Each week, a professional investor tells us where he’d put his money. This week: Ilan Chaitowitz of the Nomura Global High Conviction Fund picks three favourites.
Over the last five years classic value investors have had a torrid time. The MSCI World Value Index has underperformed its growth equivalent by 4% per year. Conventional wisdom has tied this trend to ever-lower long-term interest rates, which have kept the weakest businesses solvent and thus stopped the traditional capital cycle from buoying the strongest. This has weighed on returns in capital-intensive industries, which are where classic value stocks tend to be found. Meanwhile, major tech firms such as Amazon and Netflix seem capable of strong growth regardless of the economic backdrop.
So where should investors place their bets now? Rather than agonise over the choice between the two strategies at a time when the macroeconomic outlook is unusually unpredictable, investors can take an agnostic view of growth and focus on the underlying quality of the businesses. High-quality companies do something hard to emulate consistently well. They are unlikely to suffer irreversible declines in profitability and can typically sustain their returns for longer than the market appreciates. We only buy these world-beaters when they trade at attractive valuations.
A hot heating stock
AO Smith (NYSE: AOS) is the leading US manufacturer of water heaters for homes. The domestic market is highly concentrated, with the top three players accounting for 90%, so pricing power is strong and return on capital has trebled over the last ten years. Demand is solid as it stems mostly from people having to replace their heaters rather than from discretionary spending. The stock is especially appealing now as it has been hit by the trade dispute between the US and China, where the firm has around a third of its business. But the medium-term opportunity in Chinese urbanisation is compelling and AO Smith has increased its share buy-back programme to benefit from a re-rating.
A defensive retailer
US discount retailer Ross Stores (Nasdaq: ROST) focuses mainly on clothing. This sub-sector is one of the most defensive in the event of an economic downturn as consumers tend to trade down. It has large simple stores and offers branded clothing at prices well below the normal retail price. It has a competitive edge in sourcing products at the necessary volume and in low-cost operations, it generates high returns, and has plenty of investment opportunities in the US. The management is reliable and returns a lot of cash to shareholders.
Top-quality quality-control
Waters (NYSE: WAT) develops, sells and services quality-assurance and quality-control instruments. These test drug, water and food contents and identify contaminants. It is the market leader in liquid chromatography systems (designed to separate mixtures), so it sets the testing standards, and these are rising. With half of sales from recurring business, no single customer representing more than 2% of sales, and high switching costs, Waters has generated consistently high returns for the last ten years. The company also enjoys attractive growth opportunities in emerging markets.