Ask A Fund Manager
The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In this edition, Forager research analyst Chloe Stokes tells us the shares that made her a bucket of money during the recent US short squeeze, plus a couple of regrets.
The Motley Fool: What’s your fund (Forager International Shares Fund)’s philosophy?
Chloe Stokes: Forager’s philosophy is valuation based. We try to buy stocks where the underlying business is going to give us above-average returns over a long period of time.
We think of ourselves as value investors, but people tend to pigeonhole value investing as buying businesses trading at a low price-earnings multiple. We think that you can pay a high multiple for certain businesses and still make good money over time.
MF: Right, as long as you think that multiple increases over time?
CS: Well, as long as you think it’s justified by the cash flows of the business and the growth that you’re expecting.
MF: Fair enough. So by that philosophy, a lot of shares can be considered both value and growth, would you say?
CS: Exactly. As an analyst, it’s great because it gives us the opportunity to look at stocks across both growth and value categories, depending on the opportunity set that we see in the market at the moment.
Buying and selling
MF: What do you look at closely when considering buying a stock?
CS: We try to look at everything closely. We want to get to know the business as well as possible. One thing that we find really interesting and spend a lot of time on is understanding the bear thesis on the stock.
So thinking about why the stock is priced at where it is today and what we think that is different from the wider market view. This can be much easier in smaller liquid stocks where the answer might be as simple as that no one else is really taking the time to study the business. In larger stocks, it gets much harder, but it’s always useful to understand what you think the market’s getting it wrong and why you think you might be right.
MF: How small do you get when it comes to small stocks?
CS: It really depends… In the international fund, I guess one of our more illiquid stocks is Hallenstein Glassons Holdings Limited, which is listed in New Zealand. That’s at about NZ$450 million market cap, which means if we want to get out of our position [it’s] going to take us quite a while.
MF: I saw your experience with Bed Bath & Beyond Inc on the back of the GameStop Corp short squeeze a couple of weeks ago. That must’ve been a fantastic ride for you guys.
[Ed: Stokes’ team doubled its money in 2 days during the chaos.]
CS: Yeah. It’s definitely been one of the more exciting times to work in markets.
It’s not often my friends want to talk to me about my job, but when short-selling is all over social media, and regular people are making millions of dollars very quickly through stocks, suddenly I’m quite interesting!
MF: What triggers you to sell a share?
CS: A number of things. A broken thesis, significant price appreciation, or better opportunities elsewhere. Lately, we’ve been selling a lot of businesses that we really like because stock prices have increased so dramatically.
That doesn’t always mean selling out of an entire position. We are always thinking about the right target rating for each stock in our portfolio. That might be different to the target weight last week, based on changes in the business, the stock price, or just the rest of the portfolio.
MF: You demonstrated a few weeks ago for that US luxury retailer?
CS: Farfetch Ltd.
MF: That’s the one. You executed that strategy, didn’t you? You held on to some and sold off some.
Sometimes we’ll be trading every day, but small bits trimming positions based on what I was just talking about: stock price movements, something that’s happened in the business, maybe one stock’s gone up really significantly, and the rest of the portfolio hasn’t moved.
So we just weigh it up against the other opportunity.
MF: Where do you think the world is heading at the moment?
CS: That’s a good question. With the vaccine rolling out globally, I hope it’s heading towards a bit more normality. It’s a very interesting time people will finally see which of the COVID-induced changes are here to stay. Is corporate travel over forever? Will consumers go back to brick-and-mortar retail stores? How many organisations will actually let their employees continue to work from home once all this is over?
In terms of equity markets, I think we’re in a pretty good position. Interest rates are low, consumer savings rates are high, and people have been cooped up at home for a long time. There are pockets of the market where this is already priced in and others that are overvalued for sure. But there are also plenty of unloved or forgotten stocks.
So lots of great opportunities for active managers.
MF: You mentioned a couple of sectors where there are question marks on how well they can recover, like corporate travel. Which sectors is your team optimistic about, and which sectors are you more pessimistic about?
CS: I don’t think I really have a sector-based view. I mean, we definitely are exposed to a reopening in terms of travel and retailers as we would’ve, you would’ve heard us speaking about. But it’s not like [we’re] sitting there every day trying to make sector bets. We try to have a well-diversified portfolio.
Some stocks are exposed to the reopening, others that have done really well out of COVID. So we just want to have a well-diversified portfolio across a number of different sectors and the reopening sectors.
Definitely bottom-up fundamental analysis on every stock.
MF: Are you most of the time fully invested, or do you have some cash in hand?
CS: Right now, we hold around 5% cash. Five to 10% is a fairly normal level for us.
One of the key features of our fund is our flexibility. We can hold as much cash as we like. So I mentioned 5% to 10% is fairly normal, but we can hold less, and we can hold more. And historically have used that flexibility at various times.
Overrated and underrated shares
MF: What’s your most underrated stock at the moment?
CS: My most underrated stock is Boohoo Group PLC, a UK based online retailer of women’s clothing. The stock is being punished due to governance concerns and supply chain issues. We think the management team is focused on correcting both of those things.
I just see common signs of an extremely fast-growing business and not a systemic issue at Boohoo. Looking at the business, Boohoo has increased revenue at an average rate of 55% per year over the past 8 years. And they generated almost £1.5 billion of revenue in the past 12 months. They’ve done so profitably and without financial debt.
So we think the underlying business is excellent and that the issues I mentioned before are overweighted in the stock price. The stock’s being unfairly punished for [past] sins and the business’ well on its way to correcting.
MF: When did you guys buy in?
CS: We started buying in September.
The [public relations] issue started in July. So we bought once they’d already started being punished for it. I think we’re up kind of 20% or something like that.
We’ve done reasonably well out of it, but we still think that those issues are heavily weighing on the share price. It’s an amazing growth business.
MF: What do you think is the most overrated stock at the moment?
CS: That’s a hard question. I think it’s easy to call a stock overrated when you haven’t done enough work on it, to understand the business and the opportunity. I mean, think about how many people would have called Facebook Inc or Alphabet Inc overrated or overvalued 5 to 10 years ago. And because we have such a broad mandate, the universe of stocks we can pick from is huge.
So that means if I don’t feel like a stock looks cheap or I have a particular insight fairly quickly, I’ll leave them to the next opportunity. I never really do the work on the stocks that I might think are overrated.
We just try not to pay too much attention and focus on the stocks that are right for our portfolio.
MF: Which stock are you most proud of from a past purchase?
CS: A lot of stocks come to mind. One you were speaking about before was Farfetch. Farfetch did really well for us in a short amount of time. It’s a global platform for the luxury industry. When I was doing work on the stock in June last year, there were a lot of question marks on the business. I mean, from afar, it was just another online luxury retailer with no real competitive advantage and the threat of Amazon.com Inc lurking at every corner.
I had the view that the Farfetch platform actually added a lot of value to not only the luxury brands but to the industry as a whole. For that reason, I was confident it would end up as the dominant platform in the industry. It didn’t take long for some great results to convince the rest of the market of that.
It was great watching the thesis play out over the next couple of months. And we made a lot of money over just 6 months, and we have sold our entire stake since.
Yeah, it’s not our usual time horizon, and I’m not proud of the time it took, but [I’m proud of] having the insight before it was widely appreciated. I would’ve loved to have been able to own the business for years to come, but the opportunities that are out there at the moment it’s just too compelling.
MF: As they say, you don’t want to fall in love with a stock, do you?
CS: Exactly. Exactly. You have to try and avoid that at all costs.
MF: What is your usual investment horizon?
CS: It varies by company. It’s probably a couple of years on average, but in times like this, we’re selling much faster than usual. No stocks keep going up.
Ideally, we’d like to buy a stock and hold it for 3 to 5 years or even longer, but we can only do that if the business is performing in line with that basis and the price isn’t going up too much to the point where the stock becomes overvalued.
We buy stocks prepared to hold them forever, but our experience has been that if the value hasn’t turned up on the share price in 3 to 5 years, we’ve probably got something wrong.
MF: Yeah, it’s crazy times at the moment, isn’t it? Bed, Bath Beyond you only had for 10 days?
CS: Yes, but we didn’t actually sell that entire holding.
What we did was we were trimming our position at the highs in late January, and we realised gains almost equal to our initial investment. What we’re left in is a bet on the turnaround thesis at a cost of close to zero.
MF: Is there a move that you regret from the past? For example, a missed opportunity or buying a stock at the wrong timing or price.
CS: Definitely. For me personally, my biggest regret came during the meltdown in March. We saw brilliant companies like Nike Inc and Lululemon Athletica Inc down more than 30% in a couple of days. Those stocks would have been excellent investments at market prices, but because I never thought they were cheap enough to invest any time into, I didn’t have a thesis ready.
One great lesson has come out of it, though. It’s that we need to have a diverse bench list of stocks with a thesis and a fair evaluation, including high-quality stocks that wouldn’t usually meet your valuation hurdle. I mean, it might seem like a waste of time, but you never know when the opportunity could come along to own a high-quality business at a more than reasonable price. I wouldn’t want to miss out on owning some of my favourite businesses if the opportunity presents itself again.
I’ll give you another one because I always see people talking about errors of omission, and we obviously make errors of commission too.
One example of that is Babcock International Group PLC, a UK-listed engineering services company. We started buying the stock in May 2018 at around £7 per share.
Our thesis was pretty simple – we thought Babcock was having a tough year but would quickly return to its history of high margin growth. Babcock’s management team kept reporting decent headline numbers and then running exceptional items through the accounts. But they’re not exceptional if they happen every reporting period!
So what we did was we put a couple of stakes in the ground, and we made the decision to sell when the business didn’t meet them. We sold up completely at around £4 in April 2020, and we agreed to plant the capital into new ideas.
MF: With your first example, that’s a good lesson for even retail investors to have a target list of shares you want to buy up if the market plunges, doesn’t it?
CS: Definitely. We always have a watch list, but I think just thinking about those super high-quality companies when you love the business, but it’s just too expensive. Those are great stocks to have on a watch list.
MF: It’s good homework to do, even though it might feel so hypothetical in boom times.
CS: Exactly, exactly. But then you go through something like March, and it’s always so upsetting not being able to buy them because you just hadn’t done work.