From Specialist to Generalist: Discussing An Intrinsic Value-Based Portfolio Management Process

Transcription

1 From Specialist to Generalist: Discussing An Intrinsic Value-Based Portfolio Management Process DIAMOND-HILL.COM Diamond Hill Capital Management, Inc. 325 John H. McConnell Blvd., Suite 200 Columbus, Ohio This presentation is for educational purposes only. The views expressed are those of the research analyst as of August 2018, are subject to change, and may differ from the views of other research analysts, portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice. FOR EDUCATIONAL USE ONLY.

2 Grady Burkett, CFA Wright State University B.S., M.S. mathematics Portfolio Manager Commentary CFA Charter holder since 2010 Question & Answer Session Began investment career in 2004 Morningstar Joined Diamond Hill in 2014 Industry analyst since 2014 Co-manager of Diamond Hill Investment Partners since 2015 Co-Portfolio Manager of Global Fund since 2016 Portfolio Manager of International L.P. since 2017 FOR EDUCATIONAL USE ONLY. 2

3 Diamond Hill s Intrinsic Value Investment Philosophy Intrinsic Value Investing Estimate intrinsic value Forecast future cash flows, determine appropriate terminal multiple, apply appropriate discount rate Purchase shares when selling at an appropriate discount to intrinsic value estimate Advantages Consistent philosophy No constraints Long time horizon Challenges Forecasting future cash flows is hard Flexibility requires judgement Long time horizon requires patience FOR EDUCATIONAL USE ONLY. 3

4 Diamond Hill s Research Team Structure and Process ~30 research team members organized by sectors Industry experts Considerable autonomy in research process and idea generation Advantages for a portfolio manager Better information Richer context More ideas Diverse ideas Challenges for a portfolio manager Industry knowledge gap between specialist and generalist Portfolio knowledge gap between generalist and specialist Different people perceive information differently Different people are attracted to different types of value investments FOR EDUCATIONAL USE ONLY. 4

5 Value is Subjective FOR EDUCATIONAL USE ONLY. 5

6 Explicitly Communicate Portfolio Management Process Moat Industry structure Balance sheet Management and board 10-year growth Discount to intrinsic value estimate FOR EDUCATIONAL USE ONLY. 6

7 Goal: Maximize Advantages, Minimize Challenges Source: Cheatography. FOR EDUCATIONAL USE ONLY. 7

8 Comparing Ideas Example: BT vs. Rogers BT has dominant position in fixed broadband and strong position in wireless in UK. Rogers has dominant position in wireless and strong position in fixed broadband in Canada. Both markets are well-penetrated, mature. Rogers trades at 16x forward earnings. BT trades at <9x. Why? Which is a more attractive investment opportunity? FOR EDUCATIONAL USE ONLY. 8

9 Fundamentals and Valuation Rogers BT Moat Both enjoy scale; BT's diminished by regulator Industry Structure Tough UK regulator more competition Balance Sheet BT pension deficit shrinking, still large Management/Board Rogers family vs. BT's restructuring 10-Year Growth Rogers GDP, BT sub-gdp Valuation BT has to invest gobs in fiber w/ regulatory scrutiny! FOR EDUCATIONAL USE ONLY. 9

10 ~2/3 rd of a Firm s Intrinsic Value Starts in Year SIX! (Will BT always be restructuring? Is the fiber investment perpetual? Could the pension deficit be artificial?) (Will Rogers wireless ASP grow msd over longer term? Will the regulator stay relatively benign?) FOR EDUCATIONAL USE ONLY. 10

11 Comparing Ideas Example: Samsung vs. Apple Samsung has dominant position in memory. Apple has second most popular mobile OS and loyal customers. Both industries are mature. Samsung trades at 6x forward P/E, Apple trades at 17x. Why? Which is a more attractive investment opportunity? FOR EDUCATIONAL USE ONLY. 11

12 Fundamentals and Valuation Apple Samsung Moat Samsung scale, Apple switching costs Industry Structure Low entry barriers vs. customer concentration Balance Sheet Fortress for both Management/Board Samsung stewardship? 10-Year Growth Memory pricing at cyclical peak? Valuation Samsung prices in doom! FOR EDUCATIONAL USE ONLY. 12

13 ~2/3 rd of a Firm s Intrinsic Value Starts in Year SIX! (Is memory pricing cyclical? Will Samsung emerge stronger or weaker? Are Chinese entrants credible?) (Will Apple s ASP grow longer term? How far can it push value-added services? What s coming next?) FOR EDUCATIONAL USE ONLY. 13

14 Comparing Ideas Example: Google vs. Baidu Baidu dominates search in China; Google virtually everywhere else. Search advertising market growing d/d in and out of China. Google trades at 28x forward P/E; Baidu at 20x. Why? Which is the more attractive investment opportunity? FOR EDUCATIONAL USE ONLY. 14

15 Fundamentals and Valuation Google Baidu Moat Android, Android, Android Industry Structure Baidu faces tougher competition, regulator Balance Sheet Both net cash, Google fortress! Management/Board Can't ignore VIE structure 10-Year Growth Digital ad tailwinds Valuation Recent Chinese market sell-off FOR EDUCATIONAL USE ONLY. 15

16 ~2/3 rd of a Firm s Intrinsic Value Starts in Year SIX! (Will China s digital ad market sustain mid-teen growth? Will Alibaba, Tencent capture digital ad spend at Baidu s expense?) (Google s cloud business? Does Android solidify moat AND invite elevated regulatory scrutiny?) A valuation edge is not always enough. FOR EDUCATIONAL USE ONLY. 16

17 Evaluating New Ideas Example: Formula One Group F1 is a global motorsport racing league with 350m global fans. Owned by Liberty Media; 1/3rd of value from Live Nation. Live sports are valuable, but F1 is not fully monetizing its fan base. Under new management! Add quality DTC offering, increase league parity, add races, sponsors. Better, more visible product more engaged fans better monetization. FOR EDUCATIONAL USE ONLY. 17

18 Fundamentals and Valuation Formula One Now In 2023? Moat Unique IP, mild switching costs Industry Structure Top teams have leverage Balance Sheet Stated commitment to delever Management/Board Malone, Carey; but tracking stock 10-Year Growth Depends on fan re-engagement Valuation? FOR EDUCATIONAL USE ONLY. 18

19 Evaluating New Ideas Example: EssilorLuxottica Essilor is the largest producer of prescription lenses. Luxottica is the largest producer of eyeglass frames and sunglasses. Combined company will collect ~1/3rd of the global eyewear sales. Manufacturing and distribution cost advantages, product scope. Merger related cost savings, real cross-selling opportunities. Low cyclicality, consistent profitability, strong balance sheet. FOR EDUCATIONAL USE ONLY. 19

20 Fundamentals and Valuation EI LUX Now In 2023? Moat Cost advantages Industry Structure New entrant, buyer threats lower with merger Balance Sheet Low debt Management/Board Merger improves LUX s governance 10-Year Growth Inorganic less impactful Valuation? FOR EDUCATIONAL USE ONLY. 20

21 Evaluating New Information Example: Baidu Dominant search engine in China. Better data better results better engagement better data. Competition is high among largest internet companies in China. Foreign competition has been virtually non-existent for years. On 8/1, rumors surfaced that Google was planning to re-enter. Baidu shed 8% of market value that day. Likelihood of it happening? What if it does happen? FOR EDUCATIONAL USE ONLY. 21

22 Fundamentals and Valuation Baidu Current State Hypothetical New State Moat Dominance important in search Industry Structure Challenging new competitor Balance Sheet Net cash Management/Board Founder-led, offset by governance risks 10-Year Growth Dig ad tailwind, competitive headwind Valuation Intrinsic value potentially, not necessarily lower FOR EDUCATIONAL USE ONLY. 22

23 Evaluating New Information Example: GSK GSK has large pharma, consumer health and vaccines businesses. Pricing pressure, soft pipeline has caused challenges. Shares appeared very undervalued mid/late New CEO, Emma Walmsley has consumer background. Pfizer shops consumer business in late 2017, GSK a primary bidder. GSK walks away, displaying financial discipline FOR EDUCATIONAL USE ONLY. 23

24 Fundamentals and Valuation GSK Pre-event Post-event Moat Patents, brands cost advantages Industry Structure Average industry structure Balance Sheet Leverage elevated Management/Board Positive data point on capital allocation 10-Year Growth GDP organic Valuation Appeared deeply undervalued FOR EDUCATIONAL USE ONLY. 24