The Value Fund Monthly Update – April 2022

Performance for April 2022

The Value Fund declined by 8.9% in April 2022 and is down by 9.9% since launching in February 2022. It was a brutal month for the markets as the S&P and Nasdaq composite declined by 8.8% and 13.3% respectively, while the S&P is down 13.9% for the year and the Nasdaq composite has declined 21.2% year-to-date.

During the month we witnessed large blue-chip stocks decline substantially. Netflix was down 49% for the month, Nvidia declined 32%, Paypal dropped 24%, Amazon was down over 26%, and even the indestructible Apple declined over 11%. The portfolio is not invested in any of these businesses.

There is no way to sugarcoat the performance for the month, it was not pretty! However, if we take a long-term perspective things are not so grim;

Valuing a company

As we will say over and over again, we adopt a value investment philosophy when it comes to investing. Core to this philosophy is investing in high-quality businesses that are trading below what we believe is their fair value. A key metric we use for valuing a stock is the following:

Valuation = Enterprise Value/EBIT(Operating Income)

where;

• Enterprise value = the market capitalisation of the business + the net debt of the company.

• Market Capitalisation = Price per share * Shares outstanding

• Net Debt = All debt less cash

• EBIT = Earnings before interest and tax

It’s a simple equation and basically, the lower the Valuation the better HOWEVER the valuation for each company must be compared to the company’s historical value and the value of the company’s peers, among other factors.

Current value of the portfolio.

The total weighted valuation of the portfolio at the end of March 2022 was 9.2. As of the end of April 2022, the total weighted valuation of the portfolio is 8.0. The portfolio is, therefore “cheaper” at the end of April than it was at the beginning, meaning our expected return of the portfolio has increased.

How is that possible?

There are two reasons for the valuation decreasing;

1. The enterprise value has declined, or

2. Operating income has increased.

Although several companies within the portfolio did report earnings during the month, the reported operating income of each company was in line with our expectations. We take a very conservative approach to valuing our businesses often normalising earnings if we believe margins are stretched beyond their historical averages. Therefore the valuation is lower at the end of April because, you guessed it, the share prices declined.

Does that mean prices can’t go down further?

Definitely not! Next month we might be writing that the weighted valuation of the portfolio is 7x operating income but this is not a bad thing as it does mean the expected return of each investment and hence the total expected return of the portfolio has improved further still.

Of course, the valuation can also increase and there are two ways for this to happen;

1. EBIT declines: meaning the company’s operations/fundamentals have deteriorated. It is our job to make sure that the companies within the portfolio are high quality and that the earnings of the business are sustainable and hopefully able to grow. We are not always going to be right however and when the long-term earnings potential of a company declines we will act accordingly, or

2. The enterprise value increases: This is how we win because it means the company has increased in value.

Conclusion

As things currently stand we are pleased with the quality of the portfolio and will look to add to our top positions if share prices continue to decline and exit our less favourable positions if we require cash to load up on the best opportunities. We are also considering investing more of our own money into the portfolio given the opportunities but more on that if/when the time comes.