How you gonna beat Brazil, Bresciano? That’s the question Joga Bonito famously asked Australian soccer fans prior to the 2006 FIFA World Cup in Germany.
It’s a question we didn’t have an answer to. The Soccerwhos went down 2-0 to the South American giants in the second match of that tournament.
I often get asked a question along similar lines. How can your International Fund possibly beat the market? You have a tiny team of analysts. And you are sitting in a city about as far removed from the global financial centres as you can get. Unlike the footballers, it’s a question I can answer.
Forager’s aim is to buy businesses when they’re trading at a significant discount to their fair value and sell them for a fair or better price. If we get our valuations right, this process delivers us returns over and above the market over time. The question, of course, is why someone would sell you something for less than it’s worth?
Defining our investing edge
There are two reasons. One is a psychological edge that enables us to take advantage of irrational selling. Fund redemptions, index changes, spinoffs and the like can create situations where the former owner of a stock is forced to sell it even if they think it is cheap. Most investors fear losses, hate falling share prices and don’t handle uncertainty well.
Thanks to long-term clients, we have a longer time horizon than most investors. We are willing to suffer short term pain for long-term gain. We have a well funded business that can withstand market downturns. And we are psychologically wired to think in a contrarian manner.
Our second potential advantage is an informational edge. This edge arises when you know how to value a business better than the person selling it to you. You might know something about the business model, the accounting, the competitive landscape or the management team that other investors don’t know or under appreciate.
While we are perhaps most renowned for going against the crowd and being willing contrarians, this second bucket has been more lucrative. There have been some big successes where we didn’t have a strong informational edge. South32 is a good example of a stock that is well covered by analysts and where those analysts are much more knowledgeable about the underlying mines than us. We made money because many BHP shareholders had large cap mandates and couldn’t own the spinoff and the whole commodities sector was in a state of distress.
But these successes have been partially offset by a number of failed investments where we waded into distress without deep knowledge of the business and lost our shirts. Dolphin Geophysical and Enero immediately come to mind.
Informational edge and big wins
In the other bucket we have had some very big wins without the commensurate losses. Of course, there could be plenty of hindsight bias at play here. When something goes wrong the logical conclusion is going to be that you didn’t know it as well as you should have. But some examples in this bucket are illustrative.
Lotto24 is a German online lotteries reseller, listed on the Frankfurt stock exchange. The business model is identical to ASX-listed Jumbo Interactive, which we had owned for several years before buying into Lotto24. Indeed, it was during a meeting with Jumbo about its German expansion plans that we first heard of Lotto24. We want to be number two or three in the market, Jumbo’s Managing Director Mike Ververka told us, but Lotto24 is going to be number one.
We had seen the Jumbo business evolve here in Australia, knew that early accounting losses were inevitable in a rapidly growing business and had seen that these companies eventually become cash generating machines. Local German investors, who know 90% of their listed companies better than we do, were not forced or irrational sellers. They just didn’t know what the company was going to become. Its share price has risen from €3 in 2014 to €15 this year.
Or take our experience with airports as another example. One of my first jobs out of university was working as an analyst for Macquarie on its bid for Sydney airport. The experience taught me how wonderful these assets can be. More importantly, it showed how something with almost no accounting profits could be worth a lot of money thanks to its prodigious cash flows (almost all infrastructure assets incur depreciation and amortisation charges well in excess of cash capital expenditure).
I have made a lot of money out of that experience. Investing in Sydney airport itself, twice. And then parlaying that experience into investments in Zurich Airport and Vienna Airport in the International Fund.
Concentrated on areas of opportunity
These ideas are not easy to find, of course. We have made a lot of progress in recent years transitioning from large companies that we think are sensible investments to these types of unique opportunities.
But knowing what you are looking for is a huge start. We don’t need to cover the whole world. We need to focus our attention on the markets where there is likely to be distress, and the small number of opportunities where we are likely to have an informational advantage. That narrows it down to a much smaller universe, but it also dictates where we should be looking. All we need to do is find the 20-30 that meet our internal criteria.
It’s why we need to stay small. Informational edge is far more prevalent at the small end of the market. And why we need to remain obsessed with attracting the right long-term clients. There is no point us having the right psychological makeup if our clients are going to panic at the first signs of distress.
It’s why I am more confident than ever that we can win. While I still want to see the percentage of the portfolio invested these types of opportunities higher than it is, the progress has been encouraging. The results even more so.
Our 2018 Roadshow wraps up the 2018 financial year, explains more about our investing edge and presents a few new stocks that meet the informational edge criteria. The remaining locations and dates are below and it’s not too late to register.
Melbourne evening 26 July Melbourne lunch 27 July Sydney lunch 31 July Sydney evening 31 July Brisbane lunch 2 August
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