The Ozzie Growth Sell Off

 ANOTHER LOOK AT THE GROWTH SELL-OFF

Background

My basic investing thesis revolves around backing companies that can add assets and maintain a high ROE. Adding assets while maintaining a high return propels eps higher and with it the SP. The maths is simple, the execution is not, management and investing. I do like frameworks, especially those that win, and if you can pick a company that adds assets and holds returns, while buying at a reasonable price, you will do very well. The hard part is picking those companies that can maintain returns. Investing is not easy. I’ve found buying them at a reasonable price is the easier part (takes patience). However, in my case, I find this framework immeasurably easier than finding a company that is yet to prove itself as a quality company; I find that even harder.

Brief recap of proof point

I've done this to death before, so it will be brief. To prove the thesis, I picked 12 high ROE companies and 12 low ROE companies. The thinking here is that high ROE companies can reinvest above the cost of capital and drive intrinsic value. That holds until it doesn’t. Usually, ROE is destroyed by poor M&A or the business model moat proving to be breached.  Over the long term, the strategy of buying stocks that can maintain high returns is very powerful.

The 12 high ROE stocks I picked were ALL TNE, RMD, CSL, DMP, CHC, AUB, JBH, BRG, REA, CAR, and JHX. The measuring starts in 2014, so I did not include obvious ones like WTC and PME, because they were not listed or did not have enough data to prove themselves up (that would have been cherry picking data imo). The 12 low ROE companies were ANZ, ORI, IPL/DNL, PPT, AOV/GUD, ORG, LLC, SUN, SGP, WBC, ABC and BAP. The ROE of the high-returning group was about 27% and the low group 7%, so a large difference. I attempted to have a mix of sectors in both. In the end, it doesn’t significantly change the result, as you would expect.

The average SP movements over the 10 years to 2023 are below. The results are self-evident. There is nothing magical or underhanded here; this is what Munger and Buffett have repeatedly waxed on about. Time is the friend of the great business and not the poor business

So what's happened in the last two years?

Firstly ive changed the sample set. Since I am now measuring from Jan 2024, I have brought in the newer high ROE companies, LOV, WTC, PME and HUB and removed the ones where ROE has fallen off, CSL, DMP, JHX and AUB. The new ROE is about 30%, but that is mainly due to LOV being really high; if you adjust for LOV, it falls to 24%, so lower than before but not much, still a multiple of the cost of capital. For the low returners, only one change was made, with ABC being taken over, so I added APA. ROE has stayed around the cost of capital for this group.

The new charts are below, from Jan 2024 to current.

What do we see now?

Quality growth has had a significant pullback. To put that into context, the current retreat from ATH is 22%. Other retreats have been C19 -33%, 2022 -35%, this was when the Fed increased interest rates dramatically and rapidly, as you may recall. In 2018, when there was concern over monetary policy, the retreat was 20%. In this context, it is a reasonably large pullback, especially with no bond market ructions; if anything, the bond market should have been supportive.

The low returners have done a bit better, trading towards the top of their band. Remember, if they earn at the cost of capital, LT SPs will stay flat. Arguably, ORG has done enough to move out of this group (im no expert on ORG these days).

Summary

Liquidity follows the short-term narrative and short-term momentum. Quality growth has been the beneficiary of this at times, as we can see in the graphs above. Now, liquidity has moved to other areas. Is this an opportunity? The two factors to focus on are whether the companies are still in a positive position to add assets and maintain high returns, which pushes intrinsic value higher, and whether we are we now at now at a reasonable valuation.  Valuation, imo, is the best it's been in quite a while. Can they maintain returns? Every company has its story here, and this is where the focus should be. When there is a broad-based sell-off, imo, it's better to stick with the strength. Im looking to add or have added ALL RMD TNE REA and LOV, even WTC has copped a nibble (all previously held).

That’s how I see it, could be wrong.