Our valuation discipline —2024 outlook

Summary

• Equity markets have risen, resulting in higher valuations, particularly within the industrials sector

• Our view on valuation and our valuation discipline comes from our growth tilt due to our ethical screen¹

• Chasing momentum in this environment could leave investors with potentially overpriced portfolios

Full transcript

Why is valuation discipline so important for investors right now?

The first thing to say is valuation discipline, I think, is important in any kind of market. But in the last couple of months, we've seen equity markets particularly strong.

Locally here, the ASX is up 12%, in the last two months of 2023. And some of those growth sectors performing well as interest rate expectations have changed a bit.

The US Fed signaling some rate cuts for 2024 lit a fire under equity markets. But you're starting to see PE valuations starting to become elevated again.

And while the ASX 200, broadly speaking, the PE multiple is in line with long-term averages. On the industrial side, where we tend to focus a lot of our investment, a PE multiple of 18 times is actually above long-term historical averages.

So it does show that the market is a bit elevated after this period of good returns. And so I think in that environment, having strong valuation discipline is very important.

What’s unique about our view on valuations?

Given our style, given our ethical screening process¹, we're very much a growth investor. We invest in sectors like healthcare, technology and renewables. So we effectively operate in a growth type of universe.

But the way we think as an investment team is we are really, very valuation-oriented. So what we're looking for in business models is strong recurring revenues, strong balance sheets, cashflow generation, and really from a valuation perspective, we’re looking for those opportunities where companies are attractive from a multiple perspective, attractive relative to the broader market or even peers within the sector.

So we think that gives us a good buffer if things don't maybe pan out as well as we'd like in the near term because we think the long-term opportunity is really attractive.

One of the key things for us is we don't chase momentum. We don't want to get involved in those momentum trades that quite often you see in the short-term light up the equity markets.

Particularly in technology, you've seen over the last couple of years a number of stocks that have been chased by the momentum crowd. And then conditions turn and suddenly there's a problem there. And if you've bought in at that higher end of the market, when the momentum is running, you're left with not much if things go wrong.

Which companies are well-placed to perform in this environment?

One example would be ResMed, ResMed’s a big global franchise in the healthcare sector, that develops CPAP machines for people with Obstructive Sleep apnea. ResMed share price was impacted in the last few months by the rise of obesity drugs and the potential impact that could have on the products that it makes.

We think that impact or potential impact is overstated. But equity markets don't like uncertainty and there's a lot of uncertainty around it to the extent that the PE multiple for ResMed dropped to a decade low of 18 times. And we're just seeing that impact is overstated for this type of business. So we think there's good valuation upside and opportunity in that business over time.

The second example would be PEXA, it’s a company we’ve held in a number of funds for a while, but we think there are good valuation opportunities there, and so we've added to it.

PEXA is a really good example of a business we like – digital property settlements platform, high margins, good revenue growth, good market share, and generates a good amount of cash.

So the Australian franchise is very strong. What PEXA is trying to do is replicate that success in the UK and it's taken a little bit longer and a bit more capital than equity markets have patience for in the shorter term, but we think it’s a good opportunity over the long term for patient capital to see a really good return in this type of business as they execute on the UK opportunity. So again, we think valuation is on our side and we think that'll deliver good returns over the long term.