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Digging Beyond Profit Margins

November 20, 2017 in Best Ideas Conference, Commentary, Letters

This article is authored by MOI Global instructor Randall Abramson, chief executive officer and a portfolio manager at Trapeze Asset Management, based in Toronto. Randall is an instructor at Best Ideas 2018, the fully online conference featuring more than one hundred expert instructors from the MOI Global membership community.

Profit margins for the S&P 500 constituents, excluding financials and companies in volatile sectors such energy and materials, have been steadily rising since the end of the 2001-2002 recession (Chart 1). The median 2016 EBITDA margin for this group was 22.6%, an all-time high. The median net margin came in at 9.6%, also an all-time high.

Companies have boosted operating margins by doing more with less— optimizing administrative functions, cutting managerial layers, and restraining advertising and R&D expenditures. The S&P 500 constituents recorded median revenue of $360,000 per employee, up from $263,000 in 2003 (Chart 3). Further down the income statement, net margins have risen due to lower effective tax rates (as international revenues as a percent of total sales have risen), and record low interest rates.

Cash flow trends have not been as rosy. While profit margins have risen, cash flow return on invested capital (CFROIC)—operating cash flow generated as a percentage of the total economic capital employed to generate said cash flow—has been flat-lining. Chart 3 illustrates that the median CFROIC has actually declined since 2003, from 16.9% to 16.5% today.

Our read of this is that projects that produce returns above capital costs are hard to come by. Realizing this, the largest companies in the world have zeroed in on cost cuts and diverted cash to share buybacks to prop up bottom line results. For the full S&P 500, rather than our adjusted group referred to above, revenue per share grew at an annualized 4.4% between 2003 and 2016 whereas earnings per share grew 6%. Over the same time period, ROIC declined from 7.8% to 7.2%.

Ultimately, the chickens must come home to roost. We expect that investors will eventually zero in on free cash flow and the productivity of capital. The S&P 500 currently trades at just over 13x EV/EBITDA, reflecting optimism about margins, global growth, and continued favorable central bank monetary policy. Valuations are high on a historical basis, and may turn out to be unsustainably high should the productivity of invested capital continue to decline.

Chart 1. Median EBITDA and Net Margins for Adjusted S&P 500 Group (%)

Chart 2. Median Revenue per Employee for Adjusted S&P 500 Group ($, thousands)

Source: FactSet, Trapeze Asset Management Inc.

Chart 3. Median CFROIC for Adjusted S&P 500 Group (%)

Source: FactSet, Trapeze Asset Management Inc.

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The Generation Global Value Private Trust invests primarily in securities of large capitalization companies, typically with market caps over $5 billion at the time of purchase, but may invest in those with $2 to $5 billion market caps. Trapeze Asset Management Inc. employs a proprietary and systematic process to uncover large cap global equities which our analysis indicates are undervalued. We prefer companies with strong competitive advantages led by management teams incentivized to maximize return on capital. Our fundamental analysis provides conviction to hold 30-40 holdings that meet our criteria. Innovative trading models are used in an attempt to optimize the timing of our purchases and sales.

In addition to rigorous stock screening and research, we utilize a parallel process to monitor economic and market risk.

DISCLAIMER: The Generation Global Value Private Trust is generally available to investors who can meet certain eligibility requirements under exemptions from the prospectus requirement in order to invest. Information pertaining to the Generation Global Value Private Trust is not to be construed as a public offering of securities in any jurisdiction of Canada. The offering of units in the fund is made pursuant to its offering memorandum only to those investors in certain jurisdictions of Canada who meet certain eligibility requirements. Please read the offering memorandum carefully before investing. Investors should contact their investment dealer or Financial Advisor for more information regarding these exemptions and their requirements. The information contained herein is for informational and reference purposes only and shall not be construed to constitute any form of investment advice. Nothing contained herein shall constitute an offer, solicitation, recommendation or endorsement to buy or sell any security or other financial instrument. Investment accounts and funds managed by Trapeze Asset Management Inc. may or may not continue to hold any of the securities mentioned. Trapeze Asset Management Inc., its affiliates and/or their respective officers, directors, employees or shareholders may from time to time acquire, hold or sell securities mentioned. The information contained herein may change at any time and we have no obligation to update the information contained herein and may make investment decisions that are inconsistent with the views expressed in this presentation. It should not be assumed that any of the securities transactions or holdings mentioned were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities mentioned. Past performance is no guarantee of future results and future returns are not guaranteed. The information contained herein does not take into consideration the investment objectives, financial situation or specific needs of any particular person. Trapeze Asset Management Inc. has not taken any steps to ensure that any securities or investment strategies mentioned are suitable for any particular investor. The information contained herein must not be used, or relied upon, for the purposes of any investment decisions, in substitution for the exercise of independent judgment. The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is not guaranteed. We make no representation or warranties as to the accuracy, completeness or timeliness of the information, text, graphics or other items contained herein. We expressly disclaim all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained herein. All products and services provided by Trapeze Asset Management Inc. are subject to the respective agreements and applicable terms governing their use. The investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. Nothing herein shall constitute an offer or solicitation to anyone in any jurisdiction where such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such a solicitation.

The Phillips Conversations: Jeffrey Stacey

November 20, 2017 in Audio, Full Video, The Phillips Conversations, Transcripts

The following interview is part of The Phillips Conversations, hosted by Scott Phillips of Templeton and Phillips Capital Management.

MOI Global has partnered with Templeton Press to bring you this exclusive series of conversations on investing and the legacy of Sir John Templeton, one of the greatest investors of the 20th century.

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About the interviewee:

Jeffrey Stacey is the Founder of Stacey Muirhead Capital Management Ltd. Jeff has almost 30 years of investment industry experience. Prior to starting Stacey Muirhead Capital Management Ltd., he was employed with a boutique Toronto investment firm where he was also a shareholder. Jeff has an Honours Bachelor of Business Administration degree from Wilfrid Laurier University and is a Chartered Financial Analyst. He is a member of the Finance and Investment Committee and an Advisory Board Member of the student managed School of Accounting and Finance Investment Fund at the University of Waterloo. He is also an Advisory Board Member of the student managed Ivey Value Fund at the University of Western Ontario. Additionally, he serves as a member of the Dean’s Advisory Council at the Wilfrid Laurier University School of Business and Economics and on the Board of Trustees at Parkminster United Church. He is a former director of Rainmaker Entertainment Inc. and previously served on the Board of Trustees and Investment Management Committee at the University of Guelph.

David Swensen on Investing and Endowment Management

November 17, 2017 in Curated, Full Video, Interviews, Portfolio Management, Timeless Selections, Transcripts

Famed investor and endowment manager David Swensen, chief investment officer of Yale University, sat down for an hour-long conversation with former treasury secretary Bob Rubin at the Council on Foreign Relations in late 2017.

The interview was the keynote session of the Stephen C. Freidheim Symposium on Global Economics. The symposium focused on the future of investment management in a world of low returns, the financial pressures felt by universities, states, and individuals around the world, and methods for adjusting to low returns on investments.

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