Value is in the eye of the beholder - Milford Asset

Value is in the eye of the beholder

Stephanie Perrin

Investment Analyst

Stephanie joined Milford in July 2016 as an Investment Analyst for the Global Equity Fund. She is responsible for conducting research analysis across the portfolio of global listed equities as well as identifying new investment opportunities offshore. Previously, Stephanie spent three years as an Analyst in the Goldman Sachs Investment Banking team and has advised on a range of transactions including the IPO of Evolve Education Group and the sale of Aspire2 Group to Archer Capital. Stephanie graduated from the University of Auckland with a Bachelor of Commerce and Science, majoring in Finance, Accounting and Pharmacology.

Tens of thousands of investors recently undertook the annual pilgrimage to Omaha, Nebraska to hear words of wisdom from Warren Buffett, otherwise known as the ‘Oracle of Omaha’, at the 2019 Berkshire Hathaway annual shareholders meeting.

Buffett is heralded as the greatest value investor of all time and it’s easy to see why – since he took the helm of Berkshire Hathaway in 1964, he’s generated an annual return of just over 20%, more than double the annual return of the broader US market (the S&P 500). Put another way, an investor who put US$10k into the US market in 1964, would have around $1.5m by the end of 2018. Not a bad investment. But if that same investor had put that money into Berkshire shares, they would have a whopping US$247m by the end of 2018[1]. This illustrates the incredible power of compounding, which is the snowball effect that occurs when your earnings generate even more earnings.

Cumulative return on Berkshire Hathaway’s shares since 1964[2].

Interestingly, Berkshire’s returns of late have been less impressive. Over the last 10 years, an investor would have made ~250% investing in Berkshire, but ~300% investing in the US market[3]. There are two key reasons for this:

  1. Berkshire is a much larger company now than it was in 1964, which means there is a much more limited universe of potential investments big enough to have a significant impact on returns. In his 2014 shareholder letter, Buffett acknowledged that returns “will not come close to those of the past 50 years.” “It is harder to double the market value of a $100bn company than a $1bn company.”  Being small and nimble has its advantages.
  2. For a long time, Buffett avoided investing in technology stocks because they didn’t meet his first tenet of investing: Is the business simple and understandable? He had trouble understanding how the companies were making money and whether or not they could continue to do so going forward (i.e. was there a competitive edge?). Buffett restricts himself to his “circle of competence” – businesses he can understand and analyse. “There were a huge number of people that knew more about the game than I did,” Buffett said. “We don’t want to try to win a game we don’t understand.” 

Unfortunately for Berkshire shareholders, technology has not only been at the forefront of changing consumer and business behaviour, but also at the forefront of market returns. Over the last 10 years, the ‘FAANMG’ stocks (Facebook, Amazon, Apple, Netflix, Microsoft and Google) have driven approximately 15% of the US market returns.

Buffett is well aware of the missed opportunity, summing up his thoughts on avoiding an Amazon investment in one word in a 2017 interview: “stupidity”.

Despite having been a fan of Amazon and its founder, Jeff Bezos, Buffett underestimated him. “It’s far surpassed anything I would have dreamt could have been done. Because if I really felt it could have been done, I should have bought it.”

And in the first quarter of 2019, that’s exactly what he did. Although to be precise, it was his deputy investment managers, Todd Combs and Ted Weschler, who did the buying. His lieutenant’s “younger eyes” were able to better understand Amazon’s business model and sustainable competitive advantage.

 

Buffett buys Amazon. Image from azassociate.com

When asked if the Amazon purchase indicated a shift away from value investing, Buffett was quick to clarify that the people making the decision on Amazon are absolutely as much value investors as I was when I was looking around for all these things selling below working capital years ago. That has not changed. They took into consideration a slew of financial metrics including the company’s sales, margins, tangible assets and excess cash. The considerations are identical when you buy Amazon versus … say a bank stock that looks cheap against book value or earnings of some sort.”

So, is Amazon now a value stock and no longer a growth stock? This assumption that a company must be one or the other is a common misconception. At Milford we believe value is in the eye of the beholder. A company may look expensive at first glance, but after identifying the future opportunities for growth and taking a long-term view, you may just stumble across an undiscovered bargain.

 

Disclaimer: This article is intended to provide general information only. It does not take into account your investment needs or personal circumstances. It is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser. Past performance is not a guarantee of future performance. 

Disclosure of interest: Milford Funds Ltd. holds shares in Amazon on behalf of clients. 

[1] Berkshire Hathaway 2018 shareholder letter
[2] Berkshire Hathaway data sourced from theatlas.com
[3] 10-year total return to 15th May 2019 from Bloomberg

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