Investment

Chart of the month: March Edition

by Pierre Mouton

What is cheap? what is expensive? Choose your camp!

How to choose stocks
Company 1. Red line: trailing 12 month Earnings per Share, Green line: Price Earnings Ratio, Blue line: share price

 

How to choose stocks
Company 2. Red line: trailing 12 month Earnings per Share, Green line: Price Earnings Ratio, Blue line: share price

 

So you have here two charts showing the evolution over more than 3 years of earnings, PE multiple and price for two distinct companies. One is supposedly a safe haven stock (company 1), paying a good dividend, on which losing money seems almost impossible whereas the other one (company 2) is that kind of “hype” stocks which, at some point should fall off a cliff because of overvaluation.

An equity investor must first and foremost look at the stream of earnings a company can generate in order to decide whether to buy this or that stock. Dividends are important, but come after earnings because when a corporation generates profit and does not pay a dividend, this profit goes straight up into shareholder equity, which means that in theory profits paid in dividends or retained into the company’s balance sheet should not impact the attractiveness of a listed stock.

 

We have seen an incredible and almost unprecedented appetite during the last 3 to 5 years for quality stocks, with predictable earnings and reasonable dividends. This seems quite logical in an unstable environment. Investors are skeptical about the economic cycle, about the financial system, about capital expenditure, and so on, therefore buying into blue chips, generally in the consumer staples sector, tends to be the only acceptable investment. And in most cases, they were right! Those large caps (Nestlé, P&G, Colgate, Unilever, Coca-Cola and others) have performed honorably, paid dividends, and were quite resilient when markets were nervous.

 

In the first chart, you can see a company which has seen its share price go from 60 to 71, its PE multiple climb from 16.5x to 20.8x, and its EPS slip from 3.65 to 3.4.

In the second chart, share price soars from 40 to 109, but EPS explodes from 0.75 to 3.3…. so mechanically the PE multiple falls from 48 to 33.

 

In our view, the first company does not deserve such a valuation and favorable performance if one takes out the extraordinary fall in interest rates which has magnified the stable nature of its business. There should be no other explanation because in a “normal” environment, a corporation which sees its earnings headed down should not see its share price and PE climb.

What about the second company? It was expensive when it traded at 48 times earnings, but over the considered period earnings have been multiplied by 4.4 while share price “only” rose 2.7 times. It still trades at 33 times earnings but will soon get cheaper than company 1 thanks to EPS growth.

 

Which one would you buy today? Indeed interest rates could still fall further and help company 1’s valuation remain at current levels (or higher), but it seems difficult to imagine that the stock can trade at a substantially higher PE as long as earnings don’t grow. We largely prefer company 2 because, as said before, the stream of earnings plays in favor of the investor. At the end of the day, the winners in equity markets are those who increase earnings, not those who benefit from external forces to drive their multiple on the upside.

 

By the way, company 1 is Nestlé. Company 2 is Facebook.

 

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Antonio Mira
CHIEF FINANCIAL OFFICER, MEMBER OF THE EXECUTIVE COMMITTEE

Antonio Mira joined NS Partners in 2006 as Group Chief Financial Officer. He heads the corporate functions and is involved in coordinating and implementing the decisions of the Executive Committee.
An experienced bank auditor, Antonio started his career in 1995 with Arthur Andersen, where he worked for some 7 years before joining Ernst & Young in 2002 as a Senior Manager.
Antonio is a Swiss chartered accountant and a Business graduate of Lausanne University (HEC).

Sébastien Poiret
DEPUTY HEAD OF WEALTH MANAGEMENT

Sébastien Poiret joined NS Partners in 2008 and manages funds of hedge funds and private client mandates. He also oversees the development of the Group’s offices in Mauritius.

Prior to joining NS Partners, he served as a Trader, Head of Manager research and Portfolio Manager in the USA and Switzerland for a single hedge fund (1998-2004) and for Optimal (2004-2008), Grupo Santander’s fund-of-hedge funds operations.

Sébastien holds a Bachelor’s degree in Corporate Finance from the ESPEME Business School (EDHEC Group) and an MBA in Finance and Economics from the Institute of Business Administration, both in Nice.

Abir Oreibi
BOARD DIRECTOR

Abir Oreibi joined the Board of the NS Partners Group in 2018, where she brings her truly international perspective and rich experience.
Among many other ventures, Abir set up Alibaba.com’s first European office. After living and working in Shanghai, Hong Kong, Bangkok and London, she now lives in Geneva, where she is CEO of Lift Events, an organization that identifies technology trends, their business and social impact through the organization of events and open innovation programs. Issues related to the challenges and opportunities created by new technologies as well as the strategic responses from organizations are at the heart of Lift’s activities.
Abir holds a BA in Political Sciences from the University of Geneva. She is an investor, and member of advisory and innovation boards.

Romain Pidoux, CAIA

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Romain Pidoux joined NS Partners in 2011 and heads the Group’s Risk Management.
He started his financial career in 2005 as Head of Quantitative Analysis for a Swiss Family Office, selecting funds and managing portfolio allocation. In 2008, he switched to the alternative world and joined Peak Partners as hedge funds analyst.
He is a Chartered Alternative Investment Analyst (CAIA) and holds a Master’s degree in international relations from the Graduate Institute of International Studies at Geneva University.

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