Stephen Jenkins says he’s heard a recurring refrain throughout his 30-year career: value investing is dead.
“How can it be?” asked Jenkins, co-chief investment officer and portfolio manager with Toronto-based Sionna Investment Managers Inc. “Finding good businesses with solid cash-flow streams at [undervalued] prices will never go out of favour as long as we have public markets.”
While growth stocks have dominated for a decade, a rotation into value began last November following positive Covid vaccine news and hope for an economic revival.
Value investors still can find opportunities as earnings and cash flow normalize with the recovery, Jenkins said. While his firm continues to look for bargains, he added, “We’ve been well positioned in our portfolios for some time and … are now beginning to get paid for the groundwork we laid.”
A name that’s performed well and still offers value is New York–based Tapestry Inc., the holding company for luxury fashion brands Coach, Kate Spade and Stuart Weitzman.
Tapestry’s stock price was weak prior to the pandemic due to “some product and design missteps along with some management departures,” Jenkins said. Covid sent the stock “to significant lows, creating a great opportunity.”
The company cut costs and improved its online presence. “Their e-commerce now is north of 25% of sales, up from high single digits a year ago,” Jenkins said. “They also benefited from China reopening much earlier than the rest of the world.”
Tapestry, which has little debt, still is valued at multiples lower than its historical averages, Jenkins said, and the company’s recovery should continue with a rebound in earnings and cash flow in the coming years.
Larry Sarbit, portfolio manager with Winnipeg-based Value Partners Investments, said his criteria for what makes an ideal investment is its growth potential based on continual demand for a company’s products or services.
“We’re looking for companies that are more or less independent from the general economy,” Sarbit said, citing such value picks as phone carrier T-Mobile U.S. Inc., Google parent Alphabet Inc. and entertainment provider Liberty SiriusXM Group.
A less obvious name is Philip Morris International Inc.
“Value investors go where companies have growing free cash flows,” Sarbit said. “We own tobacco [companies] because they’re cheap, unloved — and they’ve changed.”
Philip Morris is planning to replace cigarettes with smoke-free vaping products. “They hope to have 40 million [current] customers switch by 2025,” which would represent 50% of net revenue, Sarbit said.
While the company holds the distinction of being the most blacklisted by environmental, social and governance (ESG) funds, that is likely to change with the shift to non-combustible tobacco products, Sarbit wrote in recent commentary.
Sarbit is patient enough to await the company’s transformation because he considers himself “a real business owner” of each company he holds, he said.
Toronto-based IBV Capital Ltd. invests in the conventional market and lends capital privately to public companies. Talbot Babineau, IBV’s president and CEO, said he looks for companies that will be “very durable into perpetuity,” regardless of external circumstances.
One listed name Babineau holds is U.K.-based FirstGroup PLC. This multinational transportation company provides school-bus transportation, including in North America. Covid-19 hit the company hard as schools closed. And Babineau increased his weighting.
“We understood how school-bus contracts work with the different school districts,” Babineau said: despite school closures, FirstGroup still gets paid.
Babineau described FirstGroup as “tremendously” undervalued with a near-term catalyst: it’s in the process of selling its North American business. “The lion’s share of the value will be in this transaction,” he said.
When Jenkins was asked about the risk outlook, he said the biggest risk is probably rising interest rates. “Longer-dated cash flows are at risk when rates are moving higher,” which will negatively affect growth stocks in particular, he said.
In contrast, taking a valuation-focused approach and using conservative assumptions when assessing cash flows, as Jenkins’ firm does, will prove beneficial as rates rise, he said.
“We could perhaps continue to see more of a balancing in the marketplace,” Jenkins said, with a greater proportion of returns coming from a broader base, not just tech.
Sarbit cited investors’ apparent obliviousness to high valuations as being of concern. “You can’t have a situation where the prices of businesses are vastly outpacing the growth of the economy,” he said, describing the market’s past decade. “It doesn’t last. We’ve seen that repeated over and over.”
Babineau also highlighted the risk of rising rates and high valuations. “You almost have to start creating your own opportunities,” he said, referring to his approach of offering capital to struggling companies he knows well.
“We’re flexing that part of our investment process up right now because of where we see valuations,” Babineau said. “It’s our way of adding a tremendous amount of value and sidestepping the market.”