Value Column von Hans Peter Schupp
19. JANUARY 2023
Interest rate turnaround will continue to boost value stocks in 2023
Most investors – especially those in the high-tech sector – curse the all-around rising interest rates. We look at it differently! Although we are pure equity investors. What may seem paradoxical, however, has valid reasons. Particularly the elevated level of interest rates, and the fact that they will probably remain at a high level for quite some time, this plays into the hands of our investment style. Because we are value investors. Or, more precisely, deep value investors.
In recent years, it has not been impossible to generate performance with value, but it has been rather difficult. 15 years of underperformance of value investments due to zero or negative interest rate policies have been a burden. In the past, central banks only set money market interest rates depending on economic expectations. This changed with the central banks‘ purchase programs. The capital market interest rate was also kept artificially low. Low interest rates favor growth stocks because future profits are hardly discounted anymore. With higher interest rates, however, the following applies: „A bird in the hand is better than two in the bush.”
The inflation spiral has only just begun to turn
The inflation and interest rate issue will continue to be with us, even if the latest inflation rates have recently fallen. This is because we believe the inflationary spiral has only just begun to turn. For example, minimum wages in Germany have risen by 25 percent. In order to maintain the gap to the minimum wage, trade unions will have to fight for massive wage increases. In addition, globalization has been one of the main factors behind the low price increases. Companies have relocated business activities to countries with cheaper wages or even outsourced them to other companies in low-wage countries. Now these corporations have realized that this can also boomerang. Due to the outsourcing, many companies have had problems with the timely delivery of preliminary products, which has led to significant disruptions in the production processes. I do not believe that these companies will continue to intensify their outsourcing; on the contrary, they will reverse it and tend to rely on intermediate products that are produced geographically closer and are thus within their sphere of influence. Both of these factors will lead to an increase in costs in favor of supply security. We therefore do not expect inflation to be a temporary phenomenon.
Value stocks remain attractive
This, in turn, suits our value style. How do we invest? Well, there are generally two reasons to invest in a company. Either the break-up value or the net present value of future earnings is higher than the current market value. In our approach, we assume that we theoretically own the company, and as the owner, you have two options. The first option is to close the business, sell the asset side of the balance sheet, and pay back the debt. If the surplus is higher than the investment, it is „quick money“. However, this only makes sense for holding companies whose business units have no synergies, such as the Siemens spin-offs. The second reason is that it is assumed that the present value of future profits is higher than the current market value. However, we do not follow the standard valuation models. We reject the models that forecast profits for the next three years and then assume an increase into perpetuity. These models could explain everything. But only a small change in the profit increase or in the discount factor lead to massive changes in the company’s value and therefore carry a certain risk of manipulation. In contrast, we look at what a company has generated in the past and consider whether the historical operating margins can still be achieved today. From this, we calculate the profits that a company can generate in the medium term. By the way, this is nothing different than what Benjamin Graham suggested back in 1949. Look at a few examples: Salzgitter currently has a price/earnings ratio of 1.7, which means that 60 percent of the investment sum is covered by current profits alone. The French company Quadient, which is active in the field of mail processing systems, also has a low P/E ratio of less than 6. It gets even more exciting when you look at the value of the so-called enterprise value of the company. Italian steel mill equipment supplier Danieli has net cash greater than its market capitalization. And that at a P/E ratio of 8.
The Contrarian Value Euroland Fund: Number 1 in the „Eurozone Equities“ Category
Our fund is invested in so-called deep value companies. Stock selection is always based on bottom-up criteria. We are currently overweight in financials and energy stocks, as well as basic materials and consumer cyclicals. Overall, 22 of the 32 stocks in the fund have a price-to-book ratio of less than 1. With this investment style, we were ranked number 1 in the „Eurozone equities“ category in 2022 and therefore also received the „Fund Award 2023“ from German financial magazines “Euro”, “Euro am Sonntag” and “BörseOnline”. The fund achieved an increase in value of 2.8 percent. And that as a pure equity fund. Not many funds could claim that last year.
Translation for convenience only!
The author: Hans Peter Schupp is a board member of FIDECUM AG and portfolio manager of the Contrarian Value Euroland fund.
