Investor Overwhelm and Media Influence

Investors face an abundance of choice when deciding which shares, ETFs and funds to include in a portfolio. Choice is a good thing but it can be overwhelming. Many investors turn to the experts for ideas. Responding to this the financial media follows a familiar formula:

Find a fund manager. Get a couple high level quotes on opportunities that he or she currently likes. Add some fluff about how brilliant the fund manager is and some interesting personal hobbies that usually involve a $16,000 titanium bike or an extensive collection of first growth Bordeaux.

No context is provided to these stock picks. We don’t know if they are a significant holding or an irrelevant percentage of the fund. Since this is a one time interview we have no idea when the position is sold. We don’t even know the real hypothesis of the fund manager because their view is generally expressed in a short quote. It is up to each of us to decide if this stock aligns to our investment strategy and do further research to validate the idea.

Jargon and the Illusion of Expertise

It is also confusing to dissect the brief rationale professional investors provide when recommending the purchase of a particular share. The rationale is often filled with jargon, confusing terminology, and financial metrics that many everyday investors may only narrowly grasp the meaning of.

I won’t speak for other people but when I was younger this ‘financial speak’ impressed me. I would read up on any terms I didn’t understand and as my knowledge grew I felt like I was getting the key to an exclusive club. I’m not impressed anymore. I think the smartest people are the ones that explain complex terms simply. Explaining things in a straightforward way shows confidence and humility.

But ‘financial speak’ is not going away. And every profession does it. I’ve come up with my own secret decoder. It allows me to place a stock pitch within a simple model based on where returns come from.

Where Do Returns Come From?

Following commentary on the share market can be confusing. We are inundated with data, financial metrics, and esoteric approaches to finding shares to buy. Some investors swear that if you stare at charts long enough you can unlock the secrets of future share price movements.

This is not an article about the relative merits of different investment approaches. It is not about predicting which shares will do well and which won’t. It is simply looking at the three drivers of returns and applying them to examples of share picks from fund managers that often appear in the media.

The Drivers of Returns

The first is dividends. This one should be obvious. A dividend is cash in your pocket and an important component of returns. Dividends are a by product of earnings. You need to earn money to return it to shareholders. You need to grow earnings to grow dividends.

The second driver is changes in valuation. As a partial owner of a company a shareholder is interested in how much that company earns. If what we want as investors is earnings, we can view the price we pay for a share in relation to earnings. That is why there is so much commentary about the price to earnings or P/E ratio. That is how much an investor is willing to pay for earnings.

The third driver is earnings growth. If we are willing to pay 20 times earnings for a share earning $1 and are still willing to pay 20 times earnings when the company makes $2 the share price will double.

Those are the three places that returns come from. There is a myriad of reasons that factor into dividend levels, the valuation investors are willing to pay and earnings. But we can’t lose sight of the foundational drivers of returns.

Applying the Model to Fund Manager Picks

Understanding the three factors that drive returns is not some magic formula that identifies which shares to buy and which to avoid. But it does inject some common sense when hearing a sales pitch for a share.

Example 1: Buy REITs

The AFR wrote an article titled “Macquarie says it’s time to buy real estate stocks before rate cuts”. The article quotes a report put out by Macquarie. Here is the rationale quoted in the article for Macquarie’s view that the time is right to buy real estate investment trusts:

“With the [US Federal Reserve] expected to cut in September, we would look past the risk of an RBA hike, and are now overweight REITs,”

“We expected a hawkish shift from the RBA, and it has happened. With the shift to slowdown and global banks easing, there is reason to think the RBA will hold so as not to risk pushing the $A up too far.”

[Followed by a breakdown of how this ties to dividends, valuation, and earnings – omitted here for brevity but included in the full HTML version if desired.]

Example 2: Buy Global Consumer Staples

The AFR also published an article on July 1st titled “GQG slashes tech exposure, here’s where it’s buying next”. GQG’s Brian Kersmanc is quoted saying:

“We’re seeing staples stocks trading at 52-week lows because they had a multiple de-rating...”

He argues the current valuations are unusually low and represent a buying opportunity, based mostly on the valuation driver of returns.

My Take on Both Predictions

There is a difference in the way I invest and how many fund managers invest. Most fund managers are more short-term focused despite their pleas to the contrary. I am a long-term investor and don’t care if my portfolio underperforms at different times.

In some ways both of these calls are similar. Both Macquarie and GQG think that investors are too focused on short-term factors and that eventually there will be a rotation back into ‘safer’ shares. Since both REITs and consumer staples generally pay healthy dividends these are the types of investments I favour.

Conclusion

Changing market conditions can provide opportunities, even for long-term investors. I tend to gravitate to consumer staples shares and the second article is a catalyst for me to do some more research. And that is the value of hearing what professional investors think. Their insights can be valuable for everyday investors like you and me. Just make sure you understand what they are saying and how their view will impact the drivers of returns. And of course…do your own research.