Smart Investors, it’s time to dig deeper into Smart Investing Approach (SIA) again! Today I analyse in details on why the portfolio of equities in the SIA-style Global Leaders Portfolio (GLP) looks as it does and why these certain equities and not other ones have found their place in the GLP at inception (and are still there now and for the forseeble future). Our scoring system, SIAScore, consists of 5 points (S1-S5). Let us remind the full set of SIAScore again, so that we can more easily elaborate on them going forward:
S1: growing sector 1pts/0pts,
S2: incumbent or prospective global leader 1pts/0pts,
S3: growing or stable wide margins (40%+ gross; 3yr avg) 2pts/0pts,
S4: Net Debt/EBITDA <1.5 (last 3 ended FYs) 2pts/0pts,
S5: above-average cash flows (FCF/MktCap (last 3 ended FYs) > S&P500 Dividend Yield or US 10yr Treasry Yield (higher of the values)) 2pts/0pts;
MAX TOTAL SCORE: 8pts/MIN TOTAL SCORE: 0pts/MIN SCORE TO QUALIFY: 4pts
Let me also remind you the full SIAScore table as of inception of the GLP portfolio and now as of writing this post (the structure is still the same):
Qualitative scoring (S1-S2)
As you can see S1 and S2 are the two points that are more qualitative than quantitative. They are mainly aimed at selecting stocks that fulfill the general requirements of what SIA wants to find – “the world’s best assets”. If a company does not operate in a “growing sector” (S1) (example: semiconductor sector vs. off-line shoe retailing), it certainly won’t qualify to the list of world’s best investable assets. Automatically it means that it will not be able to positively pass the test of most of the following SIAScore points (S3-S5). On the other hand, if a company does fulfill S1, it still should also fulfill S2 (be an incumbent (like INTC) or prospective (like AMD) global leader in its own sector). Otherwise it will most possibly be just another average company like many and not a candidate for being called the “world’s best asset”. The fact that S1-S2 are more qualitative (a bit more difficult to measure) makes them a little bit less important for the final scoring and each of these two points has a maximum of 1pt (not 2pts as in case of more quantitative S3-S5).
Out of 11 names so far in the GLP we have representatives of the following sectors: Semiconductors (AMD,NVDA,SWKS,INTC), Software-Infrastructure (SQ,NOW), Gaming&Multimedia (UBSFY,EA), Scientific&Technical Instruments (GRMN), Online Travel Services (BKNG) and Pharma (BIIB). As you can possibly easily see and check, all of these sectors are generally in their Growth phase. Some names like BIIB or INTC do of course also have some Value characteristics, but generally they operate in GROWING SECTORS WITH BRIGHT FUTURE AHEAD. Hence every name has a maximum of 1pt possible in S1 part of SIAScore.
Now as to S2. Only 2 names got 0pts here (SWKS,BIIB) as given an abundancy of companies available in their sectors that are more recognizable worldwide, it is hard to call them “incumbent of prospective global leaders”. The rest of the companies got a maximum of 1pt here. There is no doubt about any of them fulfilling S2 I think. INTC – No.1 in computer processors for years, AMD – INTC’s biggest growing competitor, BKNG – online booking behemoth, EA/UBSFY – both in top 5 game producers worldwide, NVDA – fastest growing computer graphic cards producer , SQ – integrated developer of mobile payments solutions with an average 45% sales growth over last 3 years, NOW – leader of SaaS cloud computing solutions.
Quantitative scoring (S3-S5)
Now let’s move on to the pure company financials scoring. Below I present tables with detailed results of every GLP equity portfolio stock for the last 3 ended Financal Years (FY) with some additional explanatory information. All data are collected on 22.06.2020 from Bloomberg (they can also be retreived from the US Securities and Exchange Commission EDGAR system).
| S3: growing or stable wide margins (40%+ gross; 3yr avg) 2pts/0pts, |
|NVDA *(FY2020 ended 26th Jan 2020 hence using last 3 years 2018/2019/2020)||59,90%||61,50%||62,10%||61,17%||2|
|UBSFY *(FY2020 ended 31st March 2020, using last 3 years 2018/2019/2020)||82,90%||82,20%||84,10%||83,07%||2|
|EA *(FY2020 ended 31st March 2020, using last 3 years 2018/2019/2020)||75,20%||73,40%||75,50%||74,70%||2|
|BKNG *(stopped reporting Gross Profit post 2017; COGS are omittable for BKNG hence taking appx 100% GPM)||97,90%||99,75%||100,00%||99,22%||2|
As you can see only AMD did not manage to get 2pts in S3 score, as its average Gross Profit Margin (GPM) for the last 3 FYs was below 40% (averaging 38,13%). Still, what’s notable, AMD’s GPM keeps increasing, which is very positive and gives proof that AMD operates in an environment, in which it is able to improve its pricing ability. That’s very typical for companies in their very Growth phase of the lifetime. SQ slightly beat the 40% minimm trashold and is also improving its GPM. the rest of names is easily way above the 40% minimum requirement, giving them a lot of pricing power and confirming very favourable long-term conditions for these companies.
| S4: Net Debt/EBITDA <1.5 (last 3 ended FYs) 2pts/0pts |
|SQ *(2017: assumed zero bacause of negative EBITDA, but company was cash-positive by usd601m in 2017)||0||-5,48||-2,94||-2,8067||2|
|NVDA *(FY2020 ended 26th Jan 2020 hence using last 3 years 2018/2019/2020)||-1,49||-1,32||-2,44||-1,7500||2|
|UBSFY *(FY2020 ended 31st March 2020, using last 3 years 2018/2019/2020)||0,67||0,37||0,52||0,5200||2|
|EA *(FY2020 ended 31st March 2020, using last 3 years 2018/2019/2020)||-2,74||-3,77||-2,65||-3,0533||2|
None of our GLP stocks has a NetDebt/EBITDA ratio higher than 1,5. Actually as many as 7 names have a negative S4 score, which means that they are cash positive and have positive EBITDA level. Only exception to the positive EBITDA requirement was SQ in 2017, hence the ratio is assumed 0 for that period. Still, SQ was easily cash positive in that year (cash was higher than outstanding debt by usd601m). As a result all our GLP stocks are very safe financially and do not have any risk of falling into distress connected with servicing its debt in the foreseeble future. This is exactly what we want by building a SIA-style portfolio. I wrote about it in details here in Deep dive into SIA (2). Please take a read!
|S5: above-average cash flows (FCF/MktCap (last 3 ended FYs) > S&P500 Dividend Yield or US 10yr Treasry Yield (higher of the values)) 2pts/0pts|
|Name||2017||2018||2019||AVG||US 10Y yield as of 22.06.2020||SP500 dividend yield as of 22.06.2020||S5 score|
|NVDA *(FY2020 ended 26th Jan 2020 hence using last 3 years 2018/2019/2020)||1,97%||3,24%||2,79%||2,67%||0,70%||1,95%||2|
|UBSFY *(FY2020 ended 31st March 2020, using last 3 years 2018/2019/2020)||8,40%||10,30%||6,10%||8,27%||0,70%||1,95%||2|
|EA *(FY2020 ended 31st March 2020, using last 3 years 2018/2019/2020)||4,27%||4,72%||5,74%||4,91%||0,70%||1,95%||2|
Three names, AMD, SQ and NOW got 0pts in S5. Their average 3-year Free Cash Flow Yield (FCF/MktCap) is no higher than either US 10-year Treasury Yield or SP500 Dividend Yield (higher of the values). In case of NOW it’s just 1,93% vs. 1,95%, but still a tiny miss. What’s notable in case of both AMD and SQ though is that this ratio constantly improves over last 3 years, so they’re both possibly on the way to reach a satisfactory FCF yield in the future to get 2pts in S5 score. All the other names nicely get full score here and the record holder is BIIB with as much as 9,1% average 3FY FCF Yield. That’s nice huh?!
The weakest stock of GLP from a fundamental perspective is AMD as of now (with 4pts total, which is the minium to qualify into GLP). We must remember though that AMD has become the most prospective competitior for INTC over the last few years, especially with the rise of its sales record-breaking Ryzen microprocessors. The company is investing hard in its unprecedented growth to possibly capitalize on it in the future.
SQ and NOW failed S5, but the Year-on-Year tendencies in SQ’s FCF generation are very promising and let assume that in a relatively short period of time it will be able to show higher FCF Yields to qualify for 2pts in S5. NOW is almost there already.
All the other 8 names in the portfolio are very strong fundamentally and get 7-8pts in SIAScore. They can me called “the world’s best assets”.
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