The Value Fund Monthly Update – June 2022

Performance for June 2022

The Value Fund declined 15.39% in June 2022 and has declined 20.79% since the fund started in February 2022.

Performance vs the Market

On paper, June’s performance is horrific, especially when compared to the market as the S&P declined 8.4% and the Nasdaq declined 8.7% for June 2022. We mention “on paper” because this is exactly what it is, a paper loss and not a permanent loss of capital. We have been through each of our investments during the month, checking, and double-checking for mistakes in our analysis. Having scrutinised each of our investments, we do not believe the long-term fundamentals of any of these businesses have deteriorated. In many cases, we added to our top investments.

The S&P 500 is down 20.6% for the first 6 months of the year while the Nasdaq composite is down 29.58%.

Comments

The main contributors to the negative performance were our semiconductor business, our computer hardware investment, an apparel company, and the portfolio’s entire exposure to the property industry.

Our semiconductor business is a market leader in an industry positioned for years of growth. That growth is not going to be in a straight line and the short-term outlook might be softer than we initially anticipated but we first bought into the company at 9x normalised operating income and when the valuation dropped to 6x normalised operating earnings during the month we were happy to add to our position.

Similarly, we consider our computer hardware business to be undervalued and we are not the only ones as the company announced it is working with a well-regarded capital allocator for ways to unlock that value. The share price fell over 26% regardless of the positive announcement and we were happy to add to our investment at under 10x normalised operating earnings.

With regards to our apparel business, all we can say here is that it is paying an over 14% dividend based on current operating earnings and around 9% dividend based on normalised earnings. We are happy to receive either yield as the company continues to outperform its record 2021 sales.

When it comes to our property exposure it would not be incorrect to expect share prices to decline as interest rates rapidly increase which naturally impacts property sales and prices. However, our exposure to property is deliberate and should not trade in sync with the industry. Our largest position in the fund, believe it or not, actually benefits from a higher interest rate environment as its ideal customers are forced to trade down because of unaffordable bond prices, benefiting the company. This misunderstanding PLUS the string of negative announcements from the company has more than halved the share price since the beginning of the year. Our analysis and conversations with management make us believe the market has got it wrong and we added to our position at 6x operating earnings.

Lastly, our real estate investment company is struggling with its high fixed-rate debt payments, however, the company continues to position itself to pay down that debt. The risk here is that the company cannot pay off its debt in time and is forced into liquidation. We believe the assets are worth far more than the company’s market capitalisation and debt, and a liquidation would fetch a higher price per share than the current share price. Again we added to this position but have kept the position at a more modest size as the risk remains that the business cannot turn around in time.

Conclusion

At the end of the month, the average weighted valuation of the portfolio is 6.4x operating income. In many cases, we have normalised earnings as many companies have record margins due to the unusual business activities during the height of the pandemic. By normalising earnings, it prevents us from being overly optimistic about the expected return yet at 6.4x operating income, the portfolio is very attractively valued.

While we are not trying to justify the abysmal performance for the month, we do not believe the long-term fundamentals of our investments have deteriorated and the only mistake we believe we have made thus far is our timing.

We do not believe it is possible to time the market. What we do know is that we were excited about the businesses we bought in February and now that many of those businesses’ share prices have dropped significantly we are even more excited to be able to buy now.