Update on reporting season and performance of IML’s large cap portfolios

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One of my favourite quotes about investing is from the ‘father of value investing’ Benjamin Graham, who said: “In the short run, the market is a voting machine, but in the long run it is a weighing machine.” I’ve been thinking about this quote a lot as I’ve looked through the performance of our Australian Share Fund and other large cap funds during the February interim results season. The Australian Share Fund declined -1% in February compared to the market’s gain of +1%. Normally, our relative performance versus the market benchmark could be explained by the results of the companies we hold. However, this reporting season there has been a large disconnect between company results and their respective share price movements. While I am disappointed with the underperformance of the portfolio during the month, the results of most of our companies that reported were strong and that gives me confidence.

Share price performance seems to be detached from company performance

As you can see by the table below many of the key holdings for our Australian Share Fund substantially increased their profits, but their share prices either moved in the opposite direction or were only marginally up.

* 1H FY 2024 vs PCP, February 2024 company results presentations
** Iress, Total Shareholder Return for month of February 2024
# Insurance result only, Suncorp bank is being sold to ANZ

Unusually, the opposite was true for many of the companies with the best share price gains in February. Indeed, their profits often fell or grew only slightly, but nevertheless the market rewarded them with strong share price gains. Many of these companies came from the technology and retail sectors which are flavour of the month right now – technology due to the Artificial Intelligence (AI) thematic and retail because markets are predicting a consumer recovery based on the expectation of falling interest rates.

* 1H FY 2024 vs PCP, February 2024 company results presentations
** Iress, Total Shareholder Return for month of February 2024

Of course, some top performers had strong profit growth too, such as Cochlear, Reece and Goodman, however they trade at lofty valuations.

Why have share prices detached from company performance?

This is where it comes back to Benjamin Graham. In the long-term, share prices should follow earnings, however in the short-term share prices are typically driven by sentiment and company result updates relative to short term expectations, rather than fundamental valuations.

For the retail companies listed above, including JB HiFi and Nick Scali, their share prices appreciated in February because they didn’t perform as badly as the market expected. If they had recently had a poor run of share price performance then this would be understandable: “turnaround stories, bouncing off their lows”. However, these companies are close to, or hit, all-time-high share prices in February. The same was the case with Wesfarmers hitting an all-time high in February and inexplicably, now trades at a higher price to earnings (PE) ratio than CSL! This has never happened before. In our view these sky-high share prices for retail stocks are hard to justify in our current economic environment. While retail sales have held up better than expected, profits are still under pressure and should remain so due to rising costs such as wages and rents and anaemic demand growth.

Investors are optimistic because consumer sentiment has improved due to the expectation of several rate cuts. But there is a risk the number of forecast rate cuts don’t materialise, or don’t come as quickly as people expect. We are already seeing rate cut expectations getting pared back. At the start of the year, in the US, people were expecting 6 or 7 rate cuts this year, now they are expecting 3. In Australia many commentators were expecting rate cuts early in 2024, now the consensus is later in 2024, or not even until 2025. This change in expectations hasn’t, yet, been reflected in share prices.

Consider the AI thematic and tech companies. We have no doubt that AI has the potential to be an amazing advancement for our lives and our economy. But not every tech company will be a beacon of growth or able to monetise AI technology. Just look at the excitement the lithium sector generated just 12 months ago and then the rollercoaster ride it has endured since. Demand for lithium continues to grow, it remains a critical part of the transition to a lower-emissions economy, but many lithium companies have turned out to be very poor investments.

One could also look back at the dot.com boom in the late 90s. The internet irrevocably changed all our lives and there were some very big winners like Google and Amazon, but there were many more losers that vanished without a trace. Our view is AI is likely to turn out much the same. There will be some big winners out of AI, but there will also be plenty which will turn out to be losers. For every Facebook, there are likely to be 5-10 Myspaces.

Where to next for IML’s large cap portfolios?

Post every reporting season the team always reviews the investment theses for all our holdings and whether our investments are on track compared to our 3-5 year expectations. We have just finished this process again, and while we will be making small tweaks to our holdings and their weightings, overall we are very comfortable with the companies we own and confident in their longer-term outlook. While the share prices of some of our key holdings have been disappointing, the underlying businesses are performing well. They’re delivering good earnings growth which isn’t reliant on a strong consumer or buoyant economy. Their management teams are executing well on their strategies and in almost all cases they are winning market share and investing in their businesses for the long term. These are the types of businesses we have always invested in and they’re the types of businesses we back to succeed over the long term.

Warren Buffet described Benjamin Graham as his ‘friend and teacher’ in his 1987 letter to Berkshire Hathaway shareholders. In the same letter he also said: “The speed at which a business’s success is recognized…is not that important, as long as the company’s intrinsic value is increasing at a satisfactory rate. In fact, delayed recognition can be an advantage: It may give us the chance to buy more of a good thing at a bargain price.”

These are the opportunities we will be looking to take advantage of in coming months.

This publication (the material) has been prepared and distributed by Natixis Investment Managers Australia Pty Limited ABN 60 088 786 289 AFSL 246830 and includes information provided by third parties, including Investors Mutual Limited (“IML”) AFSL 229988. IML is the Responsible Entity of the Investors Mutual Australian Share Fund. Although Natixis Investment Managers Australia Pty Limited believe that the material is correct, no warranty of accuracy, reliability or completeness is given, including for information provided by third party, except for liability under statute which cannot be excluded. The material is for general information only and does not take into account your personal objectives, financial situation or needs. You should consider, and consult with your professional adviser, whether the information is suitable for your circumstances. Past investment performance is not a reliable indicator of future investment performance and that no guarantee of performance, the return of capital or a particular rate of return is provided. You should consider the information contained in the Product Disclosure Statement in conjunction with the Target Market Determination, available at www.iml.com.au. It may not be reproduced, distributed or published, in whole or in part, without the prior written consent of Natixis Investment Managers Australia Pty Limited and IML. Statements of opinion are those of IML unless otherwise attributed. Except where specifically attributed to another source, all figures are based on IML research and analysis. Any investment metrics such as prospective P/E ratios and earnings forecasts referred to in this presentation constitute estimates which have been calculated by IML’s investment team based on IML’s investment processes and research. The fact that shares in a particular company may have been mentioned should not be interpreted as a recommendation to either buy, sell or hold that stock. Any commentary about specific securities is within the context of the investment strategy for the given portfolio.