“If it bleeds, it leads”, or so the old newspaper adage goes. However, digging behind the headlines is an important part of our role as we love to find companies that have the potential for growth but are plagued by bad news.
This may come and go, but if a company has a big competitive advantage then it will be durable, allowing the firm to grow again long after this morning’s newspapers have become tonight’s fish and chip wrappers.
We call these companies cyclical growth stocks. They tend to take three steps forward and one step back. If you study the companies that generated most of the stock-market value over the past 50 years, they fall into three broad categories.
After a “rapid” growth phase, many mature into either “stalwarts” or “cyclicals”.
Stalwarts are the “get rich slowly” stocks. They are the compounding machines that we expect will increase their value at more than 10 per cent each year.
They are the Estée Lauders and the Pernod Ricards that can be left alone to become a little more valuable each year.
Conversely, cyclicals require a bit more legwork to find the full story. These are stocks that face short-term challenges but – if picked wisely – have the potential to grow over the long term.
If the economy picks up and there’s a rapid increase in demand, all of a sudden a resource that was previously abundant becomes scarce. Competitors can’t cope, there’s a scramble, and prices suddenly shoot up.
Ryanair offers us an example. Before the pandemic, the vast majority of Europe’s 90 airlines were unprofitable and those making a surplus were only bringing in €1 per passenger per flight.
The exception was Ryanair. Passengers know it as a low-cost airline, but its shareholders realise it is the carrier’s low cost base that matters. The company was making a profit of €9 per passenger per flight before the pandemic, thanks to its focus on fuel-efficient aircraft and minimising costs.
While other airlines rely on business travel that may or may not rebound post-Covid, Ryanair focuses on leisure travel.
Even if some consumers give up short-haul flights to cut their carbon footprints, we believe many will cut carbon from other parts of their lives before giving up their two weeks in the southern European sun.
While Ryanair chief executive Michael O’Leary is best known for generating lots of free publicity, he is also a fantastic steward of shareholders’ capital and we look for managers who focus on long-term shareholder value, rather than short-term share price fluctuations.
They zig while others zag. They invest capital when others retrench, preparing to grow when demand returns.
In December, Ryanair increased its order for Boeing’s 737 Max model from 135 to 210, securing the aircraft far below their list price and a quieter, more fuel-efficient fleet will cement Ryanair’s competitive advantage for a decade to come.
Controversy goes hand in hand with this style of investing. Just as airlines stoke debate with their carbon emissions, so too do the diversified mining and metals groups.
Miners may go out of favour when the global economy slumps, but canny operators will still invest in their businesses, ready for demand returning.
In the past, these stocks were focused on coal, oil and gas, making it easy to say these are yesterday’s, and not tomorrow’s, companies.
However, BHP and Rio Tinto supply the iron ore needed to make the steel that can be turned into wind turbines, and the copper and aluminium required to build low-carbon infrastructure to electrify transport, heating and cooling.
You need these materials to build a low-carbon economy.
This is difficult stuff. It took us time to digest Rio Tinto’s destruction of two ancient rock shelters in Western Australia, and lots of rational people don’t want to touch these businesses, but you sometimes have to embrace the uncertainty.
If your priority was having an easy life as a fund manager, you wouldn’t own these cyclical companies. But if you want to make long-term returns for your shareholders, it’s worth diving beneath the headlines to find the stocks preparing to make a comeback.
Spencer Adair is manager of Monks at Baillie Gifford