Yo-yo markets

The market outlook feels like it has improved a little over the last couple of weeks. There has been quite a bounce since the start of the year, the Fed has signalled more accommodating monetary policy and there seems to be progress of sorts in trade negotiations between the US and China. No doubt this is just a temporary high point before the volatility resumes, but it is starting to feel like the worst may be behind us (touch wood).

I have noticed from my watchlist that some of the shares that have rallied the hardest over the last week or so are those that fell the most over the past few months. My one attempt at ‘bottom-fishing’, Keywords Studios, is actually doing OK so far. However, as I mentioned in my last post, I intend to stick with the general principle of rotating consistently towards momentum rather than trying to mix things up. I don’t think this overly restricts me anyway. Many of the shares with relatively high momentum from my watchlist have also recently experienced and started recovering from a dip in price.

I try to follow my rule of a single trade (buy & sell) every two weeks as closely as I can. However, I make an exception for the rare occasion when one of my portfolio constituents issues a profit warning, as happened with Apple last week. I strongly believe the best course of action after a profit warning is to always sell as quickly as possible, without exception. ‘Digging in’ when you have high conviction can be psychologically devastating if things don’t turn out well. And they probably won’t. After a profit warning the odds are not in your favour – by all accounts the base rate average performance for shares that have just issued a profit warning is pretty bad.  You can always come back later when the dust has settled if you’re worried about missing out on a bargain. Being able to respond quickly to profit warnings (or conversely ‘ahead of expectations’ trading updates) is a very substantial advantage that private investors have over larger institutional investors. In most shares there simply isn’t the liquidity for larger investors to get out quickly.

So last week I made an unscheduled trade, replacing Apple with Scout24 after the profit warning. The Apple situation is an interesting one. I’ve come across a lot of debate online with many sensible points on both sides of the argument. Long term I’m an Apple bull. I’m pretty confident in Apple’s competitive strengths, like its brand, and that it will have plenty of opportunities for further growth over the coming years. It seems very reasonably valued for a business of such obvious quality. Overall the long term investment case seems good, but I do have some doubts. The smartphone market is maturing and in the short term we may be near a product cycle peak. More importantly, Apple may be vulnerable to competition if it can no longer stay a step ahead on quality and avoid competing on price. Technology plays such an important role in Apple’s markets that competitive edges can be lost quickly and dramatically.

This week I made my scheduled trade, selling Insperity for a 20% loss and buying back my old favourite Paycom. I have had some doubts about Insperity pretty much since I bought it. It operates in a high growth but potentially quite competitive market (for Professional Employer Organisations). I’m concerned that at some point Insperity will face the twin challenges of dwindling new customers to go after and competition from lower cost alternatives. This point might be some way off yet, but it makes Insperity an uncomfortable investment and not really compatible with my strategy of only investing in the highest quality. While it has continued to trade very well since I bought, the share price has suffered along with everything else in the recent market weakness. I’ve bought back into a business in a similar area, but one that I think has a better proposition and more sustainable competitive advantage. I’ve written about Paycom before, so won’t do so again here.

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Scout24

Scout24 operates several platforms for digital classified advertising of cars and property in Germany and across the rest of Europe. It’s more or less a European version of Rightmove and Autotrader combined, though European markets in this area are less mature than in the UK.

Quality

  • Business economics: online platforms can be extremely profitable. Rightmove and Autotrader are two of the most profitable businesses in the UK. Scout24 has impressive operating margins of almost 40%. Its returns on capital are less impressive (currently at 8%). I think this is likely due to the number of strategic acquisitions it has made over the last few years. I expect its profitability to continue to increase over time.
  • Track record: Scout24’s track record of growth is fairly short but what track record there is seems fairly promising. It has been operating since the early 2000s but only listed as a public company fairly recently in 2015. It has grown revenues consistently and rapidly both before and since it listed (but this is muddied by a number of acquisitions).
  • Competitive advantage: Scout24 operates two-sided platforms with buyers and sellers. These sort of markets are characterised by network effects, where sellers care a lot about the range of buyers there are on the platform and vice versa. This means scale is a huge competitive advantage and frequently the largest platform can end up dominating the market (like Rightmove or Autotrader). The flip side of this is that if there are multiple players vying to become the dominant platform, competition to achieve a scale advantage can be very fierce. Scout24 is well positioned strategically as it benefits from a leading market position in pretty much all of its markets. Its strategy is to add value added services to the platform (such as car valuation tools, a finance platform and document management functionality) to maintain this position.
  • Growth prospects: these look excellent. The use of online marketplaces for these sorts of transactions is growing strongly. Scout24 also benefits from a buoyant German property market which looks set for continued growth for some time to come. One drawback is that there is some cyclicality in the underlying car and property markets.

Price

Momentum is strong – the most recent trading update was ahead of expectations and the share price has held up relatively well during the volatility of the past few months. Part of this is due to reports that Scout24 may be putting itself up for sale to a private buyer. There seems to be a lot of M&A going on in this sector at the moment. Even if no bid goes ahead the valuation seems very reasonable given the prospects for continued growth.

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