Plenty of large companies have actually performed well over the last five years. They have got attributes of growing quite quickly and, we think, are at a unique advantage over other companies. At the other end of the spectrum, and what’s really dragged the performance of the large-cap indices down, has been the very poor performance of companies like large oil stocks or large mining companies. They make up a very large part of several of the large-cap indices, so in many cases their performance has meant the whole index has performed poorly.
The good thing from the point of view of some of those companies, we believe, is now they have little or no growth factored in their price. The bad news is they’re not going to grow very fast. On the other hand, we see the potential may be there to buy that sort of company on a significant free cash flow yield premium to the market and a significant dividend yield premium to the market.
So the way I like to look at it is we have to be more patient with a company like that. We’re not expecting huge growth from such companies, but equally, neither is the market.
It’s a similar story with mining, which has generally been an area we’re not big fans of – even the large-cap stocks in the sector – because we find them very difficult to predict.
We don’t know, for example, what the price of iron ore or copper is going to be in the future and if you don’t know those prices it’s very difficult to come up with a value for a company mining those resources. However, again, the market now seems to be valuing those stocks based on metal prices that are substantially lower than current levels, so that gives us some encouragement when we start looking at those companies.
From the larger-cap perspective, I don’t worry too much about the split of overseas and domestic sales enjoyed by a company’s business. I’m trying to find attractive businesses on great free-cash-flow yield, with good management that I believe can compound up over the medium to long term. Foreign exchange volatility has been a headwind, but because I can’t predict where currencies are headed in the longer term, I tend not to let that worry me provided it’s a translational effect on that currency rather than a transactional effect.
What I mean by that is I’m relatively relaxed if a company makes its money in one particular region and all its facilities are in that region; therefore, the only time that changes in foreign exchange have an effect is when the business translates the profits back to its home currency. I’m more worried if you have a manufacturer in the UK, for example, competing with a manufacturer in the US at the moment because it would be struggling to some degree to compete: when sterling strengthens against the US dollar, the UK-manufactured goods will become more expensive to US buyers.
As investors, we are very selective about the stocks we consider for our portfolios and look at a limited universe within a broad index. That gives us the ability to still be able to find good ideas in different types of market conditions.
