July 8, 2025 • 45 mins
With European earnings growth projected to be low in 2025, investors are focusing on a potential recovery in 2026. In this episode of Inside Active, host David Cohne, mutual fund and active management analyst with Bloomberg Intelligence, along with co-host Laurent Douillet, senior equity strategist for BI, spoke with David Samra, founding partner of Artisan Partners’ International Value Group, about the similarities of value investing to two-for-one deals, with value investing providing both upside potential with downside protection. They also discussed the importance of intrinsic value, why strong balance sheets are crucial for investment safety and the inefficiencies present in non-US markets. The podcast was recorded on June 10.
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Speaker 1 (00:12):
Welcome to Inside Active, a podcast about active managers that
goes beyond sound bites and headlines and looks deeper into
their processes, challenges and philosophies and security selection. I'm David cone, I,
lead mutual fund and active research at Bloomberg Intelligence. Today
my co host is Laurent Dulier, senior equity strategist at
Bloomberg Intelligence. Laurent, thank you for joining me today.
Speaker 2 (00:35):
Thank you for inviting me.
Speaker 1 (00:37):
So you published last week your stock six hundred earnings outlook.
What can we expect for the rest of twenty twenty
five based on what you're seeing?
Speaker 2 (00:47):
I mean, I would say overall it's not that great
because the earning groups of the index has now for
them to lose single digit for twenty twenty five. At
the beginning of the year it was around seven percent.
And two main reason for this downgrade in growth expectations
are further than certainty on US tariffs given that the
(01:08):
initial rate and on the by tramp at twenty percent
was much higher than initially expected. And also we have
seen significant cuts to the forecast of some of the
commodity related sectors in Europe, black energy and also the
mining industry, despite the announcement of the five hundred billion
(01:29):
euros fiscal stimulus in Germany and also all the rumors
about the ramp up in defense spending. I think it
will take some time for all the shovels to be
put into place and to really have an impact on
the earnings level. So I think that is more twenty
twenty six rather than twenty twenty five stories what the
(01:50):
impact of US stariff are likely to play in the
second half of the year. So one of the main
reasons why we have much lower growth expectations. Whoever investors
are looking through I would say is a short term
earnings weakness and now are really focusing on the recovery
potentially in twenty twenty six, and that's the main reason
(02:11):
why the shop I saw now back to where they
were before the announcement of Liberation Day.
Speaker 1 (02:18):
Okay, we'll be interesting to watch. I think we should
hear from our guest on the topic. I'd like to
welcome David Sama, founding partner of the Artists and Partner's
International Value Team. Thank you for joining us, David Well.
Speaker 3 (02:31):
Thank you for having me. David and Laurent so.
Speaker 1 (02:34):
I'm sure you're looking at European companies. What are you
seeing in terms of earnings for the year.
Speaker 4 (02:40):
Well, there are only two large liquidity pools outside the
United States, both Europe and Japan, and so of course
our portfolio is heavily invested in Europe. And I think
what Laurent referred to in terms of earnings growth the
year backstopped by the stimulus spending by the German government.
(03:06):
So the headline number was about five hundred billion dollars,
which is about ten percent of Germany's GDP. But I
think you've got to think about that in slightly broader
terms because you're also seeing other European countries stepping up
with a little bit of stimulus spending. You saw Canada
come out with some numbers also that will support some
(03:32):
GDP growth, albeit a lot of that spending in less
productive parts of the economy, but it is supportive. But
I think a lot of the growth, you know, interestingly enough,
is coming from widening spreads at European banks, which has
little to do with what's going on with deficit spending
(03:56):
and a lot to do with what's driving the underlying
equity markets in Europe so far this year. With respect
to the tariffs. It's it's really sort of interesting as
you go through the earnings results announced during the first quarter,
which is sorry post the first quarter, which was in
(04:17):
the middle of the Liberation Day announcements, what you saw
from most companies was an itemization of the impact that
tariffs would have on their twenty twenty five earnings. So
it's already embedded in whatever estimates the broker dealers or
(04:39):
the cell side are putting out there as consensus. What
is not fully baked into the earnings are whatever teriff
rates are eventually settled between the European Union and other
parts of the world. The other thing that's not baked
(05:01):
in there are what are the economic consequences of those tariffs,
because that's much less of a linear outcome, so it's
harder to get analysts to bake that into the earnings estimates.
And I also say that there is a fair amount
of speculation on the parts of corporates and temporary tactics
(05:29):
that have been deployed on the part of corporates to
diminish the impact of the tariffs in twenty twenty five,
the most common one being the acceleration of purchases of
certain raw materials or inventories or shipping inventory into the
United States ahead of the tariffs, and of course you
(05:49):
know in twenty twenty six, you know that will anniversary
and will have an impact that none of the companies
have yet to quantify.
Speaker 3 (05:58):
And is less likely to be embedded in earning.
Speaker 4 (06:02):
So I think just in terms of, you know, what
is built into consensus From what we can see, it's
still unfinished business.
Speaker 1 (06:12):
Okay. Is there a process that you go in terms of,
you know, when you find ideas or you know, for instance,
can you tell us how an analyst's idea could make
its way into the portfolio?
Speaker 4 (06:24):
Well, we have so it's very important I think for
any successful long term active investor to have a certain discipline,
as implied by the name of our strategy, the Artists
and International Value Strategy. We are value investors and as
(06:48):
a result, the price that we pay is a very
large determinant of our investment outcomes.
Speaker 3 (06:56):
So we look to.
Speaker 4 (07:00):
To find businesses out in the marketplace that are trading
at a significant discount to what our research is telling
us that a business is worth. Those are the fundamental
concepts behind value investing. You know, it's I love two
for one deals. Value investing is sort of a two
(07:21):
for one deal because, on one hand, if you're able
to find an asset worth a dollar and you're paying
sixty cents for that asset, you get excess return, especially
if it's a decent business that grows that dollar slowly
but surely over time. You capture that underlying growth, and
you capture the unwind of the discount from sixty cents
(07:42):
all the way up to a dollar. Now, the second
part of the two for one deal is, let's say
you make a mistake, or the rules change, the government
does something like put a stimulus package, or does the opposite,
and the value of the business ends up being eighty
cents instead of a dollar. Because you've paid sixty cents,
(08:06):
you've built an emergin of safety, and you've avoided a
permanent loss of capital. So value investing, the fundamentals of
value investing allow you to effectively have that too for
one deal. Now we take it a step further. We
take a more thoughtful approach in terms of the types
of businesses that we want to be involved in. So
(08:29):
not only do we want to find a business where
there's a big spread between where it's trading and what
our research is telling us it's worth.
Speaker 3 (08:41):
But we also want.
Speaker 4 (08:42):
To have good businesses, that business where that dollar is
growing over time. That's because usually in order to get
a good deal out in the stock market during let's
say normal time periods like today, something has to be
wrong with the business. People don't give away a share
price at a cheap price when there's nothing wrong with
(09:06):
the business. When there's something wrong, the stock market generally.
Speaker 3 (09:11):
Doesn't like it.
Speaker 4 (09:11):
People don't like bad news, people shy away from it,
would prefer to be involved with companies that have good
news and maybe with share price momentum. As a result,
it takes time usually before the market is able to
recognize the fact that the security is significantly undervalued, and
(09:32):
during that time period, you want the underlying value of
the business to be growing that way. When you finally
get that revaluation, inflation which as we all know is
ever present, doesn't erode your purchasing power. So we not
only focus on securities that are undervalued, but we focus
(09:54):
on securities that are undervalued that are attached to very
good businesses. Now stopped there. We are very particular and
that we're also looking for companies with strong balance sheets.
Speaker 3 (10:08):
So why do we do that.
Speaker 4 (10:09):
You know, most of the market is focused on companies
that have an appropriate amount of leverage. We don't think
there is an appropriate amount of leverage. We actually prefer
no leverage and companies with very very strong balance sheets.
That way, if something goes wrong or we have some
bad luck, or if the company needs to repair a problem,
(10:32):
that they have the resources available to them to be
able to fix that problem, invest back in the business,
create competitive advantages, and grow over the long term. And
the fourth thing that we look for is a management
team that has a track record and history of building
(10:53):
per share per share shareholder value over time. And if
you think about the combination of an intelligent manager with
a strong balance sheet that knows how to effectively allocate capital,
what that can do, if executed well, is actually accelerate value.
(11:18):
You know, instead of you know, buying company at a
dollar and it's growing at five percent per year. So
in normal time periods you go from a dollar to
a dollar five of underlying value. If you take excess
capital and you invested, you could accelerate that value creation
to a dollar ten or a dollar fifteen. And that
(11:38):
is a very powerful driver of return. So if you
think about what we're trying to do is we're trying
to stack the odds in our favor. Right, we want
an undervalued security, a very good business in the hands
of a great management team with a strong balance sheet
to try to maximize the potential for us to.
Speaker 3 (11:56):
Have a very successful investment. And our process is one
where we focus on.
Speaker 4 (12:07):
Companies that have that characteristic, those characteristics in combination, and
then take our time to do intensive first hand research.
So we don't use any sell side research. We don't
use any databases we build. You know, we're sort of
like pre ai dinosaurs. We build all of our own
(12:30):
financial models. We use firsthand data because we need to
exercise judgment on the underlying economics of this business. We
can't outsource our judgment to an algorithm or of course
we use these tools for data gathering. But once we
get that data, we analyze it firsthand. We talk to
(12:50):
management teams, we talk to competitors, we talk to customers,
we talk to former employees, we talk to anybody who
will help us understand the long term underlying economics of
that business. And we use all of that information along
with the data that we gather to create an estimate
of intrinsic value, and then we look to purchase shares
(13:15):
only in the case where there is a meaningful discount
to intrinsic value, and that's our process. We have a
group of seven very experienced securities analysts on our team.
We are all generalists with regional responsibilities, and we're all investors.
We don't really have analysts here. We have investors who
(13:37):
can allocate capital across multiple industries, across different geographic locations,
in both develop markets and in emerging markets. So I
think David and Laurent that gives you a pretty good
sense for the way that we think about the world
and how we approach finding securities.
Speaker 1 (14:00):
We talk a little bit about the intrinsic value. You know,
you mentioned you have a bunch of different information that's
kind of going into that. Are there metrics that you
use as well or is it kind of you've got
like a proprietary system to determine its intrinsic value.
Speaker 4 (14:15):
Well, you know, I don't think there's any magic to
you know, the value of a business is the present
value of its future cash flows, and you learn that
in your first finance class. And we haven't really varied
from using a very simplified diskind of cash flow model
to perform our let's say, formal valuation of the business.
Speaker 3 (14:39):
Most of the stuff you could.
Speaker 4 (14:40):
Do on the back of a napkin, you know, and
when you know, when we think about metrics, there's shorthand
that comes from the analytical process.
Speaker 3 (14:51):
You know, pe ratio is ev to e bit pre.
Speaker 4 (14:54):
Cash flow multiples, all of those are sort of shorthand
methods to evaluate the attractiveness of a company. And of
course everything is relative, right, So if you think about
the quality of let's say LVMH, which is a large
(15:15):
luxury goods company, the quality of that business relative to
let's say BASF, which is a large German chemical conglomerate.
Of course, those are two different businesses, one with significant
brand value that results in very high levels of profitability,
and the other one that operates and commoditize, you know,
(15:37):
businesses that are tough competitively and they operate with unionized labor,
which is a much more difficult, capital intensive, lower return business.
Speaker 3 (15:50):
They're not worth the same thing.
Speaker 4 (15:52):
If they were both at eight times earnings, of course
you'd far prefer to own LVMH. Then you would prefer
to own BASF. And you know, I don't use those
two companies to pick on them, but I use them
to point out that, uh, you know, we we can
look at shorthand metrics, David, to help us put shorthand
(16:17):
valuations on companies. But everything has to be taken into
context based on the type of business that you're looking.
Speaker 2 (16:24):
At, David. I mean in terms of marketing efficiencies, I mean,
based on your long experience. Where do you think the
market or the saleside get it wrong. Is it more
in understanding the underlying value or the interesting value of
the business, or is it more in how it should
(16:45):
be valued? How your experience I mean, is making you
look for more opportunities in one way or the other.
Speaker 4 (16:55):
Well, I would say, broadly speaking, the non US market
or less efficient than the US market. So first, there's
a lot less liquidity outside the United States than there
is in the United States. So that's one. Two, you
have the complexity associated with you know, various currencies that
(17:18):
you're dealing with. Three, you have complexity with respect to cultures.
You know, what does it mean to be invested in
a French company versus an Indonesian company versus a Japanese company.
And then you have different corporate governance structures, right, different.
Speaker 3 (17:33):
Rules of the game.
Speaker 4 (17:35):
What does it mean to be a shareholder of a
South Korean company versus a shareholder of a Swiss company?
You know, what is the construct of a board of
directors in Japan versus the construct of a board of
directors in the United Kingdom. So then you have different
time zones, you have different languages, you don't really have
(17:56):
different There's a little bit of accounting differences that exists today,
but they're not.
Speaker 3 (18:02):
Nearly as as big.
Speaker 4 (18:04):
But they're they're out there, right, and and that level
of complexity makes it much more difficult for the average
investor to truly understand what they're getting themselves involved in.
Speaker 3 (18:16):
So that's that's step one.
Speaker 2 (18:19):
Uh.
Speaker 4 (18:20):
Step two UH is with respect to the cell side.
The cell side, you know, they make their money on
the corporate clients, right, So their clients are the LVMH's
of this world, not the David Sammers of this world.
And uh, and they have over the years realized that
(18:43):
in terms of brokerage commissions, their their their bread is
buttered by fast moving hedge funds, and so they love
to have you know, short term movements based on earnings
estimates and things like that, and has nothing to do
with the long term in during intrinsic value of a business.
And so the cell side tends to be very short
(19:05):
term oriented, which is an advantage for somebody who's actually investing. Right,
So let's let's talk about investing to build wealth over time,
which is a very different concept than just owning a
security to take advantage of a trend. Now, what else
is also driving in efficiency is the advent of ETFs.
(19:27):
ETFs have become you know, have played into the gamification
of investing. It has sort of dumbed down investing and
provides things like exposure to financial advisors and broker dealers.
I think if you, you know, go over to your
friend's house and ask to see their statement from their advisor,
(19:53):
you know it's likely to have ten or fifteen ETFs
in there. And so what do they own, Well, they own,
they own products, they don't own businesses or investment investments.
And all of these inputs into the way that the
equity markets operate today, plus the added inefficiencies of investing
(20:14):
out the outside the United States, that's what creates opportunities
for long term investors, and David and Laurent let's use
you know today is a really good example, because it's
really interesting to see, you know, the European markets rallying
so significantly in the first part of this year. And
(20:39):
it is fantastic that you know, some of the banks
and the defense contractors and the utilities are likely to
have growing earnings on the back of what's happening. But
if you think about the relative quality of those businesses
(21:01):
compared to you know, other potential long term compounders, those
aren't fantastic businesses. You know, that's not like Google or Facebook.
Speaker 3 (21:11):
You know, you know, these.
Speaker 4 (21:13):
Long term fantastic compounders rising very rapidly because their earnings
are growing and they have a very bright future.
Speaker 3 (21:19):
These are pretty.
Speaker 4 (21:21):
Ugly businesses that went from horribly undervalued to now still undervalued.
Speaker 3 (21:30):
But they're not, you know, they're not long term compounders.
Speaker 4 (21:32):
I mean, the banking industry and in Europe is is
fragmented and it needs to consolidate. And you know, the
regulatory environment, though less hostile than it has been over.
Speaker 3 (21:46):
The last decade, is still reasonably unhelpful.
Speaker 4 (21:52):
So you know, you're not and and what's being left
behind during this rally, are uh, you know, some of
the better businesses that are out there, which creates opportunity
for long term investors. So that gives you a sense,
Laurent in real time, you know how stock markets can be,
(22:14):
you know, incredibly short term oriented and as a result,
inefficient in our view.
Speaker 1 (22:20):
I just wanted to ask you about you know, you
were talking about, you know, the fundamental aspects and balance sheets,
and I guess, in your opinion, what is the best
indicator of a business's you know, what is their their quality?
Speaker 3 (22:32):
I should say, yeah, well so that's a good question.
Speaker 4 (22:38):
In fact, I along dialogue with somebody yesterday about this.
You can see in the financial metrics, the historical financial
metrics of a business whether or not it has historically
been a high quality business, so it shows up in
(22:58):
return on capital employe. There are other things to look at,
you know, if it's a financial would be an ROE
you have to You can look at operating profitability, you
can look at in the rate of growth, and so
you can see it generally speaking in the historical financials.
(23:19):
But that is just the beginning of the analysis rather
than the end of the analysis. Of course, you have
to make because the value of the business is the
present value of the future cash flows, not the past
cash flows. It is imperative that you are able to
make some level of determination as to whether or not
(23:41):
the conditions that allowed for that fantastic level of profitability
and returns in the past will continue to exist in
the future.
Speaker 3 (23:52):
And that's that's what we're here to do.
Speaker 4 (23:55):
You know, that's what separates, at least today, the difference
between an algorithm and a human being is that, you know,
we have to take the information that's available to us
and make some judgments around that information. And that's what
fundamental research is for. We're looking at the competitive position
(24:20):
of the company, the quality of the management, the quality
of their products, who their customers are, whether or not
their customers will still have the capability and the desire
to buy their products. What are the raw material inputs,
what are the substitute products, what is the status of
(24:42):
their competitors' products and their competitors' strategy. And when you
bundle in all this analysis, you make some assessment as
to whether or not this business will still be able
to grow and create strong levels of profitability without having
(25:03):
to put so much capital in the business. Where the
returns of the business might decline over time, in which
case it's worth far less than you know it was
worth in the past when it did not have to
do that. And so it really is that that last step,
that fundamental analysis step, which we'd call last but certainly
(25:23):
not least, part of the process that helps us determine
whether or not this business is actually a quality business.
Speaker 2 (25:34):
One question. I mean, sometimes some of your investment in
the initial stage may turn out badly, I would say,
I mean, how do you review I mean for them,
I mean positions which are not going the way you
fought it could go. I mean, because of antc in
as cutting glasses early is one way to avoid disasters.
(25:55):
So how do you process the review of investment which
unfort can it be observed stage I'm not going in
the right direction.
Speaker 4 (26:04):
Yeah, it's a very good question, and it's something that
we call reinvestment risk, and it's sort of the bane
of the value investor generally speaking. Is a value investor,
you're selling securities where the news is very good and
the share price is going up and everybody's happy and
people are jumping on the bandwagon, and you're getting involved
(26:28):
in securities where the news is very bad and people
are selling. Now, there are a couple components to your question, Laurent,
and so that you use the word disaster, and we
try to avoid disasters by some of those fundamental characteristics
that we spoke about. I mean, generally speaking, if you're
(26:49):
buying a pretty high quality business with a strong balance sheet,
very hard, not impossible, but very hard to have a
disaster associated with the business that looks statistically cheap, that
has a strong balance sheet and is fundamentally a pretty
good business. The other thing that to sort of internalize
about what value investors do is that we're very aware
(27:12):
of this reinvestment risk. So you make a certain level
of assumptions around what the trajectory of the business should
look like, and as long as the business is moving
in that direction, and we are able to separate the
facts and circumstances that are dictating how the underlying value
(27:36):
of this business is moving over time from the noise
in the marketplace. Because you know, there's there's you work
at Bloomberg, there's a lot of reporters, and reporters like
to put out headlines and say lots of things, which
is fun, and but you have to be able to
(27:56):
separate yourself and look at what's on a sober realistic basis,
what's happening to the underlying value of the business, and
as long as that moving in the direction that's pretty
consistent with your underlying assumptions, there's no reason for.
Speaker 3 (28:13):
You to change.
Speaker 4 (28:17):
You know, your expectations and value investors as a result,
are very good at averaging down. You know, it's it's
part of the process.
Speaker 3 (28:27):
You're you're there early. The news is likely to continue.
Speaker 4 (28:31):
To be bad if you've if you've baselined your expectations properly,
you understand the business deeply, You understand what the trajectory
of the business is likely to be, and the business
is following in that trajectory, and the share price continues
to go down. That creates an enormous opportunity and is
(28:54):
also an you know, part of that process. You know
that we talked about earlier in terms of the market
being inefficient. You know, if the underlying business is improving
and the share price is going down, that makes no sense, right,
But it is very very common when you're getting involved
(29:17):
with a company that's having some sort of issue, where
there are headlines being created where the share price is
going down, yet you know the changes that the management
team are making are all very positive in the companies
headed in a much better direction.
Speaker 2 (29:31):
In one of your earlier questions answer, you mentioned about
understanding the culture of the country you invest in, the
different style of corporate governance. So I think for me,
Japan or Japanese equities is a good business case of
there is so much open the market that changes, structural
(29:53):
changes happening in this market with a return of inflation,
apparently corporate changes in corporate governance making the market much
more shareholder friendly. I mean, what is your view? I mean,
do you think this is for real and it offers
really good investment opportunities for value investors, or do you
(30:13):
think that given the readies that we saw in Japanese
equities over the past two and three years, in fact
most of it is already priced in. So what is
your view on this market?
Speaker 3 (30:26):
Japan's an interesting place.
Speaker 4 (30:28):
I've been investing there for thirty years, and for most
of that time period.
Speaker 3 (30:35):
The country offered extraordinary valuations.
Speaker 4 (30:40):
You know, net nets companies trading blow cash value, and
some of that still exists, although as you said, there
have been at least in yen terms, right, and I
have to think of dollars. My shareholders are American and
I have to make money in dollars and so and
yen terms. There has been a significant rally in Japanese equities,
(31:04):
but in US dollars it hasn't been nearly as as
positive as market commentators make it make it seem to be.
You know, I can't, I can't offer my clients returns
in Turkish lera. You know, it just doesn't, It doesn't work.
But Japan has been a fascinating place to invest in
(31:25):
over the years. There was a Prime Minister came into
office five or six years ago named Shinzo Abe who
made a number of positive changes to Japan. There was
some legislation pass that started to improve corporate governance. He
changed the dialogue around where shareholders sit in the pecking
(31:53):
order of priorities for companies. So traditionally the shareholder was last,
it was, it was society, it was customers, it was employees,
and then shareholders in the pecking order, and and the
way that that displayed itself practically speaking, David and Laurent
(32:15):
was in the boardroom and with respect to the shareholding structure,
of the companies. So the board of directors was traditionally
all employees, and the chairmen and the CEO were the
same person, and all the rest of the board members,
as I indicated, were employees will all owed their job
(32:37):
to the chairman and the CEO. So if the company
wasn't operating as effectively as it could be, it was
basically a waiting game for the chairman or the CEO
to retire, and then you had to hope that the
next person in line, you know, was better. Now why
(33:01):
would the outside shareholders, who presumably have a vote.
Speaker 3 (33:05):
Put up with this?
Speaker 4 (33:06):
Well, first of all, there was a culture for domestic shareholders,
domestic Japanese shareholders of cohesion and if this is the
way the company wanted to operate, then we as shareholders
are aligned with what they want to do. And in
(33:29):
addition to that, you had cross shareholding. So there was
a structure, a historical structure that was put in place
after World War two called a CORRETSU structure where there
were groups of businesses that are all held together by
a parent treating company and a parent bank, and they
all had cross shareholdings with one another, and so a
(33:50):
large part of the voting block was within the group
that also protected the board and foreign shareholders. The result
had you know who who were the most likely cohort
to complain about poor returns or a very small force
in this equation and sully but surely and accelerated based
on the reforms that shinzo Abe had put in place,
(34:13):
these structures are starting to unwind, so you see some
of the very large companies now will have a majority
of their board will be independent directors. Even many of
the smaller companies will have a couple of independent directors
on the board. The vast majority of the board still
are employees. You've also seen reforms at the stock exchange,
(34:39):
which is not normally the part of the market where
you're expecting reforms, where you know the exchange has put
out certain return hurdles and valuation hurdles, where you know
you can be on the first section of the Tokyo
Stock Exchange if you meet certain price of book and
(35:00):
return on equity hurdles, and if you don't, you're off.
And you know that of course has liquidity and valuation implications.
And then that you know the third thing is you
know the willingness on the part of companies to create
incentive compensation that's equity based, and typically there have been bonuses,
(35:21):
but people have been paid seventy or eighty percent on
fixed in fixed salaries and very small bonuses that were
largely paid every year, you know, because there's nobody on
the board that's not going to pay the president and CEO. Right,
So you know, all of these changes are happening. It's
(35:42):
created excitement, some justified, some not. And it's also one
of the other changes that Abe has allowed for is consolidation,
is so there's more private equity, there's more consolidation. I
think that there's one final step that he was unable
(36:02):
to finally execute on, which is labor reform. The ability
and the cultural willingness to actually reduce employees.
Speaker 3 (36:12):
You know they have.
Speaker 4 (36:13):
The Japanese system was one around loyalty.
Speaker 3 (36:18):
Where you you know you and there's a lot to
be said for this.
Speaker 4 (36:22):
It's it's nice you take a job somewhere and you
work there for the rest of your life and you're
devoted to that company. It creates a very loyal family
like environment at working at a company, and.
Speaker 3 (36:37):
You know, the longer you were there, the more.
Speaker 4 (36:39):
Responsibility that you got no matter if you were good
or bad at it. So it definitely had its downside.
Speaker 3 (36:49):
And the downsides are worse than the upside.
Speaker 4 (36:51):
I mean, companies were horribly inefficient, overmanned and it's still
to this day that's the case. And in order to
generate very good returns and the way that we as
Americans think about, you know, we want companies that have twelve, thirteen, fourteen,
fifteen percent return on equity. You know that's rare in
Japan to get those sort of returns. And if you
(37:14):
sort of internalize, and I'm going to sort of bring
it back to our strategy, if you internalize, you know
what our strategy is, which is to own very good businesses.
You can imagine that over the course of many years,
it's been a difficult market for us, even as value investors,
to find a preponderance of businesses that we find to
(37:39):
be very attractive. Over the last few years, it's been
virtually impossible.
Speaker 3 (37:43):
We've only owned a.
Speaker 4 (37:44):
Couple of companies because of the end based appreciation of
securities in that market. But this year it's actually been
much better with that market again in yen terms coming
off and we're starting to see some larger better businesses
starting to trade at valuations that we're finding more attractive,
(38:06):
so we can be a little bit more productive there.
But I think that sort of embeds you know, what's
happened in Japan, and now that's spilling over into Korea.
You've seen that we've had a new election recently and
the interestingly, the the you know what we would call
in the United States a democratic party or the more
(38:28):
liberal leaning party is coming into power and as part
of what they're doing is they're implementing reforms that in
the end will create better returns for investors over time
in a similar manner to Korea has different issues than
(38:52):
Japan had, but it's sort of a very similar path
to what Japan did to try and get companies to
improve their returns.
Speaker 2 (39:02):
Okay, I mean another market which I think is also
quite interesting as an international investor is China because there
was about a year ago the question is China equities
in uninvestable or not? I mean, the market is still cheap.
I mean what is your view on that? I mean,
do you think it is a market that you are
avoiding at all costs because of lack of transparency or
(39:26):
the geopolitical risk or do you think, in fact, it
may offer some good value investments.
Speaker 4 (39:33):
I think that market is unquestionably the cheapest market in
the world. I think the Chinese economy under different leadership
definitely has the ability to be the dominant economy in
the world. Unfortunately, this leadership has imposed a government control
(39:54):
structure that will impede their ability.
Speaker 3 (39:59):
To get there.
Speaker 4 (40:00):
However, you have the cheapest valuations and some of the
best businesses in the world in China. Now, if laurent
I was sitting where you're sitting, as a European, I
would have no problem having fifteen or twenty percent of
my portfolio invested in Chinese securities. But given that my
(40:22):
clients are American, we have a geopolitical rivalry that could
at any moment be subject to an executive order barring
us from owning Chinese securities.
Speaker 3 (40:38):
And you know, that's.
Speaker 4 (40:41):
That's a risk that is hard to handicap and one
that puts us in a position of severely limiting our
exposure to Chinese securities. And I you know, because America
is the largest source of capital invested in almost every
stock market outside the United States, I think that's part
(41:02):
of the reason why valuations there are far lower than
they than they are in other parts of the world.
It's it's an opportunity for people who live and who
live and are domiciled and invest from outside the United States.
Speaker 2 (41:20):
Okay, interesting, My last question will be on European iniquities.
I mean, you did mention about many of those businesses
not being high quality, but they are a nice run
over the past two to three years. So what is
your latest view, I mean, what are the sectors or
industries that potentially you think are still good to invest
(41:42):
in Europe?
Speaker 4 (41:43):
Yeah, you know, we we as value investors, we generally find,
you know, markets to be very attractive to us when
there's some sort of pain that's going on.
Speaker 3 (41:57):
And today it seems like.
Speaker 4 (42:02):
Equity markets have chosen to focus on two things. One
is the dramatic potential of AI, which is fantastic. And
you know, we we spend a lot of time trying
to understand what's happening and what the impact could be
to the many businesses we own about forty businesses, the
(42:25):
many businesses that we own, in addition to other companies
that we don't own. The market has has preferred to
focus there, and the market has preferred to focus on,
especially in Europe, the short term implications of lower interest rates,
higher spreads, and the stimulus that's mainly coming.
Speaker 3 (42:49):
Out of Germany, and so markets are pretty buoyant.
Speaker 4 (42:55):
And as a result, you know, we don't find any
particular country, we don't think by country anyway, but any
particular industry to offer seriously attractive outcomes. The opportunity set
in markets that aren't in distress generally comes from, you know,
(43:22):
companies that are having their.
Speaker 3 (43:23):
Own particular issues. Right.
Speaker 4 (43:26):
So in our last shareholder letter we outlined the purchase
of two securities. So one is an Irish company called Icon,
which is in the contract research business, and you know,
it's having its own particular issues based on problems with
(43:46):
its customers and customers spending less, and that's creating an
opportunity to buy what is a fantastic business at a
very attractive multiple company with a strong balance sheet and
a experienced and value creating management team, and they're actively
buying back their own shares. And it really the opportunity
(44:10):
set for value investors like us in an environment like
this comes from particular companies rather than any broad swath
of the market, geography, or industry that is offering a
big opportunity set aside from the China, you know, opportunity
set that I mentioned earlier, which we effectively can't take
(44:31):
advantage of.
Speaker 1 (44:34):
Well, this is great. I really appreciate you coming on, David.
Speaker 3 (44:39):
It was nice to be here. David and Laurent. It
was a fun conversation.
Speaker 1 (44:44):
Thank you very much, and Laurent, thank you for being
my co host.
Speaker 2 (44:48):
Oh welcome.
Speaker 1 (44:50):
If you enjoyed this episode, don't forget to subscribe if
you want to, if you're interested in our research, don't
forget to go on the terminal either b I Fund
or b I Stocks until our next episode. And this
is David Cone with Inside Out.
Speaker 2 (45:11):
Mm hmm
Welcome to Inside Active, a podcast about active managers that
goes beyond sound bites and headlines and looks deeper into
their processes, challenges and philosophies and security selection. I'm David cone, I,
lead mutual fund and active research at Bloomberg Intelligence. Today
my co host is Laurent Dulier, senior equity strategist at
Bloomberg Intelligence. Laurent, thank you for joining me today.
Speaker 2 (00:35):
Thank you for inviting me.
Speaker 1 (00:37):
So you published last week your stock six hundred earnings outlook.
What can we expect for the rest of twenty twenty
five based on what you're seeing?
Speaker 2 (00:47):
I mean, I would say overall it's not that great
because the earning groups of the index has now for
them to lose single digit for twenty twenty five. At
the beginning of the year it was around seven percent.
And two main reason for this downgrade in growth expectations
are further than certainty on US tariffs given that the
(01:08):
initial rate and on the by tramp at twenty percent
was much higher than initially expected. And also we have
seen significant cuts to the forecast of some of the
commodity related sectors in Europe, black energy and also the
mining industry, despite the announcement of the five hundred billion
(01:29):
euros fiscal stimulus in Germany and also all the rumors
about the ramp up in defense spending. I think it
will take some time for all the shovels to be
put into place and to really have an impact on
the earnings level. So I think that is more twenty
twenty six rather than twenty twenty five stories what the
(01:50):
impact of US stariff are likely to play in the
second half of the year. So one of the main
reasons why we have much lower growth expectations. Whoever investors
are looking through I would say is a short term
earnings weakness and now are really focusing on the recovery
potentially in twenty twenty six, and that's the main reason
(02:11):
why the shop I saw now back to where they
were before the announcement of Liberation Day.
Speaker 1 (02:18):
Okay, we'll be interesting to watch. I think we should
hear from our guest on the topic. I'd like to
welcome David Sama, founding partner of the Artists and Partner's
International Value Team. Thank you for joining us, David Well.
Speaker 3 (02:31):
Thank you for having me. David and Laurent so.
Speaker 1 (02:34):
I'm sure you're looking at European companies. What are you
seeing in terms of earnings for the year.
Speaker 4 (02:40):
Well, there are only two large liquidity pools outside the
United States, both Europe and Japan, and so of course
our portfolio is heavily invested in Europe. And I think
what Laurent referred to in terms of earnings growth the
year backstopped by the stimulus spending by the German government.
(03:06):
So the headline number was about five hundred billion dollars,
which is about ten percent of Germany's GDP. But I
think you've got to think about that in slightly broader
terms because you're also seeing other European countries stepping up
with a little bit of stimulus spending. You saw Canada
come out with some numbers also that will support some
(03:32):
GDP growth, albeit a lot of that spending in less
productive parts of the economy, but it is supportive. But
I think a lot of the growth, you know, interestingly enough,
is coming from widening spreads at European banks, which has
little to do with what's going on with deficit spending
(03:56):
and a lot to do with what's driving the underlying
equity markets in Europe so far this year. With respect
to the tariffs. It's it's really sort of interesting as
you go through the earnings results announced during the first quarter,
which is sorry post the first quarter, which was in
(04:17):
the middle of the Liberation Day announcements, what you saw
from most companies was an itemization of the impact that
tariffs would have on their twenty twenty five earnings. So
it's already embedded in whatever estimates the broker dealers or
(04:39):
the cell side are putting out there as consensus. What
is not fully baked into the earnings are whatever teriff
rates are eventually settled between the European Union and other
parts of the world. The other thing that's not baked
(05:01):
in there are what are the economic consequences of those tariffs,
because that's much less of a linear outcome, so it's
harder to get analysts to bake that into the earnings estimates.
And I also say that there is a fair amount
of speculation on the parts of corporates and temporary tactics
(05:29):
that have been deployed on the part of corporates to
diminish the impact of the tariffs in twenty twenty five,
the most common one being the acceleration of purchases of
certain raw materials or inventories or shipping inventory into the
United States ahead of the tariffs, and of course you
(05:49):
know in twenty twenty six, you know that will anniversary
and will have an impact that none of the companies
have yet to quantify.
Speaker 3 (05:58):
And is less likely to be embedded in earning.
Speaker 4 (06:02):
So I think just in terms of, you know, what
is built into consensus From what we can see, it's
still unfinished business.
Speaker 1 (06:12):
Okay. Is there a process that you go in terms of,
you know, when you find ideas or you know, for instance,
can you tell us how an analyst's idea could make
its way into the portfolio?
Speaker 4 (06:24):
Well, we have so it's very important I think for
any successful long term active investor to have a certain discipline,
as implied by the name of our strategy, the Artists
and International Value Strategy. We are value investors and as
(06:48):
a result, the price that we pay is a very
large determinant of our investment outcomes.
Speaker 3 (06:56):
So we look to.
Speaker 4 (07:00):
To find businesses out in the marketplace that are trading
at a significant discount to what our research is telling
us that a business is worth. Those are the fundamental
concepts behind value investing. You know, it's I love two
for one deals. Value investing is sort of a two
(07:21):
for one deal because, on one hand, if you're able
to find an asset worth a dollar and you're paying
sixty cents for that asset, you get excess return, especially
if it's a decent business that grows that dollar slowly
but surely over time. You capture that underlying growth, and
you capture the unwind of the discount from sixty cents
(07:42):
all the way up to a dollar. Now, the second
part of the two for one deal is, let's say
you make a mistake, or the rules change, the government
does something like put a stimulus package, or does the opposite,
and the value of the business ends up being eighty
cents instead of a dollar. Because you've paid sixty cents,
(08:06):
you've built an emergin of safety, and you've avoided a
permanent loss of capital. So value investing, the fundamentals of
value investing allow you to effectively have that too for
one deal. Now we take it a step further. We
take a more thoughtful approach in terms of the types
of businesses that we want to be involved in. So
(08:29):
not only do we want to find a business where
there's a big spread between where it's trading and what
our research is telling us it's worth.
Speaker 3 (08:41):
But we also want.
Speaker 4 (08:42):
To have good businesses, that business where that dollar is
growing over time. That's because usually in order to get
a good deal out in the stock market during let's
say normal time periods like today, something has to be
wrong with the business. People don't give away a share
price at a cheap price when there's nothing wrong with
(09:06):
the business. When there's something wrong, the stock market generally.
Speaker 3 (09:11):
Doesn't like it.
Speaker 4 (09:11):
People don't like bad news, people shy away from it,
would prefer to be involved with companies that have good
news and maybe with share price momentum. As a result,
it takes time usually before the market is able to
recognize the fact that the security is significantly undervalued, and
(09:32):
during that time period, you want the underlying value of
the business to be growing that way. When you finally
get that revaluation, inflation which as we all know is
ever present, doesn't erode your purchasing power. So we not
only focus on securities that are undervalued, but we focus
(09:54):
on securities that are undervalued that are attached to very
good businesses. Now stopped there. We are very particular and
that we're also looking for companies with strong balance sheets.
Speaker 3 (10:08):
So why do we do that.
Speaker 4 (10:09):
You know, most of the market is focused on companies
that have an appropriate amount of leverage. We don't think
there is an appropriate amount of leverage. We actually prefer
no leverage and companies with very very strong balance sheets.
That way, if something goes wrong or we have some
bad luck, or if the company needs to repair a problem,
(10:32):
that they have the resources available to them to be
able to fix that problem, invest back in the business,
create competitive advantages, and grow over the long term. And
the fourth thing that we look for is a management
team that has a track record and history of building
(10:53):
per share per share shareholder value over time. And if
you think about the combination of an intelligent manager with
a strong balance sheet that knows how to effectively allocate capital,
what that can do, if executed well, is actually accelerate value.
(11:18):
You know, instead of you know, buying company at a
dollar and it's growing at five percent per year. So
in normal time periods you go from a dollar to
a dollar five of underlying value. If you take excess
capital and you invested, you could accelerate that value creation
to a dollar ten or a dollar fifteen. And that
(11:38):
is a very powerful driver of return. So if you
think about what we're trying to do is we're trying
to stack the odds in our favor. Right, we want
an undervalued security, a very good business in the hands
of a great management team with a strong balance sheet
to try to maximize the potential for us to.
Speaker 3 (11:56):
Have a very successful investment. And our process is one
where we focus on.
Speaker 4 (12:07):
Companies that have that characteristic, those characteristics in combination, and
then take our time to do intensive first hand research.
So we don't use any sell side research. We don't
use any databases we build. You know, we're sort of
like pre ai dinosaurs. We build all of our own
(12:30):
financial models. We use firsthand data because we need to
exercise judgment on the underlying economics of this business. We
can't outsource our judgment to an algorithm or of course
we use these tools for data gathering. But once we
get that data, we analyze it firsthand. We talk to
(12:50):
management teams, we talk to competitors, we talk to customers,
we talk to former employees, we talk to anybody who
will help us understand the long term underlying economics of
that business. And we use all of that information along
with the data that we gather to create an estimate
of intrinsic value, and then we look to purchase shares
(13:15):
only in the case where there is a meaningful discount
to intrinsic value, and that's our process. We have a
group of seven very experienced securities analysts on our team.
We are all generalists with regional responsibilities, and we're all investors.
We don't really have analysts here. We have investors who
(13:37):
can allocate capital across multiple industries, across different geographic locations,
in both develop markets and in emerging markets. So I
think David and Laurent that gives you a pretty good
sense for the way that we think about the world
and how we approach finding securities.
Speaker 1 (14:00):
We talk a little bit about the intrinsic value. You know,
you mentioned you have a bunch of different information that's
kind of going into that. Are there metrics that you
use as well or is it kind of you've got
like a proprietary system to determine its intrinsic value.
Speaker 4 (14:15):
Well, you know, I don't think there's any magic to
you know, the value of a business is the present
value of its future cash flows, and you learn that
in your first finance class. And we haven't really varied
from using a very simplified diskind of cash flow model
to perform our let's say, formal valuation of the business.
Speaker 3 (14:39):
Most of the stuff you could.
Speaker 4 (14:40):
Do on the back of a napkin, you know, and
when you know, when we think about metrics, there's shorthand
that comes from the analytical process.
Speaker 3 (14:51):
You know, pe ratio is ev to e bit pre.
Speaker 4 (14:54):
Cash flow multiples, all of those are sort of shorthand
methods to evaluate the attractiveness of a company. And of
course everything is relative, right, So if you think about
the quality of let's say LVMH, which is a large
(15:15):
luxury goods company, the quality of that business relative to
let's say BASF, which is a large German chemical conglomerate.
Of course, those are two different businesses, one with significant
brand value that results in very high levels of profitability,
and the other one that operates and commoditize, you know,
(15:37):
businesses that are tough competitively and they operate with unionized labor,
which is a much more difficult, capital intensive, lower return business.
Speaker 3 (15:50):
They're not worth the same thing.
Speaker 4 (15:52):
If they were both at eight times earnings, of course
you'd far prefer to own LVMH. Then you would prefer
to own BASF. And you know, I don't use those
two companies to pick on them, but I use them
to point out that, uh, you know, we we can
look at shorthand metrics, David, to help us put shorthand
(16:17):
valuations on companies. But everything has to be taken into
context based on the type of business that you're looking.
Speaker 2 (16:24):
At, David. I mean in terms of marketing efficiencies, I mean,
based on your long experience. Where do you think the
market or the saleside get it wrong. Is it more
in understanding the underlying value or the interesting value of
the business, or is it more in how it should
(16:45):
be valued? How your experience I mean, is making you
look for more opportunities in one way or the other.
Speaker 4 (16:55):
Well, I would say, broadly speaking, the non US market
or less efficient than the US market. So first, there's
a lot less liquidity outside the United States than there
is in the United States. So that's one. Two, you
have the complexity associated with you know, various currencies that
(17:18):
you're dealing with. Three, you have complexity with respect to cultures.
You know, what does it mean to be invested in
a French company versus an Indonesian company versus a Japanese company.
And then you have different corporate governance structures, right, different.
Speaker 3 (17:33):
Rules of the game.
Speaker 4 (17:35):
What does it mean to be a shareholder of a
South Korean company versus a shareholder of a Swiss company?
You know, what is the construct of a board of
directors in Japan versus the construct of a board of
directors in the United Kingdom. So then you have different
time zones, you have different languages, you don't really have
(17:56):
different There's a little bit of accounting differences that exists today,
but they're not.
Speaker 3 (18:02):
Nearly as as big.
Speaker 4 (18:04):
But they're they're out there, right, and and that level
of complexity makes it much more difficult for the average
investor to truly understand what they're getting themselves involved in.
Speaker 3 (18:16):
So that's that's step one.
Speaker 2 (18:19):
Uh.
Speaker 4 (18:20):
Step two UH is with respect to the cell side.
The cell side, you know, they make their money on
the corporate clients, right, So their clients are the LVMH's
of this world, not the David Sammers of this world.
And uh, and they have over the years realized that
(18:43):
in terms of brokerage commissions, their their their bread is
buttered by fast moving hedge funds, and so they love
to have you know, short term movements based on earnings
estimates and things like that, and has nothing to do
with the long term in during intrinsic value of a business.
And so the cell side tends to be very short
(19:05):
term oriented, which is an advantage for somebody who's actually investing. Right,
So let's let's talk about investing to build wealth over time,
which is a very different concept than just owning a
security to take advantage of a trend. Now, what else
is also driving in efficiency is the advent of ETFs.
(19:27):
ETFs have become you know, have played into the gamification
of investing. It has sort of dumbed down investing and
provides things like exposure to financial advisors and broker dealers.
I think if you, you know, go over to your
friend's house and ask to see their statement from their advisor,
(19:53):
you know it's likely to have ten or fifteen ETFs
in there. And so what do they own, Well, they own,
they own products, they don't own businesses or investment investments.
And all of these inputs into the way that the
equity markets operate today, plus the added inefficiencies of investing
(20:14):
out the outside the United States, that's what creates opportunities
for long term investors, and David and Laurent let's use
you know today is a really good example, because it's
really interesting to see, you know, the European markets rallying
so significantly in the first part of this year. And
(20:39):
it is fantastic that you know, some of the banks
and the defense contractors and the utilities are likely to
have growing earnings on the back of what's happening. But
if you think about the relative quality of those businesses
(21:01):
compared to you know, other potential long term compounders, those
aren't fantastic businesses. You know, that's not like Google or Facebook.
Speaker 3 (21:11):
You know, you know, these.
Speaker 4 (21:13):
Long term fantastic compounders rising very rapidly because their earnings
are growing and they have a very bright future.
Speaker 3 (21:19):
These are pretty.
Speaker 4 (21:21):
Ugly businesses that went from horribly undervalued to now still undervalued.
Speaker 3 (21:30):
But they're not, you know, they're not long term compounders.
Speaker 4 (21:32):
I mean, the banking industry and in Europe is is
fragmented and it needs to consolidate. And you know, the
regulatory environment, though less hostile than it has been over.
Speaker 3 (21:46):
The last decade, is still reasonably unhelpful.
Speaker 4 (21:52):
So you know, you're not and and what's being left
behind during this rally, are uh, you know, some of
the better businesses that are out there, which creates opportunity
for long term investors. So that gives you a sense,
Laurent in real time, you know how stock markets can be,
(22:14):
you know, incredibly short term oriented and as a result,
inefficient in our view.
Speaker 1 (22:20):
I just wanted to ask you about you know, you
were talking about, you know, the fundamental aspects and balance sheets,
and I guess, in your opinion, what is the best
indicator of a business's you know, what is their their quality?
Speaker 3 (22:32):
I should say, yeah, well so that's a good question.
Speaker 4 (22:38):
In fact, I along dialogue with somebody yesterday about this.
You can see in the financial metrics, the historical financial
metrics of a business whether or not it has historically
been a high quality business, so it shows up in
(22:58):
return on capital employe. There are other things to look at,
you know, if it's a financial would be an ROE
you have to You can look at operating profitability, you
can look at in the rate of growth, and so
you can see it generally speaking in the historical financials.
(23:19):
But that is just the beginning of the analysis rather
than the end of the analysis. Of course, you have
to make because the value of the business is the
present value of the future cash flows, not the past
cash flows. It is imperative that you are able to
make some level of determination as to whether or not
(23:41):
the conditions that allowed for that fantastic level of profitability
and returns in the past will continue to exist in
the future.
Speaker 3 (23:52):
And that's that's what we're here to do.
Speaker 4 (23:55):
You know, that's what separates, at least today, the difference
between an algorithm and a human being is that, you know,
we have to take the information that's available to us
and make some judgments around that information. And that's what
fundamental research is for. We're looking at the competitive position
(24:20):
of the company, the quality of the management, the quality
of their products, who their customers are, whether or not
their customers will still have the capability and the desire
to buy their products. What are the raw material inputs,
what are the substitute products, what is the status of
(24:42):
their competitors' products and their competitors' strategy. And when you
bundle in all this analysis, you make some assessment as
to whether or not this business will still be able
to grow and create strong levels of profitability without having
(25:03):
to put so much capital in the business. Where the
returns of the business might decline over time, in which
case it's worth far less than you know it was
worth in the past when it did not have to
do that. And so it really is that that last step,
that fundamental analysis step, which we'd call last but certainly
(25:23):
not least, part of the process that helps us determine
whether or not this business is actually a quality business.
Speaker 2 (25:34):
One question. I mean, sometimes some of your investment in
the initial stage may turn out badly, I would say,
I mean, how do you review I mean for them,
I mean positions which are not going the way you
fought it could go. I mean, because of antc in
as cutting glasses early is one way to avoid disasters.
(25:55):
So how do you process the review of investment which
unfort can it be observed stage I'm not going in
the right direction.
Speaker 4 (26:04):
Yeah, it's a very good question, and it's something that
we call reinvestment risk, and it's sort of the bane
of the value investor generally speaking. Is a value investor,
you're selling securities where the news is very good and
the share price is going up and everybody's happy and
people are jumping on the bandwagon, and you're getting involved
(26:28):
in securities where the news is very bad and people
are selling. Now, there are a couple components to your question, Laurent,
and so that you use the word disaster, and we
try to avoid disasters by some of those fundamental characteristics
that we spoke about. I mean, generally speaking, if you're
(26:49):
buying a pretty high quality business with a strong balance sheet,
very hard, not impossible, but very hard to have a
disaster associated with the business that looks statistically cheap, that
has a strong balance sheet and is fundamentally a pretty
good business. The other thing that to sort of internalize
about what value investors do is that we're very aware
(27:12):
of this reinvestment risk. So you make a certain level
of assumptions around what the trajectory of the business should
look like, and as long as the business is moving
in that direction, and we are able to separate the
facts and circumstances that are dictating how the underlying value
(27:36):
of this business is moving over time from the noise
in the marketplace. Because you know, there's there's you work
at Bloomberg, there's a lot of reporters, and reporters like
to put out headlines and say lots of things, which
is fun, and but you have to be able to
(27:56):
separate yourself and look at what's on a sober realistic basis,
what's happening to the underlying value of the business, and
as long as that moving in the direction that's pretty
consistent with your underlying assumptions, there's no reason for.
Speaker 3 (28:13):
You to change.
Speaker 4 (28:17):
You know, your expectations and value investors as a result,
are very good at averaging down. You know, it's it's
part of the process.
Speaker 3 (28:27):
You're you're there early. The news is likely to continue.
Speaker 4 (28:31):
To be bad if you've if you've baselined your expectations properly,
you understand the business deeply, You understand what the trajectory
of the business is likely to be, and the business
is following in that trajectory, and the share price continues
to go down. That creates an enormous opportunity and is
(28:54):
also an you know, part of that process. You know
that we talked about earlier in terms of the market
being inefficient. You know, if the underlying business is improving
and the share price is going down, that makes no sense, right,
But it is very very common when you're getting involved
(29:17):
with a company that's having some sort of issue, where
there are headlines being created where the share price is
going down, yet you know the changes that the management
team are making are all very positive in the companies
headed in a much better direction.
Speaker 2 (29:31):
In one of your earlier questions answer, you mentioned about
understanding the culture of the country you invest in, the
different style of corporate governance. So I think for me,
Japan or Japanese equities is a good business case of
there is so much open the market that changes, structural
(29:53):
changes happening in this market with a return of inflation,
apparently corporate changes in corporate governance making the market much
more shareholder friendly. I mean, what is your view? I mean,
do you think this is for real and it offers
really good investment opportunities for value investors, or do you
(30:13):
think that given the readies that we saw in Japanese
equities over the past two and three years, in fact
most of it is already priced in. So what is
your view on this market?
Speaker 3 (30:26):
Japan's an interesting place.
Speaker 4 (30:28):
I've been investing there for thirty years, and for most
of that time period.
Speaker 3 (30:35):
The country offered extraordinary valuations.
Speaker 4 (30:40):
You know, net nets companies trading blow cash value, and
some of that still exists, although as you said, there
have been at least in yen terms, right, and I
have to think of dollars. My shareholders are American and
I have to make money in dollars and so and
yen terms. There has been a significant rally in Japanese equities,
(31:04):
but in US dollars it hasn't been nearly as as
positive as market commentators make it make it seem to be.
You know, I can't, I can't offer my clients returns
in Turkish lera. You know, it just doesn't, It doesn't work.
But Japan has been a fascinating place to invest in
(31:25):
over the years. There was a Prime Minister came into
office five or six years ago named Shinzo Abe who
made a number of positive changes to Japan. There was
some legislation pass that started to improve corporate governance. He
changed the dialogue around where shareholders sit in the pecking
(31:53):
order of priorities for companies. So traditionally the shareholder was last,
it was, it was society, it was customers, it was employees,
and then shareholders in the pecking order, and and the
way that that displayed itself practically speaking, David and Laurent
(32:15):
was in the boardroom and with respect to the shareholding structure,
of the companies. So the board of directors was traditionally
all employees, and the chairmen and the CEO were the
same person, and all the rest of the board members,
as I indicated, were employees will all owed their job
(32:37):
to the chairman and the CEO. So if the company
wasn't operating as effectively as it could be, it was
basically a waiting game for the chairman or the CEO
to retire, and then you had to hope that the
next person in line, you know, was better. Now why
(33:01):
would the outside shareholders, who presumably have a vote.
Speaker 3 (33:05):
Put up with this?
Speaker 4 (33:06):
Well, first of all, there was a culture for domestic shareholders,
domestic Japanese shareholders of cohesion and if this is the
way the company wanted to operate, then we as shareholders
are aligned with what they want to do. And in
(33:29):
addition to that, you had cross shareholding. So there was
a structure, a historical structure that was put in place
after World War two called a CORRETSU structure where there
were groups of businesses that are all held together by
a parent treating company and a parent bank, and they
all had cross shareholdings with one another, and so a
(33:50):
large part of the voting block was within the group
that also protected the board and foreign shareholders. The result
had you know who who were the most likely cohort
to complain about poor returns or a very small force
in this equation and sully but surely and accelerated based
on the reforms that shinzo Abe had put in place,
(34:13):
these structures are starting to unwind, so you see some
of the very large companies now will have a majority
of their board will be independent directors. Even many of
the smaller companies will have a couple of independent directors
on the board. The vast majority of the board still
are employees. You've also seen reforms at the stock exchange,
(34:39):
which is not normally the part of the market where
you're expecting reforms, where you know the exchange has put
out certain return hurdles and valuation hurdles, where you know
you can be on the first section of the Tokyo
Stock Exchange if you meet certain price of book and
(35:00):
return on equity hurdles, and if you don't, you're off.
And you know that of course has liquidity and valuation implications.
And then that you know the third thing is you
know the willingness on the part of companies to create
incentive compensation that's equity based, and typically there have been bonuses,
(35:21):
but people have been paid seventy or eighty percent on
fixed in fixed salaries and very small bonuses that were
largely paid every year, you know, because there's nobody on
the board that's not going to pay the president and CEO. Right,
So you know, all of these changes are happening. It's
(35:42):
created excitement, some justified, some not. And it's also one
of the other changes that Abe has allowed for is consolidation,
is so there's more private equity, there's more consolidation. I
think that there's one final step that he was unable
(36:02):
to finally execute on, which is labor reform. The ability
and the cultural willingness to actually reduce employees.
Speaker 3 (36:12):
You know they have.
Speaker 4 (36:13):
The Japanese system was one around loyalty.
Speaker 3 (36:18):
Where you you know you and there's a lot to
be said for this.
Speaker 4 (36:22):
It's it's nice you take a job somewhere and you
work there for the rest of your life and you're
devoted to that company. It creates a very loyal family
like environment at working at a company, and.
Speaker 3 (36:37):
You know, the longer you were there, the more.
Speaker 4 (36:39):
Responsibility that you got no matter if you were good
or bad at it. So it definitely had its downside.
Speaker 3 (36:49):
And the downsides are worse than the upside.
Speaker 4 (36:51):
I mean, companies were horribly inefficient, overmanned and it's still
to this day that's the case. And in order to
generate very good returns and the way that we as
Americans think about, you know, we want companies that have twelve, thirteen, fourteen,
fifteen percent return on equity. You know that's rare in
Japan to get those sort of returns. And if you
(37:14):
sort of internalize, and I'm going to sort of bring
it back to our strategy, if you internalize, you know
what our strategy is, which is to own very good businesses.
You can imagine that over the course of many years,
it's been a difficult market for us, even as value investors,
to find a preponderance of businesses that we find to
(37:39):
be very attractive. Over the last few years, it's been
virtually impossible.
Speaker 3 (37:43):
We've only owned a.
Speaker 4 (37:44):
Couple of companies because of the end based appreciation of
securities in that market. But this year it's actually been
much better with that market again in yen terms coming
off and we're starting to see some larger better businesses
starting to trade at valuations that we're finding more attractive,
(38:06):
so we can be a little bit more productive there.
But I think that sort of embeds you know, what's
happened in Japan, and now that's spilling over into Korea.
You've seen that we've had a new election recently and
the interestingly, the the you know what we would call
in the United States a democratic party or the more
(38:28):
liberal leaning party is coming into power and as part
of what they're doing is they're implementing reforms that in
the end will create better returns for investors over time
in a similar manner to Korea has different issues than
(38:52):
Japan had, but it's sort of a very similar path
to what Japan did to try and get companies to
improve their returns.
Speaker 2 (39:02):
Okay, I mean another market which I think is also
quite interesting as an international investor is China because there
was about a year ago the question is China equities
in uninvestable or not? I mean, the market is still cheap.
I mean what is your view on that? I mean,
do you think it is a market that you are
avoiding at all costs because of lack of transparency or
(39:26):
the geopolitical risk or do you think, in fact, it
may offer some good value investments.
Speaker 4 (39:33):
I think that market is unquestionably the cheapest market in
the world. I think the Chinese economy under different leadership
definitely has the ability to be the dominant economy in
the world. Unfortunately, this leadership has imposed a government control
(39:54):
structure that will impede their ability.
Speaker 3 (39:59):
To get there.
Speaker 4 (40:00):
However, you have the cheapest valuations and some of the
best businesses in the world in China. Now, if laurent
I was sitting where you're sitting, as a European, I
would have no problem having fifteen or twenty percent of
my portfolio invested in Chinese securities. But given that my
(40:22):
clients are American, we have a geopolitical rivalry that could
at any moment be subject to an executive order barring
us from owning Chinese securities.
Speaker 3 (40:38):
And you know, that's.
Speaker 4 (40:41):
That's a risk that is hard to handicap and one
that puts us in a position of severely limiting our
exposure to Chinese securities. And I you know, because America
is the largest source of capital invested in almost every
stock market outside the United States, I think that's part
(41:02):
of the reason why valuations there are far lower than
they than they are in other parts of the world.
It's it's an opportunity for people who live and who
live and are domiciled and invest from outside the United States.
Speaker 2 (41:20):
Okay, interesting, My last question will be on European iniquities.
I mean, you did mention about many of those businesses
not being high quality, but they are a nice run
over the past two to three years. So what is
your latest view, I mean, what are the sectors or
industries that potentially you think are still good to invest
(41:42):
in Europe?
Speaker 4 (41:43):
Yeah, you know, we we as value investors, we generally find,
you know, markets to be very attractive to us when
there's some sort of pain that's going on.
Speaker 3 (41:57):
And today it seems like.
Speaker 4 (42:02):
Equity markets have chosen to focus on two things. One
is the dramatic potential of AI, which is fantastic. And
you know, we we spend a lot of time trying
to understand what's happening and what the impact could be
to the many businesses we own about forty businesses, the
(42:25):
many businesses that we own, in addition to other companies
that we don't own. The market has has preferred to
focus there, and the market has preferred to focus on,
especially in Europe, the short term implications of lower interest rates,
higher spreads, and the stimulus that's mainly coming.
Speaker 3 (42:49):
Out of Germany, and so markets are pretty buoyant.
Speaker 4 (42:55):
And as a result, you know, we don't find any
particular country, we don't think by country anyway, but any
particular industry to offer seriously attractive outcomes. The opportunity set
in markets that aren't in distress generally comes from, you know,
(43:22):
companies that are having their.
Speaker 3 (43:23):
Own particular issues. Right.
Speaker 4 (43:26):
So in our last shareholder letter we outlined the purchase
of two securities. So one is an Irish company called Icon,
which is in the contract research business, and you know,
it's having its own particular issues based on problems with
(43:46):
its customers and customers spending less, and that's creating an
opportunity to buy what is a fantastic business at a
very attractive multiple company with a strong balance sheet and
a experienced and value creating management team, and they're actively
buying back their own shares. And it really the opportunity
(44:10):
set for value investors like us in an environment like
this comes from particular companies rather than any broad swath
of the market, geography, or industry that is offering a
big opportunity set aside from the China, you know, opportunity
set that I mentioned earlier, which we effectively can't take
(44:31):
advantage of.
Speaker 1 (44:34):
Well, this is great. I really appreciate you coming on, David.
Speaker 3 (44:39):
It was nice to be here. David and Laurent. It
was a fun conversation.
Speaker 1 (44:44):
Thank you very much, and Laurent, thank you for being
my co host.
Speaker 2 (44:48):
Oh welcome.
Speaker 1 (44:50):
If you enjoyed this episode, don't forget to subscribe if
you want to, if you're interested in our research, don't
forget to go on the terminal either b I Fund
or b I Stocks until our next episode. And this
is David Cone with Inside Out.
Speaker 2 (45:11):
Mm hmm
Host
Gina Martin Adams
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