For long-term wealth creation
tive returns on bonds by bidding up their prices, so investors who previously held bonds have been forced into equities. As reluctant equity investors, they have chosen the most bond-like stocks they could find — the defensives.
So where do you go?
In a market environment such as this it is particularly important to focus on downside risk.
Allan Gray and Orbis define risk as the permanent loss of capital and we position our portfolios to limit this risk. While this can lead to short-term underperformance, we believe it is the best way to preserve and grow clients’ wealth over the long term.
To achieve this, we look at every company we own in meticulous detail. We are wary of investing in companies with weak balance sheets that cannot make it through a down-cycle and will need to raise capital or worse, capitulate. While we pick each stock we put into the portfolio on-by-one, there are currently essentially four buckets of stocks that have emerged from our bottom-up decisions:
1. Stocks that are cheap because of company- or industry-specific concerns. These are classic Orbis stocks. Prices and investor sentiment are depressed due to country, industry or company concerns — or some combination of the three. Russia’s Sberbank is a good example. At a time when financial services and Russia have both been out of favour, many investors have overlooked what is otherwise a very well-run bank, with a dominant competitive position.
2. Stocks with large cash balances that can be deployed in attractive opportunities if asset prices decline significantly. Multinational conglomerate Berkshire Hathaway stands out as a good example. Warren Buffett has cash at the ready to snap up any cheap assets as soon as they become available. We don’t think the value of that cash is reflected in the share price.
3. Stocks undergoing transformations that should enhance intrinsic value. An example is Charter Communications, one of Orbis’s largest holdings. The US cable telecom provider is currently leading the charge in consolidating the US broadband industry, with a savvy management team unlocking the synergies from one acquisition to the next. We take a long-term perspective and we don’t think the valuation that the market currently assigns to this and other such companies is reflected in their share prices.
4. Beneficiaries of innovation and change. This final bucket is for companies changing the way we do things using technology and innovation. Once again, we think the market is underappreciating the value of profitable, long-term growth — something that is more evident when taking a long-term perspective. Orbis owns a number of e-commerce companies that fit this description, with Amazon being the best-known example.
Once you mix all these buckets together you get a well-diversified group of companies that have been thoroughly analysed and all have one thing in common: the price we have paid for their earnings and assets is well below what we think they are actually worth. We won’t be right every time — historically, our success ratio has been around 60% — but paying a low price relative to fundamental value creates a margin of safety in case we are wrong.
And that is the key point: We believe underpaying for assets not only leads to superior returns in the long term, but also reduces the risk of permanent capital loss. Similarly, it is also important to avoid areas of the market that look particularly expensive, as is the case with the so-called “defensive” shares in the current environment.