SORBUS VECTOR: Manager commentary December 2022
November proved to be a good month for the VECTOR fund with a gain of +8.4%.
As we mentioned in our commentary last month, our longer term performance also remains very strong. According to Trustnet figures, as at 30th November our fund ranked first in performance out of 234 funds (in the IA UK All Companies sector) over 5 years and second out of 244 over 3 years.
One of the reasons for this outperformance is that generally our fund captures most of the upside of the UK equity markets, but tends to lose much less when markets fall. This is due to our focus on superior business models with strong balance sheets and buying such businesses with a margin of safety in terms of the price we are prepared to pay.
We view the past month’s increase as evidence that other investors are starting to appreciate the true merits of companies that are able to pass on inflationary costs, of which your fund owns.
One of the key tenets of investing is one we learned from great investors such as Warren Buffett and Nick Train (the UK’s closest equivalent to Buffett): dependable businesses that can produce even low to mid single digit growth in profits over long periods tend to be much more valuable than most investors realise.
Of course many investors have until recently preferred the glamour of the high growth stocks, where sales are rocketing but profits are often either non-existent or projected at some distant point in the future.
However, as we have stated before, humans have an inbuilt bias to extrapolate and therefore when investing usually overpay for such growth (aside from the excitement of being involved in such stocks and their associated stories/promises of future riches).
The past year has again revealed that bias to be a damaging one for investors.
In contrast when a company encounters a headwind, even a relatively mild and short term one, investors are often inclined to become impatient and sell and move onto the next stock. This is why we were able to purchase shares in several well known consumer staples businesses last year, when higher freight and raw material costs were impacting, at what we deemed to be very attractive prices as other investors sold.
In addition to having the ability to pass on such costs to their customers due to the strength of their brands which engenders loyalty, it is also true that once such costs reverse, these companies will be among the first to benefit.
As an example, PZ Cussons (purveyors of Imperial Leather and other brands) stated in their recent results that such annual cost inflation was in the order of £40m. To put that number in context, their full year profits were over £66m. Once these cost pressures reduce, those same costs will unwind and flow through to their bottom line.
In November we also added Nestle to the fund, with its strong portfolio of branded consumer products and one of the best records in terms of their rate of long term annual sales growth among its peers. It has a very wide product portfolio being strong in pet foods, infant nutrition, confectionery and beverages including water and coffee. Though the proportion of its sales from emerging markets is lower than other peers, in absolute sales within these emerging markets, it is a market leader in many, with a scale unmatched by competitors. Despite having debt, it also retains a valuable stake in the cosmetic L’Oreal which offsets this balance sheet position and with its strong cashflow it has also been buying back shares. Given the share price has fallen from a peak of almost 130 swiss francs to the purchase price of 112.5. We are now able to access this long term growth story with a low 20’s p/e.
We are happy with our current portfolio. Overall, we firmly believe our positions to be the right ones to prosper given the harsher economic times that appear to be ahead of us.
We still have cash to invest but are in no rush. The profit warnings that are currently a trickle are likely to turn into a torrent and many share prices are not yet low enough to reflect this risk. When the value has emerged we will enjoy.