As recent volatility has demonstrated, the contradictions and instability of a system piled high with debt means that yet another loss of market confidence would not be so surprising. Just a short six months ago, everything was collapsing. Markets swiftly recovered, but economic indicators and corporate earnings have continued to be quite weak.
As recent volatility has demonstrated, the contradictions and instability of a system piled high with debt means that yet another loss of market confidence would not be so surprising. Just a short six months ago, everything was collapsing. Markets swiftly recovered, but economic indicators and corporate earnings have continued to be quite weak.
Nonetheless, market conditions are something to be taken advantage of, rather than obsessed about, in our view. Investing involves a synthesis of thinking top-down, but at the same time investing bottom-up on a company-by-company basis; and our macro observations form a helpful framework for understanding individual company valuations. As always, we have maintained a focus on absolute quality, which has generally underpinned absolute and relative returns.
The equity sell-off meant that a number of companies became more attractively valued (though they have since rebounded). These are companies that we have followed for a long time, but in many cases they were previously richly-priced, on what we felt were elevated profit margins. Among the new positions in our Asia Pacific portfolios were Largan Precision, ASM Pacific and AAC Technologies.
The common theme behind these three new names is technology – and smartphones in particular. We have always debated such companies in light of the share price volatility. They are manufacturers, but with the general enthusiasm for smartphones, growth and Apple-plays in particular, all three were rated like genuine technology companies.
Today, everybody knows what is wrong with the smartphone sector, from saturation to lack of innovation. But, the companies now trade on much more appropriate valuations for cutting-edge manufacturing businesses. We assume that the smartphone cycle will again turn upwards, one day. After all, it will probably not be too long before everybody gets excited about 5G. Such enthusiasm will surely drive a big product upgrade cycle.
All three companies have good balance sheets, pay decent dividends and have strong track records. AAC Technologies is perhaps the most concentrated, or risky, with the business almost entirely focused on acoustics and haptics for smartphones (although, at least it is for both Apple and Android). The share price declined by 75% to its trough, but we expect it to remain profitable and the price-to-earnings ratio (PER) is now probably circa 16x FY19 earnings, on a much reduced profit forecast.
For Largan, the outlook seems as hazy as for AAC, but the longer-term tailwinds are perhaps more powerful and easier to understand. There is the 5G upgrade-cycle to come, but camera quality (dual, triple lenses and so on) is already a smartphone-model differentiator. In addition, vision (and the need for lenses), seems likely to be at the centre of all sorts of future long-term trends.
ASM Pacific is the only company of the three businesses run by professional managers, as opposed to entrepreneurs and owners, which is both good and bad. It is the most institutionalised too, as well as more broadly diversified by customer (though it is probably the same cycle).
Like the other two companies, ASM’s economics have more recently been dominated by the smartphone, which probably accounted for up to 40% of sales. Their stock price had similarly fallen sharply and the forward PER is now supposedly 17x. As we all turn increasingly to data and chip-content intensifies, these companies should perform well, while areas like industrial applications and the automotive industry provide new avenues for growth.
Almost irrespective of the market and economic cycle, we remain comfortable with our overall portfolio positioning. We will continue to invest in growth, on a company-by-company basis, all the time worrying most about capital preservation and focusing on absolute returns. If we can still do that in a disciplined fashion, our longer-term returns – whether absolute or relative – should compound respectably.
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