Netflix will trade at 10x earnings within the next nine years, according to Schroder Recovery’s Nick Kirrage, who says it is only ever a matter of time before growth stocks move from being overhyped to undervalued.
The tech sector has been responsible for much of the growth in world markets over the past decade or so, and although much of the focus has been on the FAANG – Facebook, Apple, Amazon, Netflix and Alphabet (Google) – stocks, Microsoft has been just as important, its gains of more than 1,000 per cent propelling it to a $1.3trn valuation.
However, while it is now on a P/E (price-to-earnings) ratio of more than 30x, in part due to the heavy premium placed on companies delivering steady earnings growth, Kirrage (pictured) pointed out you could have bought the company on a P/E of 10x in 2011 – and he believes a time will come when you will be able to buy the other tech giants on similarly reasonable valuations.
“I had a bet with an investor in one of our funds that I will buy Netflix within the next 10 years – it is now nine years, he’s had a year on it,” the manager said.
“But when do I buy it? It will be when it is on a P/E of 10. There is this belief that we must get ahead of this and own it when it is highly expensive, but you just risk huge compression.
“The areas that have the biggest chance of de-rating are the most expensive – they are not things that are going to go away overnight. They’re things like disruptive sectors, high quality sectors, staples, technology – phenomenal businesses, but I’m sure we will get a chance to buy them all.”
Kirrage said there is a misconception that value investors are constantly “bottom fishing”. For example, he said that in the past he has owned sectors that are now regarded as high quality such as pharmaceuticals and consumer staples, as well as tobacco when it was still growing.
“You had the opportunity to buy the best business franchises in the world,” he continued. “You’ve just got to be patient. And these days, people measure patience in quarters. But I’m happy to do this for a bit longer than that.”
Value managers have long been calling a revival in their investment approach, but while many claimed 2020 would be inflection point, Kirrage admitted that compared with growth, January was the third worst month for this strategy over the past 20 years.
Performance of indices in Jan 2020
Source: FE Analytics
The manager takes some comfort from the fact that it is often darkest before dawn, adding “I can’t see my hand in front of my face at the moment”.
To understand why value has underperformed for so long, he said you need to go back to the financial crisis. Whereas “boring business models with decent balance sheets” previously offered some protection from share-price falls during market crashes or recessions, in 2009 when everyone flocked to value stocks, these fell further than the rest of the market “and people were annihilated”.
However, Kirrage attributed this to specific circumstances in the run-up to the crisis.
“As we went into 2009, we had spent the best part of 10 years telling every business in the world to gear up,” he explained.
“Back then we couched it in terms of, ‘could you make your balance sheet a bit more efficient?’
“And as we went into the recession in 2009, we had some highly geared businesses and several of those were in the value space, particularly commodity companies and banking companies. Now when you start to worry about the world and you’re looking for safety, you tend not to find it in an enormous pile of balance-sheet indebtedness.
“And frankly, to my mind it is irrelevant how cheap your valuation is if you think the ultimate price is going to be zero.”
Kirrage said this is in contrast today – for example, he noted banks have spent the best part of the last decade de-leveraging and now have capital levels at 40-year highs.
It is a similar story in mining, where he pointed out most companies were close to going under and Rio Tinto had the biggest rescue rights issue in UK corporate history. Kirrage said these companies have learnt from their mistakes.
Many investors remain wary of these sectors due to their reliance on the economy, but Kirrage likened this to having an aversion to bad weather.
“In northern Canada, they get 3.5 metres average snowfall a year, but every train runs on time,” the manager said.
“In the UK, we get half a flake and the entire system goes down, because we are not prepared. This isn’t about how bad the weather is, it is about how well prepared you are.
“I look at today’s market and I think there’s a pretty heavy combination there, which is businesses are on average cheaper than the rest of the market, and in many cases, much cheaper. And they tend to have much more resilient-looking balance sheets.”
The question then, is what will be the cause of a value reversion?
Kirrage warned against looking for a specific signal – instead he simply pointed back to the best moments to invest over the course of his career, which took place in March 2003 and April 2009. Back then he said prices were so low that you could have made between 100 and 400 per cent simply through “buying any stock market in the world and closing your eyes”.
“When you look back and you look for the catalyst, the bellwether company announcement, the macroeconomic proclamation, the regulatory release, it doesn’t exist,” he explained.
“One day there are simply more buyers than sellers and the stock market’s up 2 per cent. Within a week, it’s up 4 per cent and people are shouting ‘sell, sell, this is ridiculous, the fundamentals don’t support this, get out’.
“Within six months it is up 15 per cent. ‘It is a dead cat bounce,’ they say, ‘get out and save yourself the losses.’
“And then in two years it is up 50 per cent and everyone says ‘buy’.
“It is humans, humans make stock markets, shares don’t just move around with the volatility that we see, that is human emotion doing that, fundamentals move much less slowly.
He added: “The reason this looks so compelling today is because in my experience in life, the hardest things are always the most rewarding.
“If you want to get ahead in your job, it’s not going to be easy. If you want to get fit, that’s going to be a tough road. If you want to raise kids, I’m learning that sucks sometimes.
“But the truth is, only in investment do we think the easy road is going to make us the big returns. It is always the tough choice that makes you the big returns. Today, this is a tough choice with potentially enormous returns.”
Performance of fund vs sector and index under manager
Source: FE Analytics
Data from FE Analytics shows Schroder Recovery has made 191.62 per cent since Kirrage became manager in July 2006, compared with gains of 129.14 per cent from the IA UK All Companies sector and 128.84 per cent from its FTSE All Share benchmark. However, its performance has been flat over the past two years.
The £1.1bn fund has an ongoing charges figure (OCF) of 0.91 per cent.