Over the last few years, central bank policy, hugely dependent on inflation, has driven global liquidity and asset prices. This will likely remain the biggest influence on market returns for the foreseeable future. There has, however, been extensive writing on this elsewhere and indeed feedback from journalists and marketing departments alike has advised against “writing anything about inflation and central banks as there is far too much of that already.”
It is in this environment where monetary policy is changing, that stock picking ought to be able to prove its worth. While a rising tide lifts and a falling tide lowers all boats, the distribution of returns within the equity market is generally not that well understood. Few stocks tend to generate outsized returns which help to drive the overall market. While there are many ways to successfully navigate the equity market, the characteristics of the securities that generate such outsized returns are of particular interest to active equity investors. These companies tend to be high quality, with management that has long-term thinking and often superb barriers to entry, usually due to sizeable research and development spending.
Frequently these come from companies successfully commercialising new technologies in industries that are not capital intensive, allowing high returns on capital. New technologies can drive earnings, valuation and sentiment. It is important for investors to continue to have a valuation in mind and not be carried away by positive sentiment on stocks. On the way up, equity prices of securities have a habit of swinging from cheap through fair value and on to expensive and vastly overpriced. Similarly, when the market falls, equity prices typically swing from overpriced to fair value and can become very cheap indeed. The underlying intrinsic value of firms should be expected to rise over time as companies grow and business models are demonstrably de-risked. The pendulum of market valuation, however, distorts the return profile that is delivered to investors. Many global equity growth investors, for instance, were on the receiving end of particularly negative returns during 2022 as interest rate increases raised discount rates – decreasing assessments of the intrinsic value of stocks. While this ought to have been expected, avoiding very overvalued growth stocks was a performance differentiator last year.
Fruitfully finding ways to express views on new technologies within listed equities can be challenging. The excitement around new technology can mean that valuations become too rich at an early stage of development. There may be many potential firms in each area from which only a handful are expected to win, and new technologies might be only a small part of listed businesses. Understanding embedded growth assumptions in market valuations is important, as is an assessment of where on the valuation pendulum securities are, but ultimately an assessment of intrinsic value is key to generating good returns.
Disruptive technologies can offer a better solution to existing business models. One such example is the Invisalign system pioneered by Align. Using their customised 3D printed clear aligners the company can free up a large amount of time for dentists and orthodontists while providing patients with a more aesthetic solution during their treatment than traditional wire braces. Hopes and expectations for the company within the market were very high at the start of 2022 and the shares performed particularly poorly over the year, derating from a P/E ratio of 70x to 35x. Expectations were previously too high for a variety of factors. One of these was the importance of China to the business, which had been 8% of sales. Despite this being visible in reports from the company, the sudden reduction of sales when patients were unable to attend dentists, as well as the elective nature of many treatments, has contributed to reduced growth expectations. With these now considerably more realistic, a much lower entry price and the technology passing a penetration level of 15% which often indicates an acceleration in adoption, we have included the company in the Ashburton Global Equity Growth Fund.
An area of interest to pharmaceutical companies and researchers for over two decades has been the use of personalised medicines. Given that it is now expected that close to half of all deaths will be from cancers, oncology therapies have been a big focus of research efforts. Chimeric antigen receptor T (CAR-T) cells are a form of therapy in which T cells are extracted, reprogrammed and reintroduced into patients to alter their immune responses. The US Food and Drug Administration has approved six CAR-T cell therapies since 2017, and in 2021 their shared annual revenue was $1.7bn. This is however a small fraction of the revenue of the companies in the field with marketed products including Bristol Myers Squibb, J&J, Novartis and Gilead. All currently approved therapies have several challenges relating to longevity and toxicity. There are over 130 different CAR-T therapies currently in development. Within our Ashburton Global Equity Growth Fund, we have taken a small position in a CAR-T specialist, who has recently reported positive interim pivotal clinical trial results with only around 3% toxicity events versus general levels in approved drugs of 50%. Despite this, and numerous licensing deals of their specialist knowledge in CAR-T programming, the company trades at a huge discount to peers with approved drugs that are licenced to major pharmaceutical companies. Interestingly a few years ago while there was an epic clinical trial risk, the company traded at over twenty times the current price.
Artificial Intelligence and automation are exciting fields with multiple applications across industries with far-reaching end markets spanning the likes of assisted driving, recommendation systems, fraud prevention and diagnostics. While there is little doubt that growth will outstrip GDP for the foreseeable future, excitement over the new technology in terms of the multiples paid was simply too high. We found that several of the firms involved in the area had fairly incredible assumptions implicit in their valuations at the beginning of 2022. The market multiples on which Nvidia trades, for instance, have halved and the share now falls within our intrinsic valuation framework. Nvidia has a keen focus on artificial intelligence with its technologically leading graphic processing units.
Given that the big winners are likely to come from companies benefiting from new technologies it is important to keep abreast of new developments. Ultimately, avoiding losing money during the early stages of a technology hype cycle is important. Identifying those companies that are being de-risked and some element of change is observed, are key to long-term success and beating the market.
Nvidia and Align Technology are held within the recently launched Ashburton Global Equity Growth Fund.
Disclaimer
Collective Investment Schemes are generally medium- to long-term investments. The value of participatory interests (units) may go down as well as up. Past performance is not necessarily a guide to future performance. Collective investments are traded at ruling prices and can engage in scrip lending and borrowing. The manager does not provide any guarantee either with respect to the capital or the return of a portfolio. A schedule of fees, charges, and maximum commissions, as well as a detailed description of how performance fees are calculated and applied, is available on request from Ashburton Management Company (“the Manager”). The Manager may close the portfolio to new investors in order to manage it efficiently according to its mandate. Ashburton Management Company is a registered and approved Manager of Collective Investment Schemes in Securities.