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Identifying Quality Value in Global Markets

Brian_KrawezBrian Krawez, President of Scharf Investments (Partner of iM Global Partner since April 2019)

It is well understood that a handful of US tech giants were at the fore of the market’s climb in 2020 that put many stock indexes at or near all-time highs. Investors also saw US companies outperform global peers in many industries as part of a shift to perceived safety by investors worldwide. Global, dominant US tech firms - and in some cases their Chinese counterparts - have moved from being a growth play to something that is beloved by all because they are seen as safe.

There is, however, no such thing as an ‘everything stock’. While it is hard to say that large-cap tech stocks are in danger of becoming ‘nothing stocks’ (they do have strong fundamentals unlike dotcom bubble stocks) there is a tendency for a counter-force to arise whenever things go extremely well for a certain subset of stocks for a long period of time.

The current market is reminiscent of the late 1990s tech bubble. Is it sustainable for FANGAM stocks to be worth more than Europe and LatAm markets combined? Or that Apple can gain more market value in a few days than the market capitalization of all but a handful of Japanese companies?

With interest rates essentially near zero, some investors are dismissing price as a consideration and counting on the low-rate environment continuing to serve as a boost. While low rates do justify slightly higher than historic multiples, we remain steadfast in the belief that valuation matters, and continue to focus on finding companies that can compound at a good clip for years to come.

Against this backdrop, there are quite a lot of companies trading at very reasonable multiples. When we consider the multiples we pay versus the quality of the companies, we feel good about the opportunities being created as more and more investors focus on a smaller and smaller group of companies. Investors do not have to pay astronomical prices to own strong businesses if they are willing to look in the right places.

While the pandemic and related shutdowns of many businesses and schools have undoubtedly affected companies’ bottom lines, we do not think the pandemic is going to massively change the investing world in a permanent fashion.

There are compelling opportunities aside from the hottest technology stocks, and three themes we are attracted to are: ‘anti-tech’, compelling global opportunities and underappreciated quality.

With many investors caught up in the rise of technology companies, there are a number of attractive companies we would categorize as “anti-tech.” These businesses may seem boring or old-fashioned, but boring is beautiful when it means compounding growth over the long term in a way that will enrich investors.

Berkshire Hathaway is a great example. Whenever critics suggest Warren Buffett is a dinosaur, it is usually a signal to buy. We are yet again seeing suggestions that the company has lost its touch, even when Apple is its largest investment holding. Trading near book value, Berkshire is at its most attractive valuation in a decade.

McKesson, the pharmaceutical distribution company with a hundred-year history and a leading market share, is another ‘boring’ company that continues to showcase strong earnings growth and return on equity but remains attractive due to factors like the overhang of opioid litigation.

We are finding compelling opportunities globally in areas like healthcare, consumer staples and others that have been somewhat ignored even as the broader market races to new heights. These are companies doing well fundamentally with attractive valuations.

As many investors focus on the US, and the market’s highest fliers, we are finding better opportunities in Europe and Asia, where bargains can still be found. Samsung is an example.

In the tech sector, US and Chinese giants dominate the headlines and can leave some very large, successful businesses as almost afterthoughts. Samsung, because it is based in South Korea, trades at a sharp discount to US and China-based peers, but is the largest technology company in the world by revenue. The company has dominant positions in key areas like DRAM, NAND, and OLED displays for mobile devices and TVs, and has a fortress balance sheet with $80 billion of net cash, 27% of its market cap.

A third area of opportunity is in underappreciated quality. While we are not trying to pick short-term winners and losers from the pandemic, we have observed some situations where the short-term realities have led investors to re-evaluate the long-term trajectory of an industry or business.

The cable industry is a key beneficiary of increasing internet use at home, which has been greatly accelerated by the pandemic and work-from-home requirements. Companies like Comcast, which we own, have been seen as risky in some quarters due to accelerating cord-cutting on the cable TV side. However, we have observed that these companies are becoming more profitable as cord-cutting goes on, since pay TV has become a lower margin business over time, due to increasing programming costs. As broadband subscriber counts grow and customers increasingly upgrade to faster speeds, cable companies are earning more from Internet-only subscribers than they did from video bundlers in the past.

The cable opportunity does not only exist in the US either. We’ve also identified Grupo Televisa, now Mexico’s second largest broadband provider, as a well-run company positioned to benefit from similar fundamental trends. Televisa’s management team has closely watched the cable story unfold in the US, and over the last decade has built a world-class network, capable of serving over 40% of Mexican households. While the pandemic is a challenge in the short term, the rollout of broadband internet service to a broader swath of the population is a compelling long-term opportunity in multiple geographies.

The COVID-19 pandemic was the biggest story of 2020. As for most major stock averages, they seemingly overcame any concerns about the virus as they entered the fall at or near record highs. We believe that many investors have become too short-term oriented in trying to determine “winners” and “losers” from the pandemic, when there is far greater long-term opportunity to be found by looking globally with a focus on value.

For discussion purposes only: the information and data contained in this document does not in any way constitute an offer or recommendation or advice to buy or sell financial instruments.

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