This article is authored by MOI Global instructor Ole Soeberg, founder of Nordic Investment Partners, based in Copenhagen.
Having lived the ups and downs of global financial markets since the early 1980s, the last couple of years have certainly been interesting and have provided new perspectives, to say the least. Lower US corporate taxes in 2018, followed by easier monetary conditions in 2019 boosted valuations to new highs in late 2019. Then the game stopped in early 2020, caused by the global pandemic, and then the bull run marched on in 2020 and 2021, driven by surplus liquidity and strong earnings. Only investors on steroids would have imagined the 2020-21 run in March 2020. No matter the overall market mood, there are underlying trends that do not stop with lockdowns or high valuations and are to some extent immune to economic cycles.
Early on in my career I found growth companies more interesting as they have more potential than cyclical and traditional businesses, albeit the latter two can also have good managers and business models that create solid returns over time. Computers, software, and new innovative drugs were obvious hunting grounds for investment ideas back then. The big challenge, however, was to learn how to hold onto an investment and let it do the value creation work. As example, I bought Microsoft after the crash in October 1987 as it suddenly was less highly valued. After a decent return, it was sold in 1988. In hindsight, the sell was a very poor investment decision and boiled down to an observable profit and a young spirit ready for the next hunt. No other investors told me the value of patience at that time, but I wish I had learned it early on. Unfortunately, patience is not learned in one instance, so additional “too early sells” had to teach me discipline.
The Tiger Crisis in 1997 opened up a honey pot of Asian growth companies, such as Samsung. The company is still part of my investment portfolio but has been sized down several times. The financial crisis in 2008 again opened the honey pot to get good growth companies at low valuations, which helped fuel performance for the next decade.
700 of world’s 4,000 largest companies are valued at more than 10x sales
Fast forward from 2008 and to 2021, when more than 700 companies are priced above $5 billion and valued at more than 10x sales (source: Refinitiv Global). There is an easy illustration of the challenge posed by those kind of valuations: Ferrari, the high-end car brand, trades at 10x sales and is a well-known business. Based on consensus EPS for 2021-24 (as of September 2021) and using the general market earnings yield of 5% for discounting, Ferrari must grow earnings at least 12% annually over the 2025-41 period to support the recent stock price. A simplistic view is that ~75% of Ferrari’s sales come from cars and spare parts, while ~25% is from engines, commercial, and other. Let’s assume car sales is the key driver for Ferrari; then the company may need to sell 100,000 cars in 2041, as compared to the 10,000 current unit run-rate. That may well happen as global affluence increases and more individuals can afford a Ferrari, but during the last six years, with a roaring bull market, Ferrari’s car sales have grown at a rate of 6% annually.
The list of 700 companies contains many firms that are completely unknown to most investors, and to justify a valuation of 50x sales one must be pretty optimistic on the longer-term prospects for the business if it is to generate value for investors. I have my doubts that most of the 700 companies will be successful.
Opportunities for valuation-minded investors in renewable energy?
With many companies aggressively valued, what is the curious investor to do? I spend lots of time identifying growth pockets for the next 10-20 years and digging into many companies to find the few that might — or might not — be the next 20-, 50- or 100-baggers.
CO2 reduction is high on the agenda, as is making the earth’s resource consumption more sustainable for the benefit of future generations. To change the fossil fuel economy into a renewable energy economy requires billions, if not trillions, of dollars in investment. The journey has barely just begun, with the trend gaining momentum in the last decade.
Denmark, my home country, was an early bird in wind power renewables, supported by government subsidies. It never broke the government bank to do so and, along the way, the windmill industry developed into a world leader in the field, with Vestas Wind Systems (Denmark: VWS) as the global leader. As a stockbroker and participant in the public listing of Vestas in 1998, I recall that the arguments against the investment case were many. One argument was that the major industrial power companies, such as General Electric, Mitsubishi, and Siemens, would let Vestas and competitor NEG Micon kickstart the market, and then the big industrials would take it from there. The fact is that Vestas today has much better profitability and a stronger market position than competitors General Electric Renewable Energy and Siemens Gamesa.
Founders are often the best stewards for sustainable and solid value creation. In the Vestas case that was not part of it as the company was founded in 1898 and the founder was long gone. However, the family continued to develop the business. It expanded into wind turbines in 1945 and started focusing solely on wind turbines after 1989. Today, Vestas is an institutionalized public company, with the founder ethos mostly hidden from outside view.
Previewing my idea for European Investing Summit 2021
The company I’ll highlight is a Norwegian industrials business that has grown from almost nothing in 1995 to a NOK 3.5 billion business today. The founding family is a major shareholder. The journey over the next 10-15 years has only begun after a major reorganization to serve customers’ CO2 reduction needs in the best possible way.
The investment qualifies for long-term growth of at least 10%, with good profitability and returns on capital employed in excess of 15%. The observable valuation in 2021 is not a bargain, but once we look out to 2024-25, the valuation becomes a bargain. As a result, it might be a good time to get to know the business and perhaps build a long-term position, allowing the intrinsic value creation to materialize over time.
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