Stocks are supposed to go down in a recession, or at least that’s what conventional wisdom would tell you. But much to the amazement of many investors and commentators, they’ve done exactly the opposite through this COVID-induced recession. While this might seem nonsensical, Nick Griffin, Chief Investment Officer at Munro Partners, points out that equity markets and the economy are very different things.
“Equity markets are not necessarily the economy; they are the top 200 companies in Australia and the top 500 companies in the United States. To use the United States as an example, most of the economy — in fact more than 65% of the economy — is not listed.”
And it’s those smaller, unlisted businesses that have been hardest hit this year, with larger listed companies being the beneficiaries in many cases.
In this Q&A, I quiz Nick on some well-known and not-so-well-known trends. He also explains why ‘the winner’ effect has accelerated, and why he expects Amazon’s earnings to double over the next three years.
As economies begin to return to normal, are you seeing reversals, continuations or accelerations in the trends that became popular during COVID?
Surprisingly, we are still seeing acceleration in the trends that became popular during COVID. Zoom is an interesting example as it was still posting all-time peak usage rates in late September. I think the hard thing that a lot of people are trying to work out is how much of the big shift that happened during COVID will be permanent once we return to normal. We’d argue it will be a lot more than people think.
What are some key trends for investors that you don't think are widely understood or appreciated yet?
I think the big one that amazingly is still not appreciated today is the speed with which digitalisation occurs in different industries. We've had the internet for more than 20 years now and it's disrupted so many different industries along the way. But as digitalisation accelerates, in accordance with Moore's law, it disrupts things at an increasingly faster rate. To continue with the Zoom example, Zoom is effectively taking away market share from airlines and from business travel. Zoom's market cap is now at the same size as every airline on the planet. That might make sense if you think about how the world could be in 10, 20 or 30 years from now. From that point of view, what a lot of people still miss is that as digitalisation gets better, as computers get faster, disruption accelerates, and more industries get disrupted. Despite the fact it's happened for 20 years, people still don't seem to appreciate it.
A lot of the trends that you invest in are fairly well known and widely discussed. Does that mean they're already fully priced into markets?
That is a great question and it's very hard this year to work that out. We would say no, but there are two trends worth commenting on. Previously, digitalization happened at a very steady rate. For example, card was taking over from cash at about a share of 1.5% per annum. Or to give you another example, e-commerce took 20 years to go from 0% of all retail sales to 20%. So, it'd take roughly 1% share from retail sales every year. This year e-commerce has taken another 7 or 8% of share. That works out to seven years of growth in one year. It's hard to work out how permanent that is, but I'd argue more permanent than most people think.
The second thing that people get confused by is P/E multiples. They look at the multiples these companies are on for next year but what they miss is how much embedded value has been pulled forward. How much can Amazon now monetise its greater prime user base, or how much can PayPal monetise all these new users? If anything, it's accelerated what we thought was going to happen over five years. The performance that we thought might occur over five years could be accelerated into a much shorter timeframe.
As has been discussed fairly widely, low rates tend to support equity markets – the P in PE ratio, the price. But the E, the earnings, is equally important. Do you think that lower rates are enough to compensate for the lost earnings?
The answer is yes. But I also don't think that you've actually lost that much earnings. It's important to recognise that when you think about the equity market. Equity markets are not necessarily the economy; they are the top 200 companies in Australia and the top 500 companies in the United States. To use the United States as an example, most of the economy — in fact more than 65% of the economy — is not listed. Unfortunately, it’s these small businesses and family businesses that are not listed. What you're seeing with the lower rates is an attempt to support the entire economy.
But it also happens to support the equity market. It is sad and unfortunate, but it is a fact of how our economic system works that these top 500 companies can access that cheap credit really easily. They can borrow money in the bond market, they can raise capital in the equity market, and they can take share from these smaller guys. The smaller guys need the lower rates to stay afloat, but it's ultimately not helping them take share back against the bigger companies. So, the equity markets earnings actually haven't gone down that much. If you look at the US earnings expectations into next year, they're not that much below where they were in 2019. Yet the interest rate environment has gotten better, and that's why the equity market is higher.
Future earnings will be lower than expected, or growth will be lower and so earnings will be lower. I get that. But again, I would stress that the actual S&P 500 is different. It's important to remember that the index generally favours companies that are winning. If you look at the S&P 500, there are actually more companies in it that are winning today, more taking share today than losing share. On top of that, their share prices are going up so their weight in the index goes up. The index evolves towards the winners over time. But it is important to stress that this isn't just a ‘this year’ thing; this has been happening for many years. The equity market grows at roughly 8% per annum. GDP does not grow at 8% per annum. This is the winner effect. As we move from a pre-COVID world to a post-COVID world that will be exactly the same as before.
What are some of the key indicators you look for to separate structural winners from structural losers?
This is a really important point. It goes back to what I was saying about the index and about the equity market. The equity market is made up of a handful of exceptional companies and thousands and thousands of really average ones. Over time, it evolves towards these exceptional companies. Ten or twenty years ago, those exceptional companies were the likes of Exxon and General Electric and Boeing. Now those exceptional companies are Amazon, Facebook, Google and Apple. As we go forward, there will be a new bunch of exceptional companies. Inevitably, there has to be. Every time, if you go back over those stories, there's generally either a founder or a group of individuals that have helped to start things off.
What you need to look for is those management teams that have the wherewithal to bring a company into the future. But also, the ability and insight to see how the world is going to change and how their company will benefit from that. That's the same today with Tesla as it was with Boeing in the seventies, or as it was with Coca-Cola 60 or 70 years before that, or McDonald's around the same time. It's always: what's the structural change and who are the people who are able to deliver that structural change? That will give you the exceptional company that you're looking for.
What's a company or a product today that most people probably haven't heard of, but which you think will be familiar to most in five or 10-years’ time?
I’ll give you one you have heard of, but I think people underestimate how big it could be. The one I’ll give you is a company called HelloFresh. Many people will have been marketed a HelloFresh box. They probably had a go at it and decided this isn't a very good product because they didn't enjoy cooking the menu. But what we have learned through the pandemic is online groceries are going to penetrate at some point. We know that online penetrated electronics, and we know that online has penetrated clothing, and it's now moving into groceries. HelloFresh is a small company based in Germany and it's less than $10 billion market cap today. The founders are still running it today and they're still only in their 30s. They founded this company when they were 23 and we think they're onto something.
Delivered food boxes will ultimately become part of your grocery shopping in the long run. The share of your grocery shopping that they need to get is tiny for this company to be significantly bigger than it is today. They are the number one provider of this product in 20 countries around the world. All they need is for people to believe that this could make up part of their grocery shopping. Then COVID came along and introduced people to the product, whether it's HelloFresh's product or someone else's, or even your local restaurants. But they've ultimately broken down the barrier that was there. That's why we think HelloFresh will be a bigger part of your grocery shopping in the future.
Jeff Bezos has said that Amazon's quarterly results are pretty much fully baked about three years out. What do you think Amazon's results will look like in three years’ time? And how do you think the business will have changed or not changed over that time?
We think Amazon's going to make roughly $50 billion in EBITDA this year, off a $370 billion revenue base. Their margins are actually quite low with their EBITDA margin at only 15%. On our numbers, we think sales will continue to grow at roughly 20 to 25% per annum, and the margins will expand. So, in three years’ time, we think they could be making a hundred billion in EBITDA. That's reasonably easy to work out from here. In terms of how the business will evolve, I think they'll just continue to execute in the way that they have.
The reason why we're confident in saying that is because e-commerce still has more share to take, even in their most developed market, the US. Amazon has more share to take in other countries around the world as well. Plus, cloud computing has more share to take. And it's important to remember that cloud computing is still less than 20% of enterprise workloads today. Amazon is not even the number one retailer in any country that they currently operate in. They only operate in roughly a third of the countries of the world. So, we think they execute the same way they've been executing. The runway is still very long, and the market underestimates just how long that runway is and how long the growth can go on for.
How would you describe the best investment opportunity that you're pursuing?
I think the specific examples that we like is when we find something that we know has worked before, that could work again. I'll give you two answers here. The first is to go and look into different countries to find where the same thing could happen again. If you look at China, it's pretty clear that they're not going to be using US technology in the long run. They're going to build this whole new technology stack. We know who the Amazon for China is, it's Alibaba. We know who the Facebook and the PayPal are for China, they’re Tencent and Ant Financial. But who's going to be the Microsoft? Who's going to be the semiconductor company? Who's going to be the salesforce.com? There are all these software companies that are probably going to come along that are going to give you this wonderful opportunity in China to effectively repeat what you just did in the US.
A very similar thing is happening in Japan right now. In Japan, you see small accounting software companies, small Shopify type businesses appearing that are going to help the Japanese economy, which is very far behind the digital curve, come forward again. That would be one, which is to go and look at things and see the things that have worked before that we could work again.
The second big one out there is the decarbonization of the planet. We are right at the start of trying to decarbonize the planet. There is a whole range of statements of intent, which is basically to go to net carbon zero by 2050. When we say net carbon zero by 2050, like Europe's been saying, it's not produce less carbon, it means produce no carbon. We've already seen one great company appear out of this, which is Tesla. There will be many others. Without data, if I looked over at a 20-year time horizon, this is clearly the place you want to be looking to find those next big winners.
Finally, what excites you the most about your role?
The best bit about our job is that we get to meet these very smart people who have found great opportunities. They've managed to find the right investors in the alignment to help them execute on their goals. I mentioned the HelloFresh guys before, who we think are pretty bright. You obviously get to talk to the Jeff Bezos' of the world as well, and you get inside their way of thinking, or you get to read what they've written, and then you get to apply it to other opportunities. So, we're very lucky. At the core of what we do, it is a people and relationship business, and many of these groups need capital. And if they've got the right plan, then we're happy to invest because in the end, we can all win together.
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