War

2022 is turning out to be a pretty unpleasant year for investing in growth stocks. After a dire January, February turned out not to be a whole lot better and March has started off grimly too. Much of this has been driven by the same fears of inflation and impending interest rate rises. However, events have now of course been overtaken by the Russian invasion of Ukraine.

The rapid escalation of the Russia Ukraine conflict has taken a lot of people, including me, by surprise. I don’t think many were expecting an all out invasion or the extent of sanctions on Russia that have followed. It’s pretty scary and obviously devastating for the Ukrainian people. The possible economic repercussions are also troubling. Energy and commodity prices have been soaring, adding to the existing inflationary pressures, but also weakening the economy and making a serious recession seem more of an imminent possibility. This has caused some market panic, so far hurting my UK small cap holdings more severely than my larger US holdings.

Obviously in hindsight I wish I had raised more cash around the end of last year, or better still bought some commodities. It’s probably a bit late for raising more now but I’m tempted to buy some commodities. I’ve made mistake of selling near the bottom of a market crash before and keen not to repeat this again. A market bottom may still be a little way off but hopefully not too far. It has started to feel like we are nearing the point of maximum pessimism at the bottom where the indiscriminate selling is exhausted. Historically it has often been a good time to buy stocks near the start of a war.

The valuations of many of the high quality businesses in my watchlist and portfolio are starting to look cheap. I have been a bit surprised by extent of the rotation away from growth and small caps that preceded the onset of the Ukraine conflict. The market narrative has seemed to focus most heavily on the idea that higher interest rates will disproportionately hurt higher valued growth stocks. While true to an extent, this ignores the other side of the equation ie the effect of the inflation in increasing future returns (and reducing the real interest rate). To me the key point is how well positioned businesses are to generate returns that keep up with inflation ie the higher quality businesses. These businesses would also be more resilient to any recessionary impacts.

This means my current focus when making trades is on trading up to higher long term conviction, though there are also opportunities emerging in some UK small caps where illiquidity has caused them to sell off particularly excessively in the past week. I am also considering diversifying/hedging my portfolio by buying some commodities which look set to do well for the near term at least.

Over the past month I’ve made three trades. I sold out of Impax Asset Management, Canada Goose and Adyen. I sold Impax (and also heavily reduced Liontrust) nearer the beginning of the month, as these asset managers seemed particularly exposed to market volatility. I sold Canada Goose after it issued a profit warning caused by the effect of omicron-related lockdowns in Europe. This did catch me by surprise – I was more worried about China sales which turned out OK in the end. Canada Goose still seems very cheap and its move to a more direct-to-consumer business model seems to be progressing successfully so I do still have my eye on opportunities to reinvest. I sold Adyen in advance of its results as I was troubled by the high valuation and PayPal’s poor results. In the short term this was a mistake as the results were excellent, but the shares have fallen back again in the recent volatility anyway. I think I’d want the valuation to come down more before I considered reinvesting.

To replace these sales I bought Bioventix, Intuit and Copart. Bioventix is an erstwhile favourite that has been in the doldrums for a while as it was negatively affected by covid restrictions and awaits sales of its new Troponin test to grow. Bioventix is reasonably valued, incredibly profitable and seems fairly inflation and recession-proof. There is a risk that its next results disappoint but it should be well-set after that so I’d see any sell-off as an opportunity. Intuit is another share I’ve held before (but sold far too soon). The business is very high quality and while the valuation is still quite high, the recent sell-off makes it seem like a decent time to buy. Again it is one where I would be prepared to buy more if it fell further. Copart is a new position.

Copart

Copart is a US-listed business that provides online auctions to sell salvaged motor vehicles to be repaired or recycled. It is a large international business worth around £21bn. I think it is an excellent quality business and have admired it for some time.

Quality

  • Business economics: Copart is not exactly capital light and does require significant investments in physical assets to grow. However, these investments have so far turned out to be highly profitable with Copart consistently making high margins and very decent returns on capital.
  • Track record: Copart started operating its online auctions pretty much as the internet took off and hasn’t really looked back since, gradually expanding internationally. It has an excellent track record of consistent growth in revenues and profits for many years.
  • Competitive advantage: Copart’s competitive advantage looks rock solid. It is by far the largest and most successful player in a market where scale is very important. There are economies of scale from network effects in the operation of its auctions, its agreements with insurers and in its international network of physical locations that would be extremely hard for a rival to replicate.
  • Growth prospects: historically Copart has been able to grow successfully by consolidating a fragmented market, both gaining market share organically from less sophisticated rivals and through acquisitions. These opportunities naturally diminish over time with Copart’s success but there still looks to be a lot of scope for international expansion beyond Copart’s core markets and for Copart to supply more value-added services. Copart’s fortune’s partly depend on accident rates, which should be fairly stable but could vary to some extent from macroeconomic conditions. Copart has benefitted from a trend for vehicles to get written off for salvage more easily as they have become more sophisticated and difficult to repair. This looks likely to provide a tailwind for some time.

Price

Momentum in the underlying business looks strong. Copart’s recent results was very good. Price momentum is actually relatively good for the shares on my watchlist, which isn’t saying a great deal. The price is down 20% from its highs but (hopefully) showing signs of stabilising. The valuation seems reasonable.

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