appears likely to experience stable secular growth, though may be a little cyclical in line with demand for cars. There are no obvious technological risks. It appears to have plenty of scope to reinvest for further growth with good revenue visibility and a lot of recent investment in manufacturing capacity, staff and new products.
Momentum is excellent with the share price near all time highs and excellent results issued this week. The valuation is fairly high but seems justified by the prospects for continued rapid growth.