As the third quarter of 2021 drew to a close all eyes were on Government bond yields, which had shifted sharply in response to commentary from central bankers that hinted interest rate rises might be more likely and sooner than currently expected.
The victims of these rate rises have been some of the finest businesses and the market’s most prized assets who are richly valued. These moves highlight the continued importance of valuation even in a strategy that focusses on high quality businesses. Put simply, it has been a reminder to us all that great businesses are not always great investments.
To illustrate this point, consider Cisco Systems, a business that is not held in the Coleman Street funds but is one of the global leaders in technology and cyber-security. Over the last twenty-one years, Cisco has been able to grow sales at a compounded annual growth rate of nearly 5% and profits at nearly 7%. They have been able to hold gross margins flat at around 60% throughout that time and have consistently achieved operating profit margins north of 20%. They have generated buckets of cash, which they have reinvested at a very high return on capital, and they have always held a net cash position on the balance sheet.
Over the same twenty-one years, the compounded annual return to shareholders has been just 0.02% versus the S&P at 5.4% and significantly less than inflation. By almost anyone’s definition, Cisco has been a great business but a disappointing investment.
Valuation remains an important part of our investment philosophy in the Coleman Street funds. We will only seek to invest in what we deem to be great businesses but we will not pay more than what we deem to be a fair price - usually based on the cash that we think that business can produce over its useful life.
As a couple of examples, we have continued to add to our positions in Next and Hargreaves Lansdown in the UK, Kering and Nordnet in Europe and Berkshire Hathaway and Etsy in the US.
The views expressed in this article are those of the author. The value of investments and the income from them can go down as well as up and investors may not get the amount originally invested. Past performance is not a reliable indicator to future results.
James Godrich, fund manager of the CSI Funds.
