It's been a terrible year for mid- and small-cap ASX shares, and professional fund managers have fared no better than retail investors.
Montgomery Investment Management chief investment officer Roger Montgomery is no exception, recently making a stunning revelation about his personal holdings.
"When I first invested in the Polen Capital Global Small and Mid Cap Fund, I didn't expect the unit price to decline by nearly 40%," he said.
"But it has."
That's all good and well, but everyone's portfolios are in the red right now.
The big question is whether it's time to buy up bargains, or are there more falls to come?
"Several friends have asked me to let them know when I decide to make additional investments in equities," he said on his blog.
"Of course, I can't predict what will happen in markets in the short term… [But] over the longer term, I am acutely aware of the old investing aphorism: the lower the price you pay, the higher your return."
Earnings will now rule the share market
The aggregate forward price-to-earnings ratio of the stocks in the Polen Capital fund was 44 when it started its journey.
Now that ratio has tumbled to 25 times.
Montgomery analysed this drop to figure out a clue about whether it's time to buy.
"If I break up the PE multiple compression of the portfolio into its components, we find about 70% is due to lower prices but 30% is due to higher earnings the companies have generated," he said.
"And that's the point. Polen calculates the companies in the portfolio have grown earnings by nearly 25% per annum over the last five years on revenue growth of 18.5% per annum over the last five years."
And forward earnings growth for the next five years is estimated to range between 20% and 25%.
'I will be calling my banker'
The fact that an increase in earnings is a major contributor to the dramatic fall in PE ratios gives Montgomery much confidence.
"Unless the [US] Fed surprises with even more aggressive rate hikes, the future direction of the market should now be determined by earnings growth."
He reckons that explains why Warren Buffett's Berkshire Hathaway Inc (NYSE: BRK.A) bought up more than US$51 billion of shares in the March quarter.
"I trust you can see why I have instructed my banker to transfer additional funds into the Polen Capital Global Small and Mid Cap Fund," said Montgomery.
"And if the market continues to fall, I will be calling my banker again to continue the process of dollar cost averaging."
A spanner in the works is possible though, in the form of a global recession.
Montgomery admits it's possible, but unlikely.
"Current economic forecasts for the rest of 2022 and 2023 aren't suggesting any negative rates of growth," he said.
"So, with PEs now at recent historical lows, I'd prefer to look at the earnings growth of the companies we own."
