“I have learned over the past 30 years that every time you are asked to pick one company, you can be assured that particular company will end up on the front page of the paper – and not in a positive way,” said George Fraise of Sustainable Growth Advisers when asked to name a holding in his portfolio he is particularly excited about at the moment.
However, despite his misgivings, he is one of four of the managers at Alliance Trust to offer an example of a stock they are backing in the current market environment.
Alliance Trust has an unusual set-up for a multi-manager product in that it takes 20 stock-picks from a blend of managers rather than investing directly in their funds.
Here are the four managers and their selections.
George Fraise
First up is Fraise (pictured), who warned that after 10 years of a global bull market, valuations are not as attractive today as they were a decade ago. In addition he said that with central banks moving from accommodative monetary policies to neutral ones, investors will have to be more selective about which companies they invest in in order to generate returns
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This led him to select Chinese education company New Oriental. Although this stock was hit in the recent volatility, with its share price almost halving from its peak this year, Fraise said it has a solid business model.
“New Oriental provides outside-of-school tutoring and teaching to prepare children for the national entrance exam at the end of high school in China,” he explained.
“The particular score you get on that exam which is at the end of high school determines which university you can go to and which job you ultimately get, so it really determines the direction a child’s life is going to go in, so it is a pretty important thing.”
Fraise said there are numerous tailwinds that should drive demand for New Oriental’s services. First, the removal of China’s one-child policy should result in an increase in the number of children entering the school system over the coming years; and second, Premier Xi Jinping has stated education will be an integral part of the next 10-year plan and has committed to increased spending on this area.
“All of those are leading to a long-term tailwind of growth for a company like New Oriental in a market environment that has penalised the stock dramatically over the short term,” Fraise added. “We think that is an opportunity.”
Andrew Wellington
Lyrical Asset Management’s Andrew Wellington (pictured), who runs the global quality value mandate, selected Flex, formerly Flextronics, which provides electronic manufacturing services
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“It makes Bose headphones for Bose, for example,” Wellington said. “You know, most of the companies that make stuff don’t actually make stuff. They hire other companies such as Flex to make the stuff they ‘make’.
“This is not part of our thesis but if there are tariffs and disruptions, they should benefit greatly because they have a global manufacturing base and people will need to turn to them.”
Wellington said that while Flex has been doing “exceptionally well, and won a tremendous amount of business”, this is not being reflected in the numbers as after winning a contract it has to spend large amounts of capital to build a factory. As a result, the number of contracts it has recently won have depressed this year’s earnings.
“Next year those contracts start to produce revenue and so there is a pretty significant earnings growth rate and it is only 7.5x earnings at today’s prices,” Wellington added. “And if that sounds cheap, that’s because it really is.”
Rajiv Jain
GQG Partners’ Rajiv Jain, who runs the global and emerging markets mandate for high-quality sustainable businesses, selected Facebook to take advantage of the shifts in the global advertising market.
“I don’t do long and short positions in this portfolio, but if we looked at what I would short, the classic advertising agencies all look like shorts to me,” he said.
“We talk to a lot of digital advertising agencies and they say, ‘if we don’t go to Facebook or Alphabet [Google], where do we go?’
“Ninety per cent of incremental advertising dollars are going into Google and Facebook and that trend is still in the early stages. Only a third of advertising has shifted to digital but when we talk to consumer staples companies or car companies, that is the biggest trend.
“The younger generation doesn’t watch TV; TV viewership in the US for example has been declining at 7.5 to 8 per cent annually for the past decade.”
Jain said that when there are such compelling tailwinds, the main problem is usually that the stock is overpriced. However, he pointed out that Facebook's average revenue is still less than $2 per user, meaning there is plenty of room for upside, while it takes just 15 people in Johannesburg to run its entire Africa division of 225 million users, meaning that “the leverage in this model is incredibly high”.
“Now there is clearly more noise,” he added. “Facebook might have missed the earnings and the stock is down quite a bit this year, but if you look at the underlying earnings, it said these are going to slow down from 30 per cent growth to mid-20 per cent growth – so the revenues are still growing by north of 20 per cent. And you have a founder who basically controls the company, which we like.
“One of the common themes over the past few years is that some of our companies are not earning that much early on because they have the ability and willingness to take a long-term view.”
Greg Herr
Even though First Pacific Advisors’ Greg Herr runs the long-term value mandate on Alliance Trust, he has also chosen a tech stock, pointing everything in this sector is not as expensive as the FAANGs.
He has gone for Oracle, one of the world’s largest providers of enterprise resource planning (ERP) software, which allows businesses to automate back-office functions.
“Oracle provides very mission-critical products and 80 per cent of its revenues recur every year, so it doesn’t have to go out and sell the products to new customers,” said Herr.
“It is very profitable, the cashflow dynamics are very attractive and it has very high returns on capital.”
Despite these attributes, Herr noted the market has been pessimistic about its prospects, with analysts saying there hasn’t been a significant transition among its customers to cloud-based computing.
However, Herr said there are three different sectors in the enterprise software industry and he expects the one that Oracle occupies to follow in the footsteps of the other two.
“Standalone companies like salesforce.com have had very significant growth over the last 10 years, and then more recently we have seen companies like Microsoft and Adobe also transition customers to the cloud very well,” he continued.
“Oracle and companies like SAP, which is another ERP provider, have had very little traction so far because they are much more complex products to shift to cloud environments.
“And so as we sit here today, the business is trading at 10x operating profit, we are getting an 8 or 9 per cent free cash-flow yield and a 1.5 to 2 per cent dividend yield and a very high stream of recurring revenues.
“About 80 per cent of the cashflow this business generates is being distributed through dividends or share purchases so we are kind of getting paid to wait while that transition plays out successfully over the next few years.”