Have you subscribed to our newsletter?
If you would like to receive our weekly article and additional Seed insights via email, please scroll down to the bottom of this page to subscribe to our free newsletterLine spacer
Buffett is reported to have said that “Investing is simple, but not easy.”
Well investing may be simple, but the return data over the last few years most definitely proves that investing is not easy. Chart 1 (below) reflects the long run investment returns from an investment into local listed shares over various time periods. It highlights not only average returns, but times when investors had excellent starting dates and, hence, superior returns, and times with just the opposite.
In seeking a potentially higher degree of inflation hedge against hard earned capital, investors have invested into businesses and property, both privately and publicly traded. However, for companies that are publicly listed, this chart paints a sober picture of the volatility of investment returns over various time periods. On average, the 5-year return has been approximately 18%, but from 1970 this has fluctuated from a high of 46% (investing in June 1982) and a low of just over 3% per annum for those investors buying ten years later in August 1972. Over the last 5 years, the return has also been a very low 6% (i.e. near historical lows).
Chart 1: Range of JSE All Share Returns Over Rolling Periods Source : Iress, Seed Investments (31 October 2018)
The very low returns over the past 5 years reflects the difficulty of investing, which can be ascribed to at least two main reasons –
- Firstly, it is difficult for a company itself to generate excess returns above the cost of capital over extended periods.
- Secondly, where companies do achieve high returns themselves, many investors fail to benefit because they typically overpay and, so, receive a lower investment return than the company itself generates.
Touching on Point 1 some of the reasons include:
- Businesses are by definition competitive, and so winning businesses entice competition and greater investment, which in turn leads to lower returns for the incumbent. A possible example may be telecommunications businesses. While regulated, the first movers enjoyed superior returns, which reduced as competition was allowed to enter.
- Shifts in consumer demands.
- Ongoing technology advancements, resulting in businesses constantly having to invest in order to remain competitive and avoid becoming obsolete (for example, Netflix versus Blockbuster).
- Poor capital allocation by management – in the South African context numerous examples of local companies investing offshore with sub-optimal returns.
Touching on Point 2:
- Especially with respect to listed businesses, where prices, and hence valuations, fluctuate far more than the economics of the underlying business, investors are driven by fear and greed.
- Fear drives many investors out at lower prices and greed drives many investors to pay up after valuations have increased substantially.
- Shortened time horizons have investors trading in and out of companies.
History highlights the fact that capital prices are far more volatile than the underlying businesses themselves. When investors become nervous and withdraw capital, the result is a fall in prices. Falling prices result in improved valuations.
Attractive starting valuations are one of the main ingredients for superior subsequent returns for patient investors. Clearly, valuations have improved substantially as prices have tumbled over the last year. What is not that clear, however, is whether they fully reflect the risks and low growth environment.
Our view in allocating capital at these improved valuations, is to take a considered and phased approach.Kind regards,
Ian De Lange