For EDM Inversión, our Spanish equity investment fund, we apply a style that has characterised our company for more than 30 years: long-term investment in quality Spanish companies. How do we define quality? Businesses that meet the following requisites: profit growth, profitability, balance sheet strength, cash generation, good management teams, and reasonable valuations. This strict investment criteria explains the low turnover of our portfolio. The main driver of a share’s profitability is increasing profits. Therefore, companies that grow on a continual basis may remain in our portfolios for several years. The fund’s average rotation is 20%, equal to a per-company average of five years in the portfolio.
With a sufficient number of quality companies it is not necessary to have a highly diversified portfolio. Just 20-30 securities can achieve the risk mitigation provided by diversification. At the same time, this approach enables us to maintain our conviction, meaning, the relevant weightings in the selected companies.
Another important factor in our investment style is time. We are long-term investors. To paraphrase the successful investor, Howard Marks, time is more important than timing. Over the long term, company share prices shift according to profit growth, but in the short term, market psychology causes fluctuations that divorce price from fundamental value. These fluctuations present excellent opportunities to invest or divest. It is also the case that, in years like this one, when markets are moved by macroeconomic perceptions and impulses, regardless of the fundamentals of each company, these fluctuations can penalise portfolios. This is happening in 2022.
One example of the impact of market psychology and its macro approach is the reaction to our companies’ published results. Thus far in 2022, one-third of the portfolio has yielded positive returns, while more than 50% has suffered excessive corrections due to the market’s current short-term approach, which focuses more on macroeconomic and quantitative factors rather than fundamental analyses of the businesses.
The majority in this latter group have published Q3 2022 results in line with or exceeding consensus expectations, and yet, they have experienced price corrections because Mr. Market anticipates macro events that may penalise them in the coming months. In addition, nearly 10% of our investments consist of companies that benefitted from the pandemic (“COVID winners”), but the market believes they will become “COVID losers”, assuming that the profits generated in 2020 and 2021 are not sustainable. We disagree.
One aspect that gives us great comfort is the fact that, at more than 85% of EDM Inversión companies, “insiders”—be they the companies themselves, their executives, or their main shareholders—are buying back shares. They know their business best and they have long-term investment prospects, just like us at EDM.
The fund currently trades at multiples similar to those in 2012 (year of speculation about a eurozone breakup). That year both the stock market and the fund became much cheaper, due to a strong compression in multiples. However, in the three subsequent years, EDM Inversión gained 133%, far outpacing the 95% obtained by the IBEX 35 NR index. We are confident that the current portfolio, with 2023 P/E valuation multiples of 9.5x, a dividend yield of 3.5%, average portfolio ROE (return on equity) of 15%, and profit growth exceeding 10% in the coming years, has the capacity to perform comparably in the next three years.
Alberto Fayos,
Fund Manager EDM Inversion
