Valuation: avoiding growth and value traps

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  • 39 mins 39 secs

Learning: Structured


  • Douglas Turnbull, Global Smaller Companies & Emerging Markets Fund Manager, Invesco
  • John Botham, Global Equities Product Director, Invesco
  • Oliver Collin, European Equities Fund Manager

Learning outcomes:

  1. Why valuation matters in buying, selling and avoiding stocks
  2. Where growth, quality and value fit into valuation
  3. The role of active management in valuation

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Channel: Akademia


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PRESENTER: Hello and welcome to this Akademia learning unit with me, Mark Colegate. Today, we are looking at valuation: what it is and why it is so fundamentally important to investment returns. To do that, I’m joined here in the studio by three members of Invesco’s Equities team. Let’s meet them. They are Douglas Turnbull, who is a global smaller companies and emerging markets fund manager; John Botham, Global Equities Product Director; and Oliver Collin, European Equities Fund Manager. In this session, we are covering why valuation matters in buying, selling and avoiding stocks; where growth, quality and value fit into a valuation assessment; and the role of active management in valuation.

So, Doug, why is valuation so important to what you can generate as an equity return?

DOUGLAS TURNBULL: Well, Mark, because investing and stock picking without valuation is really just storytelling. On a panel talking about valuation-based investing I guess it’s a race to who can quote Warren Buffett first, and I’m going to go and win because I’m coming in first, and it was he who said, quoting Ben Graham, that price is what you pay, value is what you get. And that’s exactly it. There’s two parts to any stock picking decision. It’s finding an interesting story, finding a business that’s doing something of interest and for the future. The valuation; however, is in saying what is it that you are getting for the price that you’re paying today, and that is ultimately how we’re going to generate our returns. It’s in the gap of perception between what the market thinks is going to happen and what we think is going to happen and that gap can be captured in the price in the valuation.

PRESENTER: And, John, leading on from that, so there’s partly the entry point you get in, but how important is the sell discipline when you sell out, because we’ve seen lots of stocks over time, they’ve gone up a lot and they’ve come back down again?

JOHN BONHAM: Absolutely, it’s vital, because we’ve only got to look at a whole range of stock charts to see that many good companies round trip in terms of price, they perform well then perform badly, and if you time the sell decision incorrectly you lose your excess returns. So I think it’s important to be disciplined in terms of how much you think a company’s worth. You also need to have some discipline around the alternatives available in the market because what you have in your portfolio at any particular point in time may not be the most attractive stocks in the market. And also you must have a strong discipline for what we would call thesis violation. When a company let you buy it for one particular reason and for whatever circumstances, maybe macroeconomic or competitive threat or management change or whatever, the company doesn’t deliver what you expect it to and then you’ve got to be pretty ruthless in terms of weeding out your mistakes.

PRESENTER: And, Ollie, overall, would you say valuation has been overlooked somewhat in the last few years? We’ve had low interest rates, people have bought longer and lots of longer and longer duration assets. Everything’s been going up.

OLIVER COLLIN: Yes, so sort of following on from Doug’s first point, the valuation or the price of an asset and equity is a function of the business model, and it’s a function of the multiple that you put in that business model. The reason you put a multiple on the business is based on the quality of that business model. So a monopoly with endless runway will evidently get a higher multiple than a cyclical business at any point in the cycle. What happens in terms of that multiple is you get an anchoring to the risk-free rate, and that risk-free rate is the 10-year bond yield, or more realistically it’s the real yield so it’s that bond yield less the inflation rate.

Now what’s happened is because of the monetary policy since GFC and more so because of the re-ignition of inflation, so those real yields have gone negative and we’ve lost that anchoring. When you lose that anchoring of the multiple, the business quality becomes everything. And so we’ve been through a period, particularly since I would say 2018, where you can see the quality of the business has been the complete defining part of the share price. What’s interesting I think today is as inflation is coming back into the system, as rates have started to have upside risk, not just ever downside, so that anchoring is coming back and you’re seeing the market begin to rationalise against not just the quality but also the multiple of the business.

PRESENTER: So, Doug, when you’re looking at putting a valuation on something, to what extent does it have true predictive power, to what extent are you taking a sort of calculated outcome on what the future might hold?

DOUGLAS TURNBULL: So there are really three ways that one can get paid for owning a stock. And we’ve already touched on almost all of them in the discussions so far. Those three ways are the earnings that a stock is going to produce in the future that for the same multiple if the company grows its earnings, it will be worth more in the future. Secondly, is the multiple itself. It’s what multiple do you want to put on those earnings in the future. So for the same earnings the company, the market might think that company is worth more in future. They put a higher multiple on it and so the value goes up. There is also a third way, which is that the company may pay you back some of those earnings directly in terms of dividends and so that will also contribute to the return that you get.

Really all of our work, all of our analysis, all of our forecasting can be boiled down into inputs for each of those: how do we think a company’s earnings are going to progress over a certain time period, what do we think an appropriate multiple is going to be to put on those and what payout are we going to get back from those. And if we know those three inputs, we know what we expect the return from that investment to be. And put crudely a stock market over the longer period of time will return about 7% a year. So if we can find stocks where our analysis shows that those inputs should give us let’s say 10% a year, then that looks like a pretty good investment to us.

Now, to the question of how much of that can be known, of course all of those require our own analysis and our own subjective views on what is the right multiple to put on business cases. What kind of earnings can those business cases generate and how much are they going to pay back to us. And of course that is where we as active managers have a really important role to play; in fact that is really the heart of what we do. To Ollie’s comment earlier, there has been a lot of debate over where multiple levels should be at the moment. And going through choppier economic environment, as we are today, there is also more debate perhaps about what the earnings trajectory for some businesses look like. But that ultimately is the role of the fund manager, the role of the investment analyst, to go out to talk to those companies, to do the industry analysis and to come up with the inputs that we think will drive our expected returns for an individual stock.

PRESENTER: And John, I want to come to something you were saying earlier about testing the thesis, how do you, having gone through this process, bought a stock, put it in a portfolio, what can you do to stop yourself going native on that stock?

JOHN BONHAM: Well, I think the first element is to keep very much in touch with the company, the companies you invest in, keep on top of the investment case, continually examine and challenge each other within the team as to whether that investment case is still intact. In simple terms, don’t fall in love with your investments. I mean there’s a lot of work being done in terms of behavioural finance, about anchoring, in terms of valuation, the valuations of companies, and be aware of that and be aware of your failings, because we’re all human beings after all and it’s important that we challenge ourselves as a team and play devil’s advocate often with companies that we hold to ensure that they’re still fit for purpose and can still deliver upside.

OLIVER COLLIN: And can I just add to that point that John’s making. The first and critical part of a process is to identify what that investment thesis is. And it sounds stupid, it sounds simple but write it down, clearly define it. By doing that, you’ve got an anchor to go back to. But then there’s the second point which is the collegiate nature of each of the individual product teams within Invesco and also the floor as a whole, to keep us honest to those investment theses that we’re putting together, and it’s that that stops that investment creep and that can lead to you getting caught in value traps.

PRESENTER: And Ollie, you were talking about quality a moment or two ago, is quality the opposite of value, I just, we keep hearing these phrases like quality, growth, value out there, clearly they’re connected to valuation?

OLIVER COLLIN: Yes, it’s a good question and one that’s quite close to my heart. Because I can’t bear factors, I can’t bear the labelling of factors. Because by quality, growth and value, value at the end of that list sounds like it’s the opposite of quality and growth. And I would argue that that’s not the case. In terms of quality, I would measure that in terms of the balance sheet strength, the cashflow generation and the opportunity set that that business has and that could be in a cyclical part of the market. But there are value stocks that are defensive assets intrinsically, like the insurance sector or food retail sector or even large cap pharma in Europe, which I would put in the value basket. The second point is what does growth really mean.

We’ve been through a period in a post-GFC world of growth being scarce, and that’s a function of many things, but one of those being monetary policy at the expense of fiscal. I think in a post-COVID world we’re in a more fiscal dominated with monetary accommodation. And that fiscal is wrapped up for example in Europe particularly in the green agenda, that’s capital intensive, and it’s a long-term retooling opportunity for Europe, which means that some cyclical businesses will look like secular growth stories, because those providers of that technology will have a growth trajectory lasting at least a decade and I’m not sure they therefore deserve not to be considered to be growth businesses.

PRESENTER: And John, some of these aspects we’ve been talking around quality value growth, do the same rules apply in all parts of the world or are there variations? I mean you’re covered global, so the US for example which is traditionally on a premium…

JOHN BONHAM: It is on a premium, because in the round there might be, well it is to do partly with the make-up of the market, the US equity market in general earns a higher return on equity overall than Europe, Japan or Asia, so therefore it deserves a premium. But similar principles I think apply, to Ollie’s point regarding the green agenda, that’s much more of a European phenomena, European, UK phenomena at the moment, so that’s not something which is necessarily playing out in the same way in the US or other markets. But I totally agree with Ollie that the simple labelling value, growth, quality, it is simple and the market is far more nuanced than that. And it’s very possible for stocks which potentially have quite high earnings multiples on them to actually offer good value if you’re comfortable with and you can get, you’re sure about the growth trajectory to come and the longevity of that growth trajectory, that’s what’s really important.

PRESENTER: So could you for example, on that could you have argued at some point something like Tesla was actually a value stock?

JOHN BONHAM: I think we’d struggle with that one.

PRESENTER: You’d struggle with that one. But have you got example of something that’s now seen as very growthy that, you know, and quite rich that you say actually that’s a value player, just a big company that we’d…?

JOHN BONHAM: Well, I mean I think you could easily look at some of the big things like, I don’t know, Alphabet or something like that, which traditionally has always been a very high multiple stock. You can argue now because of the earnings growth, it’s outpaced the share price growth and the free cash generation, where these companies generate humungous amounts of free cashflow, in many respects it doesn’t look that expensive now on many measures. So stocks which traditionally have been seen as very growthy, such as Alphabet is a good example, you can argue them now from a value perspective as well.

PRESENTER: Doug, what are your thoughts on that, particularly with, because I know you’re investing in emerging markets and I want to get your thoughts on I suppose the top-down element. I mean how does country risk fit into this, because when a country goes out of favour in emerging markets, its currency or whatever can be hit very quickly with obviously a knock-on effect on the valuation of the company’s base then?

DOUGLAS TURNBULL: Yes absolutely you do get quite a lot of regional variation in valuation. And that’s true in emerging markets I think perhaps to a greater degree, but it’s true across the whole world. China is a really good example. It’s a market that has been dominated until quite recently by a lot of growth stocks. A lot of internet businesses in China have been doing really well. But the macroeconomic weather in China has changed, the regulatory environment in China has changed, and so the market there has taken a real hit and a lot of these stocks have seen their multiples significantly questioned and significantly marked down, which has made China as a market look considerably cheaper. And that’s very much an idiosyncratic policy-driven, macroeconomic factor. You’ll find other markets in emerging markets do tend to trade at different kind of valuation levels, always have and more or less always will. For instance India tends to trade very expensive. South Korea tends to trade very cheap. There are lots of reasons behind that.

A bit like as John was saying, some of it’s the composition of the kind of stocks that you find in those countries. Some of it is also the amount of domestic savings chasing the amount of domestic market cap. But, with a small cap hat on, that’s also true around the world that one of the ways we approach small cap investing is to rely heavily on regional expertise, because different markets, different regions have very different characteristics. And that’s as true as looking at the difference between for instance Brazil and South Africa as it would be between looking at Sweden and Germany, understanding those regional differences and the nuances within them. And to your point on emerging markets, where you do have perhaps more country risk factors to weigh up as well, it’s really important to have that regional expertise and focus.

PRESENTER: Ollie, putting all this together particularly with European context where Europe [unclear 0:15:12], somebody watching this might say actually a lot of the levers they’re talking about, the things that influence this are regulation, government policy, it’s got very little to do with the underlying companies. Would there be any truth in that, you know, the really big decisions you need to get right aren’t at the stock level, it’s working out what the politicians, the regulators in the case of climate change, the scientists as such?

OLIVER COLLIN: There’s a lot to unpack in that question. If I go back 20 years when I started doing this or just around then, it was much more about the companies and much less about policy. We were in a period of policy and regulation, or deregulation. I think we’ve gone now through a series of events. Think we’ve had major events like Brexit, we’ve had the rise of popularism and that’s caused a change of policy. I mentioned earlier we’ve now got fiscal policy with monetary. We’ve been through a period of monetary and no fiscal. We’ve been through an austerity drive in the first years after the global financial crisis. And those changes in inputs need to be factored in to the modelling of a sector and at company level. But to say it’s all about those would be wrong. We’re talking about valuation. Valuation is an opportunity; it’s not a reason to take action.

Valuation is something we need to understand. So why is a company trading where it is, whether it’s a high valuation or a low valuation. Then you work out what’s going to change to realise that change in valuation. Maybe it’s a highly valued company coming down or a lower valuation company going up, and you work through the different elements that are going to drive that business. It could be management, it could be product, it could be sector, it could be economic, it could be political, or more than likely it’s going to be a combination of all of those things, and you need to build that in to your modelling of the business. I think we’ve got to remember we’re buying, as we mentioned earlier, an investment thesis. The valuation is what you realise if that investment thesis comes in, but that investment thesis is about putting all of those inputs into a business model and working out what’s going to come out at the other end, whether that be in two years, three years or five years. And I think one of the things that Invesco is very good at is having that long-term view to allow the changes embedded in those businesses to work through and realise that valuation opportunity.

PRESENTER: Well, I want to get thoughts from each of you just as a worked example of a company we would have heard of from your respective markets. But Ollie, can I start with you on that, I mean obviously valuation is different from value, but within that value to call it that sort of bucket, have you got an example of something that you are looking at at the moment, you’ve invested in?

OLIVER COLLIN: Yes so I’ll give you something that’s deep valued, deeply cyclical and we think hugely interesting for those reasons and the name is ArcelorMittal. So it’s a global steel business. The business today has a market cap of £25bn, has net cash of about £5bn, so an enterprise value of £20bn. Last year its EBITDA was the best part of £20bn, which puts the company on one times EBITDA historic. Now we know it’s a cyclical business and we know there are a lot of events going on globally that have driven margins for steel companies wider than anyone could have anticipated. But the interesting opportunity here is that if we normalise those earnings numbers, let’s put them on £10bn, then the stock is still incredibly cheap. But the question might be well we’ve had this supercycle, there’s a risk of demand destruction. So then we start distressing those numbers and saying well where is the trough EBITDA of a business like that? And for us that number would be around about £4bn. We’ve been there post-GFC, we’ve been there post-COVID and still on those numbers the stock’s trading on a multiple of five times EBITDA.

A trough, these cyclicals trade at premium multiples and therefore we think the mechanics really defend you as an equity owner of that business. The opportunity, the investment thesis isn’t about that valuation, that’s the supportive part, the reason we don’t believe the capital’s at risk, the opportunity comes from the green agenda, comes from retooling, comes from more protective borders, comes from more regionalisation versus globalisation, comes from Chinese policy being more environmentally backed and less exports, and therefore the opportunity that that business has is better than it’s ever been over the last 20- year period.

PRESENTER: In terms of what that opportunity could be, what is it, because I suppose certainly here in the UK with things like British Steel, it’s always it’s an industry that has got no margin, everything’s being crunched together, there’s a race to the bottom, why would that not be the case…?

OLIVER COLLIN: Because for exactly the reasons we’ve got that opinion, there’s a race to consolidation. One of the most, one of the interesting parts of the green agenda is it’s not just about who supplies into the green agenda; it’s what you supply into the new economy. What I mean by that is a lot of traditional legacy, capital intensive businesses that have perhaps been run for cash, that haven’t had the creative destruction because of rates keeping zombie businesses afloat, think about cement, think about steel, think about the heavy industrials, these businesses are still around today, but they’re going to struggle in a world where yes we need to build new towers and new electrification networks and put cement into green the economy, but we also need green cement and green steel to do that. And that means the businesses out there have to invest themselves to product the right type of steel, the green carbon or low carbon steel themselves.

Names like Arcelor can do that and you get a consolidation and a winner takes all and typically in economic cycles, those cyclical businesses make supernormal returns in that period. We haven’t had that in the last decade or more because of the policy push from the top, but we believe we’ll get that going forward.

PRESENTER: And just a quick final question on it, in the case of let’s call it green steel or the ability to create it, is that something that involves a huge amount of proprietary technology and sort of intellectual knowledge or is that something, is that where the value is in this sort of greener world?

OLIVER COLLIN: Without doubt, yes, and therefore scale players will be winners on that regard, but there’s also the simple truth that it’s going to cost money and it’s going to take resource to be able to invest in existing steel plants and upgrade those steel plants. So businesses with for example Arcelor that are currently sat on a net cash position, are in a stronger position to be able to do that than those others that have not got that balance sheet to lean back on. And I think again when we’re thinking about valuation, that’s part of the analysis. It’s how much opportunity does the company have and how much ability does it have to actually deliver on that opportunity based on its fundamentals, balance sheet, cashflow generation and the management’s ability to see and predict into the future.

PRESENTER: And John, can you give us an example. You’re looking across the global portfolios and also address particularly this issue there’s so much information out there, why do you think you’ve got a better ability to see the key bits of information that count over the [crosstalk 0:22:53] as a whole.

JOHN BONHAM: I’ll take that second. I mean a stock we found very interesting, we still own is through the pandemic in March 2020, and into April, May of that year was Coca-Cola. We all know it, an extremely well known company. It took a real hit through that period and was trading as cheap, or cheaper than it had done versus its peers and the US market both on a range of valuation measures because more than 50% of Cola-Cola’s products are drunk out of home and obviously we weren’t going to bars or restaurants any more. We thought that looked quite interesting and a strong balance sheet, new management who are increasing the amount the profit converted into free cashflow, strong marketing agenda, being really ruthless in cutting down some of the small brands they have in various markets around the world, and so it’s come to pass. Volumes have recovered nicely and again the strength of the brand, I’d venture a guess that you won’t be buying Tesco’s cola next week, you’ll be sticking to your Coca-Cola, and it has real pricing power in what is now a difficult environment. So that’s proved an interesting investment.

To your second point regarding information advantages in the manner of information, you’re absolutely right, and I think it is that perhaps is a reason why smaller company fund managers do find it easier to outperform their benchmarks than large company managers. One reason is because of the other end of the scale, the lack of information on smaller companies creates a more room for active managers. But nevertheless in larger companies, it’s very important, there’s so much information you can’t take it all in. So you stick to your reliable sources, obviously the first one is the company, the company’s publications, the annual reports, for example, and you meet management. You talk to the management. You don’t get, you hope you’re stringent with management and you don’t get misled by them. And you also talk to industry experts. Those can be industry consultants. They could be analysts, industry analysts. But it’s important always to form your own opinion and then to keep challenging it, come back to what I said earlier, keep challenging your conclusions.

PRESENTER: And just coming back to Coca-Cola, John, when you bought it, obviously the world was in lockdown, they were selling half as much Coke and other brands as they were but lockdown wasn’t going to last forever. When you bought it, how much were you thinking about how long a term holding you wanted Coca-Cola to be: was this a short-term opportunity?

JOHN BONHAM: We saw it a short, an opportunity in the short term but we also think longer term, it still has, we’ve seen them acquire Costa coffee and roll that out globally so they’re being, they’re trying to get into new beverages shall we say. And also the focus on their key brands is very important and again you’ve probably seen in the supermarkets yourself, the whole range of innovation that they’re bringing out into their core brands. So we think, very strong cash conversion, the attractive dividend they pay, a market for the carbonated soft drinks, which whilst it’s saturated in the US still offers some growth in a number of emerging markets. We think, you know, the business can continue to deliver attractive returns going forward.

PRESENTER: And Doug, finally a thought from you, have you got an example of a company and talk us through why you like it and where valuation and how you think about valuation plays into your thesis?

DOUGLAS TURNBULL: Yes so I’ll talk a bit about Alibaba, which again is probably a fairly well-known business, a Chinese ecommerce giant who is the first leader really in that market. And it serves a couple of quite interesting purposes. Because to the idea that there’s value and growth as two kind of binaries that are in opposition to each other I think this stock and the journey it’s been on over the past decade or so would give the lie to that, in that Alibaba IPOed amid great fanfare in 2014 and actually didn’t do very well subsequently. It was pretty out of favour for some time and there were some reasons for that. The Chinese economy around that time was perhaps slowing a bit. There had been some regulatory concerns. There were also questions about Chinese businesses listed in the US. Which if anybody’s been following Alibaba and this space recently sounds very familiar. But in between then and now this is a stock that had done fantastically well. The business had grown really quickly in line with China’s shopping patterns changing from traditional methods to online, almost bypassing a lot of bricks and mortar retail and going straight from traditional to ecommerce. But in the last couple of years it’s a stock that’s come under a huge amount of pressure, down almost 75% from the peak. And on our numbers, if you were to strip out the cloud business, a bit like Amazon web services within it, the core ecommerce business is now trading on about five times earnings.

Now, sure, the road ahead for Alibaba won’t be as smooth as the road it’s already travelled. There is more competition. The business is getting a little bit more mature. But we absolutely believe five times, a multiple that you would not put on a low growth business, you’d think that’s probably a kind of no growth business, that is inappropriate for a stock like Alibaba. And what I think this shows us is that you can find stocks which have a pretty decent growth trajectory at times trading with some of the characteristics you might ascribe to value stocks. And I think all that goes to show is that those two labels are pretty unhelpful. And that actually value and growth exist on a spectrum with growth at one end, value at the other, the further down either ends of those spectrums you go, the more risk potentially that you’re taking, but the good ideas tend to be found somewhere in the middle with both characteristics. And the good ideas tend to be found when the market has given up on them and when there is an element of contrarian thinking allowing you to get that conviction, allowing you to have, as Ollie said, the valuation Alibaba is not the reason to buy it, but it’s the opportunity today to buy into it.

PRESENTER: But Doug if you look at stocks like Alibaba or Tencent which have been really big in, you know, for example emerging markets or Chinese equity indices, there’s always that exercise that people do and say, you know, look at the largest companies today, now look in 10 or 20 years’ time, it’s never the same ones. Is there a danger of catching, something like Alibaba, how do you make sure you’re not catching a falling knife even if it’s a knife that’s falling quite slowly?

DOUGLAS TURNBULL: Again that’s where the work that you’ve done on understanding the business, understanding the opportunity set in front of it, gives us conviction. We’re not buying it because we just see a low numbered multiple. I think it’s very easy to think that valuation led investing is just going out and buying stocks that sit in a value bucket that just have a low numbered multiple in front of them. Rather valuation based investing is looking at the value which we see can be unlocked by the opportunities in front of them. And as I said look absolutely Alibaba faces much more competition than it had done going forward. At the moment, there’s a lot of regulatory pressure on them, but I don’t think that means our work certainly leads us to have conviction that that does not mean this is a business in decline. And actually the fact that it has got to this kind of valuation I think speaks to another thing which is important in our philosophy as investing of looking for non-consensual ideas that when fundamentals are trending badly, when there has been a pullback in the investment case, it can be very tempting for the market just to extrapolate that out almost sort of indefinitely. And so what we’ve seen specifically in the Chinese internet recently is a lot of regulatory pressure.

The regulator has essentially caught up to a lot of business models that have been developed very quickly and has been starting to put in place a framework so that these can be operated in a sustainable, healthy manner. Whether that’s around data protection, consumer rights, anti-monopolistic activities, all things which in the longer term are good for the environment, are good for the health of the Chinese ecommerce sector, but in the short term the market has looked at this, has seen a negative and just doesn’t want to know, and I think that’s where the opportunity lies.

OLIVER COLLIN: Just following on from that I think the bit that the market struggles to value properly is change. And that works both ways. A great business can be compounded too far into the future because the market doesn’t price the negative change that’s inevitable whether that be regulatory or competitive or whatever it might be. In the same way that a business that’s undertaking some form of embedded change, that could be their diversity and part of their business, it could that management’s changing, it could be that industry dynamics are changing, those changes are typically really poorly valued by the market and that leads to a valuation opportunity. To me that’s what value investing is, it’s about analysing change. And the reason the market’s bad at it is because it’s difficult, it’s harder to do, and if you get it wrong, you end up a long way from where you wanted to be. So the engagement doesn’t stop at the investment decision, the engagement gets stronger throughout the holding period of that company and that’s, as mentioned earlier, a number of years.

PRESENTER: And John, just on that, how important is active management, because someone watching this might say OK there’s lots of ideas and principles around valuation, think about, you know, we’ve talked about some of the psychological issues as well, pop that all into a computer programme, get some sort of smart beta-type index fund in there and we can do everything fund managers can but far fewer bits.

JOHN BONHAM: Look active management has been under pressure for some time for exactly the reasons you suggest. I think there’s a few things there. The first is almost philosophical, you know, how do we allocate capital in a communist or Marxist, something that’s done by the government, in a quasi-capitalist system it’s done by individuals such as ourselves, but in the world that you describe or where we are all completely passive, who allocates that capital, who decides which IPOs should work and which shouldn’t come to the market. There’s nobody there to do that. So I think active management fulfils an important role in that sense in terms of capital allocation.

The other thing I think is important to highlight is and perhaps it’s begun to come home a little bit to roost more recently with the problems of Netflix and Facebook is that passive management inevitably leads to, if you’re just buying indices, is that the big just get bigger. There’s nobody there to perform this valuation, with the valuation discipline that we’ve just described to say no those, the outlook for that company is not as good, it’s not worth as much as you suggest when it’s baked into the share price, and as we’ve seen recently with Netflix and Facebook, companies do run into problems at times, and that wouldn’t necessarily in a world work which was completely passive, that wouldn’t necessarily result in influencing share prices.

PRESENTER: Now, we are pretty much out of time so I wanted to finish by getting a final thought from each of you. One key thought to leave us with when it comes to valuation, why it’s important and why everybody needs to consider valuation as part of their investment process, Doug?

DOUGLAS TURNBULL: Sure so I think as I said earlier thinking about value and growth as binaries as opposites to each other is unhelpful when realistically there is a spectrum and that all companies exist somewhere on that spectrum and based on where market sentiment goes, as the case of Alibaba shows, it can move up and down that spectrum. I think the absolute importance is in active management, because the further down the ends of those spectrum you get, the bigger the risks become. Ollie’s talked a bit about how to avoid value traps at one end of the spectrum. But in emerging markets especially where there is a lot more growth on offer, there’s a real risk of falling into a growth trap as well, and what we mean by that is stocks where the probability of realising what the market is pricing in is actually very low.

Take one example perhaps of a Chinese EV manufacturer making futuristic cars, and they’ve got a brilliant business model whereby they’ve rethought it, you don’t drive your car in and plug it in and charge it. You drive it to their station, they just take the battery out and put a new one in, charge the battery in the back room and the next car comes along, takes that battery and on you go. Now it’s a great business. But at its peak, about a year and a half ago, on our numbers it was pricing in something like 25% market share of the whole Chinese car market in 2030. Now, this is a very competitive industry, especially in China, this is an industry that does not have winner take all dynamics. The market might be right, they could do that, but we think the probability of that having been achieved was very small, and yet that was a stock that had done phenomenally well.

We saw that as a massive growth trap as something to avoid. And that is absolutely the importance of active management here of finding those traps and avoiding them and on the other hand finding the really interesting opportunities that do exist somewhere on that spectrum where we think there is a much better chance of getting paid out.

PRESENTER: John, a final thought from you.

JOHN BONHAM: I just bring it back to why it’s so important, just bring it back to basics that ultimately the share price should reflect the present value of future cashflows that the company’s going to generate. And our job and the importance of valuation is trying to define when that share price does or doesn’t overestimates or underestimates the present value of those future cashflows and that ultimately is what all of our work and all of our discussion, debates is all about. And I think unless you have that underpinning to your investment strategy, you’re in the middle of the sea without a compass.

PRESENTER: Ollie, final thought.

OLIVER COLLIN: I don’t think there are any asset managers out there or very few that say valuation isn’t important; everybody has some sort of valuation underpinning to what they’re doing. There are two distinct I think parts to types of investment: one is owning quality compounders, owning those businesses that have above cost of capital returns on a sustainable basis and you can put a high multiple on those businesses. That’s one way of making money. Another way of making money is to go back to this point about looking for change embedded within a company or a sector or a region and working out, analysing how that change is going to manifest going forward and as it manifests what the businesses will look like, what the free cashflow generation will look like and putting a multiple on those businesses. Our view is that by doing that second way, we are in a less crowded space. We’re in a space that’s differentiated and therefore get it right and you can make outsize returns and that in a nutshell is why valuation is so important.

PRESENTER: We are out of time and have to leave it there. My thanks to Douglas Turnbull, John Botham and Oliver Collin, from all of us here, goodbye for now.
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