Page 33 - DIY Investor Magazine | Issue 32

Yes, to answer your question more directly, there are areas of the market that we’re invested in that are able to pass inflation through quite quickly and quite easily. Some are regulated utilities, for example, where they can automatically pass through inflation because of the way their pricing mechanism works. Others, like energy clearly have benefited from higher commodity prices. But most companies that have been around a long time and earned decent returns are able to cope with a modest amount of inflation and pass it through.
‘THE INCOME SIDE OF THE TRUST HAS RECOVERED QUITE NICELY AS WELL’
They may not all pass it through immediately, there may be some lags, and we are seeing more individual company volatility, individual problems, as companies deal with inflation in their cost base before they can pass it through, and so
on. I think we are in for a more volatile period in individual companies, but generally, many of the businesses in the portfolio can cope with higher inflation and a modest amount of inflation is not really a concern.
JC: And, as you say, in the scheme of things the inflation rate is relatively modest compared to where it has been in the past; we’re perhaps just used to those figures being so low for rates and inflation as well. Is that part of the issue here, that really in the bigger picture, actually, we’re nowhere near as steep as we’ve perhaps been before?
SG: Well, interest rates are really low. Inflation has gone up quite a lot in the short term, and of course some of that feels like it’s transitory, some of it feels like it’s going to come off
in terms of the year on year increasing commodity prices in energy costs; I don’t think we’re going to see big sustained increases of those types of assets on a year on year basis in the future.
Hopefully the inflation rate comes back a bit, but interest rates are still very, very low; we’re starting to go up, of course, but it’s very hard for the government or Bank of England to raise interest rates too high because there’s so much debt in the system. So the cost to most of the country of higher interest rates and to consumers of higher mortgage costs would be unbearable if interest rates moved up to where we saw them in the ‘80s and the ‘70s. So we are very sensitive to high rates, and therefore, we’re probably not going to see very high levels of interest rates in the short to medium term.
JC: Now, Simon, we’ve talked many times about value investing on this podcast, but how far do you think there is left for value to run? Are there still quality value stocks out there to be found? I think I know what you’re going to answer, but I’m keen for your thoughts on this.
SG: It’s been interesting because we did see a bit of a rally in the value factor over the turn of last year from about November to the Spring, when we had the first positive vaccines news. But really value as a style has not been a great performer.
Last year was OK, but certainly for the two or three years before that it was quite a poor performer; lowly-priced shares were not on average performing that well. We’ve done quite well despite that headwind to our style, because we’ve been able to identify those lowly-priced companies that really are genuinely good businesses that were under-priced, rather than companies which have more structural problems, where you might say they were cheap for a reason.
‘MANY OF THE BUSINESSES IN THE PORTFOLIO CAN COPE WITH HIGHER INFLATION’
And I think that that still remains the case. There are still plenty of opportunities out there to buy really interesting companies; good businesses that are lowly rated.
To answer your question directly, the anomalies within the market, the spread of valuations, is still remarkably wide. I would say at the extreme end it’s come in a bit: some of the cheapest, some of the lowest price companies from last year have now re-raced upwards, and some of the most expensive higher-growth companies have come down a bit in valuation.
But there’s still enormous variation within the market, and one thing that I think has become more prevalent in the last six months or so has been earnings momentum.
So companies that are seeing upgrades to their earnings forecasts are generally performing very well in terms of share prices, and that can drive anomalies in the market
as well, because clearly just because a company is seeing improvements in today’s earnings expectations doesn’t necessarily mean that the company’s worth a lot more in the long term, so if the market goes too far on some of those trends, that can create opportunities as well.
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DIY Investor Magazine · Feb 2022