Some of the generally accepted methods for valuing companies are no longer relevant, meaning investors need to re-think the metrics they use, according to Allianz’s Lucy MacDonald.
It’s been an argument put forward because of the proliferation of companies with huge amounts of intangible assets, such as intellectual property, patents and subscribers that don’t make it on to balance sheets.
This is especially true in the technology sector. Amazon (AMZN), in particular, is accepted to be a difficult firm to value due to its exponential growth rate. It currently trades on around 130 times last year’s earnings, even after its near-20% fall since early September.
But MacDonald, manager of the Morningstar Bronze Rated Brunner Investment Trust (BUT), thinks technological change and digitalisation now means a whole new set of metrics and analysis are needed in order to get an edge on the market.
“There was a huge amount of focus on the FAANG stocks and, yes, they are big, important companies, but actually, what’s happening with technology is bigger even than them and it is affecting every company that we are investing in,” says MacDonald.
“It’s changing the way that companies are behaving and it’s changing the way that we, as investors, are looking at companies and it is something that is transforming everything.”
Of course, technological change can work both ways for companies. On the one hand, it is disrupting industries like never before – like in the retail sector. But there’s also plenty to be gained from applying technology within businesses, like increased productivity, better services for customers and gaining more data about, and therefore creating more value from, customers and clients.
Investors Need More Than Company Accounts
One way it’s informing Brunner’s approach is through the make up of management and the board of directors. Some will need to learn and understand new skills, while bringing in younger, more tech savvy members would be beneficial.
But the big way is through basic accounting. Accounting, explains MacDonald, has always lagged, but nowadays it lags more significantly. This means the information investors have through company accounts to influence their decisions is “no longer sufficient”.
MacDonald says accounting data has become significantly less relevant than it was even 30 years ago, let alone 50-60 years ago. “What we’re doing as investors is trying to establish what the value of a company is, but also to see what their value creation is,” she says.
There’s a difference in how such assets are reported. For example, if a company buys a brand, some patents or intellectual property, it goes on the balance sheet; if the company creates the same asset itself, it does not go on the balance sheet.
“We like the companies that are creating their own because they will look as if they are less valuable.”
It's something Morningstar's company analysts have long taken note of within its Economic Moat data point on stock research reports.
Below, MacDonald and Matthew Tillett, who runs the UK sleeve of Brunner, run through three examples of companies they’ve bought recently.
Informa (INF)
The media industry is one sector that is being disrupted at a fast pace. General news has already moved online, while both Netflix and Amazon are changing how consumers watch TV programmes.
As a result, valuations are depressed. This may mean investors need to be extra careful where they tread, but it also throws up interesting opportunities.
Informa is the global market leader in organising and running media industry exhibitions. It’s an area Tillett says is much harder to disrupt and is still an important part of the networking process for business executives. Further, “there are huge scale benefits to owning the premier exhibition in a particular industry – anybody who’s anyone has to go to those exhibitions,” he adds.
While Informa is the market leader here, the industry is very fragmented, so its market share is less than 10% and has potential to grow further. More importantly, the exhibition space hasn’t really seen technological innovations come through yet, despite being a perfect arena for it.
The events organisers have hoardes of information on every person attending the event, from exhibitors to attendees. There are plenty of ways this data can be used to the company’s benefit, including cross-selling, maximising exhibitors’ positions and using different pricing models.
This is a big opportunity for Informa and is something that excites Tillett and MacDonald, should management be able to implement it properly.
Informa bought rival UBM for £4 billion in January 2018 and Tillett reckons the deal is likely to add 3-4% organic revenue growth, with operating margins of around 32%. Despite that, the market was sceptical of the combination, meaning Brunner was able to add the stock to the portfolio then at a price/earnings multiple of around 15 times.
SThree (STHR)
Another UK company, SThree is a recruitment company specialising in careers in sectors including science, technology, engineering and mathematics. The jobs it finds candidates for are high-value jobs paying six-figure salaries.
Tillett says there’s a debate over whether technological change is a positive or a negative for recruitment firms. The negative side is it makes it easier for recruiters and internal HR departments to screen candidates and find the best one. “That’s likely to lead to, and already has in some cases, some price pressure.”
But this pressure is largely confined to commoditised areas where you don’t need human interactions. SThree, on the other hand, is focused on niche positions that are difficult to fill, so a specialised recruiter is needed.
Tillett says management is high quality and forward thinking. They saw this change coming, he says, and pivoted from being a primarily UK-based IT recruitment company a decade ago to becoming more global and more niche.
Today, only 10-15% of the business is UK-focused, with its main operations in Germany, the US and the Far East. And they are much less reliant on the heavily commoditised IT sector. “We think this is a management team that is ahead of the game,” he says.
Despite this change in strategy having taken place over the past decade, investors don’t seem to have cottoned on. As a result, it can still be picked up for just 13 times earnings, which means it’s priced for zero growth currently.
Ecolab (ECL)
US firm Ecolab provides water, hygiene and energy solutions and on-site services to companies in sectors like hospitality, health and energy.
As its product is a service and consultancy, it is a very high-return business, says MacDonald. Around 90% of its revenues are on a recurring basis and returns on capital are consistently around 15%-plus.
Its technological innovation is twofold. First, it is able to give their consultants more ways of being able to monitor usage in their specific fields, and to automatically re-order services when needed.
Second, it has been putting sensors into the field, meaning they can get more data, easily. Because they service around 3 million sites worldwide, this is handy as it means they need to employ fewer people to go around collecting that data for them. Therefore, they can re-assign other employees to more productive and interesting tasks.
It also allows them to collect better data, which helps build their understanding of and usefulness to the customer, making their services more sticky.
