A tale of two stocks

As financial markets surge to successive new highs, we could be forgiven for thinking making money in the stock market is easy. This might be true for passive index investors and a portfolio of winning stocks, but it has most definitely not been the case

In the words of a recent market commentator: “the market is awash with contradictions”. In our time, we have been through a few stock market cycles and we readily admit to being genuinely perplexed by many aspects of the more recent market action.

We would like to highlight one such disconnect. Graph 1 shows the divergent paths of two domestically-listed stocks.

Graph 1

   (click on picture to enlarge)

Source: I-Net

Stock one (Naspers) is clearly popular. It has been a winning stock for quite a while and has generated an annual return of 47% since March 2009 and outpaced earnings by a factor of five times. It pays a miniscule dividend and earnings appear to be a secondary consideration, with the stock currently trading at close to 50 times earnings. Popularity of such magnitude is often well deserved and typically rooted in a strong belief or a well-anchored perception. In this case, the last 10 years have been champagne years for the underlying businesses and management’s operating style. It could be argued that the missteps and lessons learned in preceding years more than prepared the business for their current streak of successes. Market participants have, however, banished all such failings from their collective memory and, today, the narrative surrounding the stock makes no mention of the inherent business volatility or the risk of a slowdown in growth. Management have the Midas touch and the stock valuation discounts nothing less than a repeat performance in the next decade. Let us state for record that we are avid admirers of stock one but current expectations are too lofty for our investment appetite. We wait patiently on the side lines for (hopefully) another opportunity to partner with such a wonderful suite of businesses.

In direct contrast, stock two (African Bank) has fallen from grace and now trades well below the lows established during the Global Financial Crisis (GFC). It is one of a rare breed of stocks that seem oblivious to abundant liquidity and QEternity. For a stock to trade below the GFC lows requires some combination of management ineptitude and a significant deterioration in fundamentals.

It is true that the operating environment for stock two has become more challenging. It is equally true that the speed of the recent deterioration, together with a decline in the dividend (and a variety of one-off charges), has impacted negatively on the market’s perception of management. Management have lost the Midas touch and failed to deliver on a major acquisition of four years ago. Market participants have voted with their feet and the recent sell-off reflects their belief that future results are likely to be worse.

Time will tell, but a few facts remain quite intriguing. A repeat of the recent half-year results (a result that management considers to trough earnings for the banking unit) will give you better annual earnings than the company reported at the March 2009 lows. If the recent sell off is correct and things are indeed worse, it is not yet apparent in operating results. The dividend yield (after a temporary raising of the dividend cover) is around 5%. The stocks trade at a price-to-book of less than one times, a price that places a negative value on management, the company’s dominant market position, wide distribution network and diversified client base. We have long admired stock two and, while we cannot tell how things will unfold, we hold the stock on behalf of clients as discounted expectations are now low enough to not require rosy projections to achieve a reasonable prospective return.