Why and when it pays to follow the less popular view
10 June 2019
Rob Perrone, investment counsellor at Orbis Investments, believes it is better to be contrary and ‘picky about prices’. Fiona Bond reports
It may not seem like the most obvious factor, but Perrone says investors considering attractive investment opportunities should look at companies’ capital investment cycles.
According to Perrone, if lots of people are eager to invest in a particular company, the company can sell shares and bonds at higher prices and investors will receive smaller returns for their money. However, if fewer people want to invest, they’ll be able to buy at lower prices.
For Perrone, this is a key component in how Orbis manages its funds.
“It is a reason we are contrarian. Better to be picky about prices than to join a throng of buyers in a cash-throwing contest,” he explains. “Over the years, we’ve found that analysing the investment patterns of companies in an industry can yield insights into its future profit potential.”
Perrone says businesses’ investment decisions are ranked by the value that each potential project will create for the business. Not surprisingly, at the top of the list are the most profitable opportunities; at the bottom, projects whose value upon the company’s bottom line is almost negligible. Projects at the top of the list receive funding first, resulting in less value created for each pound spent as the company works its way to the bottom of the list.
However, if companies decide to fund only their top projects, the rate of return tends to rise. For this reason, Perrone argues that industries that are out of favour with investors and so cannot access capital as easily often go on to deliver attractive profits.
He says: “Without money flowing in, not only are incumbent companies likely to spend their capital more wisely, would-be upstarts can’t get off the ground and so existing companies have less of a reason to compete as fiercely – all of which often means that prices and thus profits remain high.”
Perrone points to an interesting trend in the investment levels of the energy and technology sectors, which he says reflects this dynamic.
Since the oil price crash in 2014, the global oil majors have reduced spending and focused more heavily upon the best opportunities. As a result, they tend to embark on more profitable projects; a reason why Total, BP and Royal Dutch Shell are held in one or more strategies.
In contrast, Perrone says the tech giants Facebook, Amazon, Apple, Microsoft, Google/Alphabet have ramped up investment in recent years. While Orbis continues to find Alphabet and Facebook attractive, Perrone notes that much of the investment from each of the FAAMGs is in areas like cloud, where the biggest firms compete with each other and intense completion is anathema to returns.
Perrone explains: “Though the tech giants remain strong businesses, this spending warrants close attention, as it could cause their historically high returns on capital to fall. Yet, this trend in tech spending suggests opportunities for other companies. In a gold rush, selling shovels can be more profitable than joining in the digging.”
Perrone added that while cycles of capital investing are far from the only consideration for a company’s fundamentals, past experience suggests a good rule of thumb for investors is: go where the capital isn’t.
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