The valuation of Nestlé sums up what is wrong with the current market, according to Artemis Investment Management’s Mark Page (pictured), who says it shows investors are willing to discard any notion of a fair price for the chance to buy into a “quality business”.
Page, manager of the Artemis European Opportunities fund, attempts to forecast the compounding potential of companies over periods of at least five years, pointing out the longer an investor holds on to a share, the more the quality of the underlying business tends to be reflected in its valuation
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However, this is only one part of his process – the second involves looking at the company’s current valuation compared with what the market has been prepared to pay for it on a historical basis and working out whether its projected earnings growth is priced-in.
The manager said this leads to a buy-strategy pattern that is “bizarrely contrarian”.
“Usually what happens is the market is much more short term,” he explained. “The entry route into most holdings is a short-term disappointment from a very high-quality company.
“We say, ‘well, okay, hang on a second. I understand the reasons why you may have missed an earnings number short term’. Or actually, the market may have got obsessed with the fact they do business in Brazil, or whatever it may be. But we know the company has demonstrated a long term set of capabilities, so we are quite happy to enter into a stock that’s had a short-term disappointment.
“And it is usually something as simple as an earnings number when the market was hoping for something, but it got something else.”
Just as the manager will often buy into a company on short-term bad news, he will also sell out if there is too much excitement around it.
“Sometimes the market gets obsessed about a short-term event, then it ramps the share price up to such a level that despite it being a very high-quality company for us, we simply can’t justify buying in,” he added.
“If those two metrics don’t justify its place, we will simply kick that one out, because there are all sorts of other ones trying to make their way in.”
As an example of how this works in practice, Page pointed to Danone, which he owns, and Nestlé, which he doesn’t.
Performance of stocks over 1yr
Source: Google Finance
The manager noted that Danone was not an “instantaneous contrarian” purchase, saying its management team had been “effectively obsessed” with volume growth rather than profitability for quite some time. Numerous acquisitions were made in line with this strategy, such as the purchase of WhiteWave, a manufacturer of plant-based foods and beverages, which saw its share price take a hit.
“The market went ‘here we go again, you’re buying volume, you paid quite a high price for it’,” Page continued.
“But then the management actually turned around and said there was a change of focus, they recognised what they were doing. They said, ‘okay, we need to integrate WhiteWave, we can’t neglect some of the European businesses’.
“With a lot of European companies that people get very excited about, it’s all about the emerging market possibilities, but they need to sort out the margin in their home business because it matters massively.
“China’s very exciting, early-life nutrition in China, particularly. But in Europe you’ve still effectively got a water and yoghurt business.”
While the market was sceptical of Danone’s change of focus, Page became convinced it was moving in the right direction after meeting with the management team, and this made him look at the company in a new light.
He noted it has a high-quality portfolio of businesses tapping into major trends such as early-life nutrition, health drinks and milk substitutes. And although the delivery has been poor in the past, the management has put a number of safeguards in place that will prevent it from gearing up excessively in future, which should help improve margins.
“We bought it on about 17x earnings,” he continued. “If you compare it with something like Nestlé, which probably trades on 30-something times for marginally more earnings per share growth, we would far rather have Danone which is out of favour, has a really good portfolio of businesses and a new focus of management.
“That’s the trouble with this market right now. People have gone ‘well, Nestlé is the highest quality business’, and it is. I don’t want to pay 30-something times for it, though.
“And even though Danone has actually done reasonably well for us, it’s still trading around its historic sort of 10-year average, whereas Nestlé is not. Nestlé is way in excess of its 10-year average.”
Data from FE Analytics shows Artemis European Opportunities has made 135.44 per cent since launch in November 2011, compared with gains of 110.66 per cent from its FTSE World Europe ex UK benchmark and 104.84 per cent from its IA Europe ex UK sector.
Performance of fund vs sector and index since launch
Source: FE Analytics
It is £337m in size and has ongoing charges of 0.86 per cent.