Winter trades

It was a disappointing end to a difficult year as hopes of a Santa rally mitigating some of the damage have vanished. The US stock markets and UK mid cap and small caps look like they might be heading back towards their lows, reinforcing the prior downtrend. It still looks fairly gloomy as we head into 2023.

Stock market weakness was clearly linked to the Fed’s continued hawkishness, despite signs that inflation is starting to come down quicker than expected in the US. The market initially reacted very positively to the inflation data but slumped after Powell was about as hawkish as he could be in his comments the next day. It seems that a lot of investors are waiting for a Fed ‘pivot’ as a cue for equities (particularly growth stocks) to start performing again and so are speculating on its timing – the recent Fed comments suggesting it might take longer than previously anticipated. I find it a bit strange that the Fed hawkish comments appear to matter so much to the stock market, relative to the more positive news that US inflation is coming down faster than expected. If inflation keeps coming down and the economy slows it seems inevitable a pivot will come at some point soon, despite the Fed’s current hawkish tone. Possibly the market is now concerned that the Fed exacerbates an ugly recession by continuing to raise rates too fast and for too long before it pivots. This is clearly a risk but overall I am feeling more optimistic that we will survive our macroeconomic woes without anything breaking.

I have been thinking about my strategy in light of the challenges this year. I feel like I’ve expended too much mental energy thinking about what the overall market might do and how to position my portfolio accordingly. In particular, I have been preoccupied with the idea that momentum tends not to work so well at market bottoms at which point it can make sense to invest in the biggest fallers instead. This has made my stock selection more tricky and led me to be overly concerned about the gyrations of the overall stock market and when the bear market might come to an end.

I’m coming round to the view that this is more trouble than it’s worth. I think I would probably be better off just following my momentum strategy more mechanically through thick and thin. Beyond the mental effort required, there is a significant cost to being too early in anticipating a change in market direction and I don’t feel confident in getting this right. As a result the overall benefit seems quite marginal or possibly even negative. This is my current thinking but I intend to review my 2022 performance and strategy more fully at some point in January.

Over the past quarter I made several trades to bring my portfolio more in line with the largely momentum-based mechanistic scoring on my watchlist spreadsheet. I sold Canada Goose, Broadridge, Moncler, Beeks Financial and Shopify, all largely because momentum was weaker. I replaced them with LVMH, 4Imprint, Keywords Studios, Games Workshop and Monster Beverage. The latter three are all investments I have held before where trading is currently going well and momentum is relatively strong.

LVMH

LVMH is a huge luxury fashion conglomerate, worth around £300bn. It has been formed over time through a series of mergers and acquisitions that have brought together many well-known luxury brands over a diversified set of activities, including drinks, fashion, cosmetics and jewellery. Its CEO and co-founder Bernard Arnault recently became the richest person in the world as Elon Musk’s wealth declined along with Tesla’s share price.

Quality

  • Business economics: unsurprisingly, selling luxury goods is a very profitable business. Gross margins are very high and much of the operating costs are focused on marketing where there is some discretion to adjust expenditure. LVMH has operating margins of over 25% and returns on capital of around 20%.
  • Track record: LVMH was formed by a merger between Louis Vuitton and Moët Hennessy in 1987, though many of the underlying brands have been around for well over one hundred years. Recent growth in revenues and profits has been steady and consistent but unsurprisingly not that fast given the scale of the business.
  • Competitive advantage: LVMH’s competitive advantage is about as rock-solid as they come. It has a huge number of well-known brands, many of which have been market-leading for years and look set to continue. Luxury customers are not very price-sensitive and value distinct brands. Consequently LVMH has a lot of pricing power. While individual brands can drift in and out of fashion over time, LVMH has a large and highly diversified portfolio. LVMH also benefits from being much larger than its rivals as there are advantages to scale in distribution and marketing and optimally allocating capital investment to the right areas. Given the nature of the products there is virtually no risk from technological disruption, resulting in more certainty that LVMH’s competitive advantage will endure over the very long term.
  • Growth prospects: LVMH’s size means it is unrealistic to expect it to grow that quickly, but it should have ample opportunity to grow slowly and steadily for a long time. Demand is fairly defensive so growth should be fairly consistent. The overall luxury goods market is set to grow for many years. LVMH’s strong market position should enable it to grow at a somewhat faster rate, as it has done for several years. LVMH can also continue to grow by acquisition.

Price

LVMH’s businesses are performing very strongly at the moment. Revenues are up 28% versus last year as lockdowns have eased and international travel recovered. The easing of Covid restrictions in China should provide a further tailwind. The share price has performed relatively strongly (though this is not saying much) and has more or less recovered the highs set back in 2021.

The valuation seems fairly cheap for such a high quality business.

4Imprint

4Imprint is a distributor of promotional products, such as pens bags and clothing, personalised for its customers to show their brand. It is worth around £1.2bn and, while UK-listed, has its business almost entirely focused on the US.

4Imprint doesn’t manufacture its own products but is more of a distributor. Its business model is heavily focused on marketing to find new customers. 4Imprint then provides them with a reliable and responsive service where they can get a full range of promotional products in one place.

Quality

  • Business economics: 4Imprint is a very profitable business. The profit margins are not very high: as a distributor 4Imprint has fairly low gross margins and, after marketing expenses, operating margins typically end up in the mid single-digits. However, capital requirements are fairly low and returns of capital are very respectable, at over 60% in recent years.
  • Track record: 4Imprint has been selling promotional products for at least 30 years. It has an extremely impressive track record of consistently growing revenues and profits in recent years with the share price up around 100-fold over 20 years.
  • Competitive advantage: despite the impressive track record it is hard to identify much of a competitive advantage. This is a relatively weak point where 4Imprint scrapes through onto my watchlist. It seems to be just about the largest player in a fragmented market and has growing market share but faces some other similar size competitors. There should be some benefits to scale in marketing and contracting with suppliers but they don’t seem especially significant. It doesn’t seem to require anything particularly special to replicate 4Imprint’s distribution business. Consequently, barriers to entry don’t appear to be that high. On the plus side 4Imprint serves a narrow niche. Purchases of promotional products will often be seen as of minor significance in the context of the customer’s overall business (and may often be unplanned). This means that customers may be somewhat less price sensitive and more sensitive to having a reliable and timely service.
  • Growth prospects: the growth prospects look decent. The track record of growth is impressive and there is little to suggest that 4Imprint is reaching the boundaries of its addressable market. There is plenty of scope to further grow market share or expand geographically. One downside is that the market appears likely to be quite cyclical. Notably demand fell off a cliff during the pandemic.

PRICE

Momentum is very strong, with the business now firing on all cylinders as it recovers from the pandemic. The share price has recently broken out to new highs. The valuation still seems very reasonable – it would be very cheap if growth continues on anything like the same trajectory but some slow down seems likely.

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