We believe cashflow is the most important driver of shareholder returns. Quite simply, we want to buy companies that are generating strong and sustainable cashflows and are attractively valued on those cashflows.
In this video we discuss what this means for our process and what may lie ahead. Here are some of the key takeaways.
- We believe cashflow is the most important driver of shareholder returns
- In 2022, we tilted portfolios towards defensive value as the market backdrop became more cautious.
- We are positive on value.
- We remain somewhat negative on growth.
When we look at how markets are likely to perform, we look at three key variables: trend, valuation, and corporate aggression. Is there a trend that's developing in the market, either a downtrend or an uptrend? Valuation – what are the markets saying? Corporate aggression – which is a good leading indicator of market weakness.
Trends
- Right now Europe is in a tentative upward trend. North America is mixed but a much better picture than it was seven or eight months ago.
- Commodities are in a downward trend having come under a lot of pressure recently with negative headwinds.
- Economic indicators are trending downwards over general fears about the possibility of recession.
Valuation of markets
- Recovery in markets seen over the last six months or so suggests economic headwinds may be less severe than people think.
- Markets are looking cheaper than they were 18 months ago. Europe is more or less fair value. North America is less expensive than it was.
- Generally, we are trending upwards and valuation is less of a headwind than it was a year ago.
Corporate aggression
This looks at the tendency of companies to make significant investments and behave in a way that could lead to profit warnings. Aggregating the data across the whole market provides a good indicator of potential market weakness.
- North America – there was a period of significant corporate aggression towards the end of 2021, that preceded market weakness in 2022. However, this behaviour has significantly declined, which is positive for markets.
- Europe – A similar pattern was observed in Europe. However, while in North America there has been a precipitous collapse in that sort of behaviour, in Europe it is still quite elevated, which makes us cautious.
Value, momentum and growth
Value
- We had a fantastic signal for this in 2020 after the Covid selloff, and that encouraged us to shift our portfolios from growth to value in the immediate aftermath.
- Value has had a renaissance in the last year and a half, but coming off the back of a dreadful 10 year period, there's still quite a long way to make up that underperformance.
- Value is still very cheap at the moment. Therefore, we are positive about value stocks at the moment and think that there's potential for value as a style to do well.
Momentum
- Our 'momentum efficiency' measure aggregates several different indicators that tell us whether the environment's good or risky for momentum. A good score is plus four, a bad score is minus four. Currently it's between one and two. Generally, when the score is above one, momentum tends to perform very well.
- As a measure, it's therefore an ideal environment for momentum, in terms of investing in rising stocks before they peak. We think that it could perform very well over the next six months and it's therefore currently prominent in our portfolios.
Growth
- We are still quite negative on growth stocks as they continue to be relatively expensive. There was a huge surge in valuation of high-growth stocks post Covid, but since then they've come under notable pressure.
- Yet having largely excluded growth from the portfolio 12 months ago, we're now starting to look at attractive growth stocks that have good momentum, with some entering the portfolio this year.
- In North America there are quite a lot of growth stocks that are looking very attractive relative to their own history.
A good example…
A recent example of a stock we purchased for our European Dynamic Fund is the French luxury good retailer Hermes. This company generates a very high cash return on capital and has an excellent momentum score. This reflects its strong business momentum and share price momentum. The company is generating double digit organic growth and seeing improvements in its operating margins. It has a very strong balance sheet with a substantial net cash position. And finally, with all this cash, it grows its annual dividend by more than 20%.
Conclusion
All the historic evidence shows that stocks with the strongest cashflow characteristics outperform over the long term. Our investment process is flexible. We can use our market regime indicators and our secondary scores to tilt the Fund towards certain styles depending on the prevailing market conditions. We'll continue to apply the investment process with the usual discipline and rigour. This investment process has been in place for many years and our European Dynamic Fund has delivered excellent returns for investors over this period.
KEY RISKS
Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested.
The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.
Investment in Funds managed by the Cashflow Solution team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. Some of the Funds may invest in derivatives. The use of derivatives may create leverage or gearing. A relatively small movement in the value of a derivative's underlying investment may have a larger impact, positive or negative, on the value of a fund than if the underlying investment was held instead. Some of the funds may hold a concentrated portfolio of stocks. If the price of one of these stocks should move significantly, this may have a notable effect on the value of the respective portfolio.
DISCLAIMER
This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.
This should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust.
