Performance Review FY2024--
REVIEW OF PERFORMANCE fy2024
The numbers are in for 2024. The portfolio generated 20.8% (after
costs and some cash taxes[1]),
the benchmark return was 13.4%. I am satisfied with the result, considering all
things. What are all things? Was I in the fortunate receipt of much good luck
(or bad luck), or did I utilise much higher risk in a rising market? Did style
assist me? Does the result differ from what could be considered a random outcome
(that is the hardest to assess)?
I will attempt to address some of these in the following
text.
The following post will be divided into several sections
addressing various segments. To reiterate my investment philosophy is to buy
quality companies when they are reasonably priced. Of course, this sets a conscious
boundary on likely results, up and down. I am consciously setting a limit on
risk by skewing the portfolio almost totally to quality growth companies with a
long history of profitable businesses. The belief is that over the long term,
the best risk-adjusted returns are made from buying great companies at reasonable
prices and then holding them.
Part One --Analysis of the Benchmark
The benchmark comprised equally weighted 587 stocks. Some conclusions
I have come to are, that the skewing of returns is consistent in the benchmark in
both bull and bear markets. This means I should only use the average returns of
the benchmark and not the median return and will not use the median any longer.
Previously I used both. The reason is that stocks can only fall 100% but could rise
many times. For instance, the worst stock in the benchmark, Core Lithium was
down 90%, and the best Droneshield was up 664%!
The benchmark will be reduced in the future to increase quality.
There are not enough profitable, quality companies listed in Australia with a
broad sectoral spread. Although theoretically, the recent strong market should have
helped a riskier benchmark. To alter the benchmark in this manner after a bear
year could be construed as attempting to time the market, that is not the case
here, as far as I can tell. The benchmark improves quality as it is reduced.
One observation of the stock returns in the benchmark is
that usually, you would expect the more speculative names to own the extremes
of the benchmark returns as the stories either played out or didn’t. That was
so this year, however, there was a reasonable representation of large-cap names
in the top 10% of performers. These largely comprised the AI theme, the weight
loss giants and a few takeovers (that you could see every year). Given the size
of these companies, the market cap indices would have likely outperformed the
EW index this year.
Part Two—Analysis of those stocks held over the whole year
(30 positions)
Since the b/m was up 14% I will focus on those stocks in a
band of +/-20% around the index or +34% and -6%. The rest are in the middle. The
following is not meant to be an in-depth stock analysis that analysis is for
the individual stock notes.
Note-- all gains and losses do not include dividends.
In the portfolio, eleven stocks generated over 34% for the
year and five stocks earned below -6% for the year (not including dividends). Recalling,
a great “hit rate” is 60%. That should be kept in mind when assessing all
return numbers. In raw terms the hit rate was 68%, which means the returns were
generated by a broad set of companies, indicating less reliance on luck. The weights
that each stock holds are important and I won't disclose these weights (since
they vary through the year), but five of the outperformers were constantly in the
top 10 positions and no underperformers, greatly assisting the results.
The eleven outperformers were LOV, CAR, REA, GOOGL, AMD.US,
TSM.US, FPH, NAB, HUB, BRG, PNI
The five disappointing stocks were CKF, DMP, DRR, IDX, TLS
What conclusions can we draw from this?
There was some AI theme with the US stocks benefiting from
the AI interest but not to an outsized degree. The rest are largely well-managed,
strongly positioned and growing companies, with valuation assessment being the
main issue. NAB stands out as the outlier, likely sales candidate.
TSM was initiated due to the fear of Chinese invasion of Taiwan
while the GOOGL position was opened on the fear that GOOGL had lost the AI race
(it’s a long race). Both were non-consensus buys of quality companies at the
time.
My strategy is I’m reluctant to exit a well-managed company
with the business performing well just on valuation. I may sell some (20-50%) and
wait.
The losers were smaller positions, but we can see that the
QSR theme is well represented as the post-C19 boom and bust with the volatility
that brings playing a part. They do need intense management to continue to do well.
IDX was bought as a stable business. That instantly became an
issue as the growth in operating costs exceeded the government-mandated price increases,
therefore crushing margins. Although difficult to rationalise, and why it shouldn't
return to normal margins, the extent of the damage was so severe that selling instantly
on the first downgrade (due to its size) was the best strategy. TLS and DRR are
income plays, TLS was cycling a strong year, while DRR made an acquisition late
in the year that was not well received.
Part three—Analysis of new positions (12 stocks)
The 12 new positions were V.US, Adyen, Evolution AB, FNV.US,
LVMH, Pernod Ricard, NCK, SHL, IEL, MIN, DDR, and RMD. Six international positions
and six domestic ones. These moves must be considered within the overall
investment strategy, ie buy quality when it is on sale, together with a decision
to own individual international shares. The funding for these purchases (always
a consideration) has come from an international quality growth ETF and selling
income shares highlighted below. These moves are a conscious decision.
Almost all the purchases were after significant falls in the
share prices. Except for RMD, no positions made the top 10 holdings and the RMD
position has subsequently been reduced from the top 10.
From a strategic point, the positions are relatively early
in their development, the risk comes that the share price falls were a precursor
of more poor news with deteriorating fundamentals and further capital deployed will
have to be gauged against this risk. Not all stories will work out with happy
endings. On a different note, I have some sympathy for holding the portfolio’s
gold position through a streamer rather than an operator, due to the lower
risk, to be implemented as valuations allow. Secondly, I want to limit the portfolio
exposure to resources and will manage positions to cap exposure. Due to the difficulty
of accurately forecasting returns in this area.
There is little doubt that the changes add to the quality of
the portfolio, whether that quality persists is the issue to be monitored.
Part Four—Analysis of exited positions (8 stocks)
The 8 stocks exited were, ORG, SGR, URW, WPR, WDS, A2M, CDA
and BABA.US. The first five positions were the stub of the large income
portfolio that is being run down and now is around a few per cent of the
portfolio. The income experience was mixed but overall not great. These were
small positions and the capital has been recycled to the above. Some of these
stories could recover but the persistence of returns is far from certain. That leads
to the sale of BABA, my only Chinese position. In this regard, I changed my view
regarding the Chinese investing environment and no longer see the cheapness here
as clearly leading to good shareholder returns. There is just too much risk and
I sold at a modest profit. The last two are more interesting and difficult,
being A2M and CDA. CDA is a profitable and growing company. The track record is
not bad, it was hit with a large decline in the metal detector business, which should
stabilise, but acquired a communication business, that so far has done well. There
is a possibility that it continues to do well. I have decided to sit out, but I
have no significant issues with the company. A reasonable profit was made. A2M
was sold at a loss. Long ago A2M lost its most profitable distribution channel
and has been struggling to replicate that success. While progress has been
acceptable, the long-term end game does not appear to be clear to me. The company
could do well, but less problematic stories exist.
No companies sold were top 10 holdings, most far from it.
Part Five—Strategy Review
A few strategic shifts are being undertaken in the
portfolio.
Firstly, the shift from Income stocks to Growth stocks is
about 80% complete. The requirement for income is not as great as previously perceived
and income holdings mostly weigh on capital returns. That move is well
underway.
Secondly, the move to individual international shares is making
progress. It is expected that opportunities will be rare in this space and much
due diligence is required. The market's reliance on momentum and short-term
results will offer some opportunities. The strategy will be followed with
patience and research effort.
The playing around in micro caps has been mixed with disappointing
results. Disappointing losers have offset large winners. Over the year not much
capital has been tied up here, around 2-5%. Not large but the resources potentially
could be better deployed. The major problem here is that the amount of historical
data is just not large enough to reduce the variability of outcomes, meaning
more trading and scrutiny of small details. Liquidity is also an issue.
One area that could throw up some interesting possibilities is
turnarounds. Although notoriously tricky, a systemic approach can be deployed
where a sensible assessment can be made of valuation together with changes in strategy
where the payoffs are asymmetrical. Much work and timing are required but could
pay off well.
Part Six—Missed Opportunities/Lessons Learnt
The portfolio has seen several instances of holdings that
have been held through the tough times and then sold just as a long uprun in
share price has started. As a second point, the screening process has
identified potential targets that I have passed over and then the shares have increased
severalfold.
Is there a behavioural bias which means we are missing out
on these gains? Every investor will miss some winners, it comes with the
territory, but I can identify several big misses after work was done or the
shares held and sold before a significant move higher. These were (over the
last few years), SNL 3X, Meta 5X, NVDA 6x, MRM 8X, spring to mind.
The lesson I have taken away is that when these opportunities
arise, much more due diligence is required. A cursory look at fundamentals and
recent results are not enough to gain a conviction, much more effort is needed.
In an investment market driven by momentum, selling early can be a dangerous
and value-destructive undertaking. The market is driven by short-term good news
with valuation taking a back seat for quite a while.
The lesson is if an opportunity presents drop everything and
undergo a deep dive, don't give up if the answers take some digging. Keep to
quality.
Thirdly, continually turning over new opportunities may not
be productive, many opportunities are already being monitored but more work is
required to increase conviction rather than just adding to the watch list.
I have also noticed my inability to incorporate important news
promptly. That is the case, especially for good news. An area that needs work.
Conclusions and Outlook
2024 is the third year of outperformance of the fund against
the benchmark. One year closer to underperformance.
The portfolio, IMO, is relatively conservative with capital preservation
as important as generating adequate returns. There is no “start again” option.
I will challenge myself to do this every year, of course
when the numbers are bad, usually, the silence is deafening in this game.
Finally, despite my best efforts, these results have not been
audited and could contain some errors.
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