What lo­cal in­vestors need to know

Finweek English Edition - - COVER STORY -

In­vestors can­not look at val­u­a­tions as they would their lo­cal in­vest­ments. Many seem com­pletely over­val­ued, but need to be an­a­lysed dif­fer­ently.

An­chor Cap­i­tal’s Sean Ash­ton says while some of the com­pa­nies it is in­vested in, which in­clude Ama­zon, Face­book, Al­pha­bet, Price­line Group, PayPal, Ac­tivi­sion Bliz­zard and Ap­ple, may trade at el­e­vated P/E multiples of 25 or more, “we do not agree that they are all to some ex­tent over­val­ued”.

He adds: “Our as­sess­ment of value is the ex­tent of cash gen­er­ated by the busi­ness and the ex­pected growth in these cash flow streams, dis­counted at an ap­pro­pri­ate dis­count rate.

“For ex­am­ple, while Face­book trades at a for­ward 24 P/E mul­ti­ple, un­like tech com­pa­nies of the late 1990s, this busi­ness gen­er­ates ex­cep­tional cash flows and our dis­counted cash flow val­u­a­tion sug­gests fur­ther up­side.”

Ash­ton says that in the US tech space there is of­ten a very large di­ver­gence be­tween re­ported earn­ings and “non-GAAP” (gen­er­ally ac­cepted ac­count­ing prin­ci­ples) or ad­justed earn­ings – which typ­i­cally re­lates to adding back non-cash charges such as share op­tion ex­penses or amor­ti­sa­tion of in­tan­gi­bles.

“Be­cause of this, we would cau­tion that in­vestors pay close at­ten­tion to the level of free cash flows of the com­pany be­ing re­searched, and that the val­u­a­tion is well un­der­pinned by free cash flow gen­er­a­tion.”

Ama­zon would be an ex­cep­tion as it has de­lib­er­ately in­vested heav­ily in growth at the ex­pense of prof­itabil­ity.

“Very im­por­tantly, in­vestors should en­sure they un­der­stand the busi­ness model of the com­pany in ques­tion, how it gen­er­ates its rev­enues (or is likely to) and whether they are com­fort­able that the busi­ness model is sus­tain­able.

“We would cau­tion strongly against blindly fol­low­ing the next ‘hot IPO’ [ini­tial public of­fer­ing] with­out first get­ting a han­dle on these is­sues.”

Coro­na­tion’s Marc Talpert says in­vestors should not ig­nore val­u­a­tion. “Val­u­a­tion al­ways matters, but you mustn’t get too fix­ated on short-term val­u­a­tion met­rics like a one-year for­ward P/E. Rather look at how long can they grow above nor­mal and what mar­gins the busi­ness can ul­ti­mately gen­er­ate.”

For tech com­pa­nies, it is im­por­tant to look at the qual­ity of man­age­ment and the ex­tent to which the team fo­cuses on the long term. “While they have been dis­rup­tive, there is no say­ing they won’t be dis­rupted them­selves. It is im­por­tant for them to rein­vest in in­no­va­tion,” says Talpert. “That is what com­pa­nies like Ama­zon have done so well. They op­er­ate with a sense of para­noia that they are go­ing to be dis­rupted and con­stantly rein­vent the busi­ness. “Some­times these com­pa­nies don’t gen­er­ate prof­its [and as a re­sult] in­vestors can come to the wrong con­clu­sion. Some­times the busi­ness model in­volves spend­ing a lot and cre­at­ing a bar­rier to en­try, which down the line will lead to a sig­nif­i­cant re­turn.” ed­i­to­rial@fin­week.co.za

"While Face­book trades at a for­ward 24P/E mul­ti­ple, un­like tech com­pa­nies of the late 1990s, this busi­ness gen­er­ates ex­cep­tional cash flows and our dis­counted cash flow val­u­a­tion sug­gests fur­ther up­side."

Sean Ash­ton Chief in­vest­ment of­fi­cer at An­chor Cap­i­tal

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