Step in to your kitchen, bathroom or cleaning supply cupboard and you will more than likely find a Unilever product. It is said that 2.5 billion people a day use a Unilever product. Dove, Domestos, Hellmans, Knorr, Lipton, Lynx, Persil, Surf, Toni & Guy, Ben & Jerrys, Magnum. The list goes on and all. I could spend all day typing. In all Unilever sells over 400 different brands in 190 countries!
The brands Unilever span across Beauty & Personal Care, Home Care and Foods & Refreshment. There are ubiquitous but unique. And this uniqueness is what is important. It gives products with legitimate brands the ability to charge a higher price than they could ordinarily could. It gives them pricing power.
But before we can look at the case for investing in companies with strong brands, we first need to understand what a brand is.
The History Of Brands
Let’s travel through time, back to the 1800’s. It is fair to say life was local. You didn’t experience a world more than a few dozen miles outside of your birthplace. You ate local produce. You wore clothes made by the local seamstress. You wore shoes made by the local cordwainer. Your house was built by the local lumber. In essence, you personally knew the per-son making the products you used.
Then came the industrial revolution. And the world got just that little bit bigger. New methods of transportation were game-changers. Railroads transferred goods farther and faster than ever before. And everything changed. Take the following excerpt from the book The Rise and Fall of American Growth:
“As America became more urban and as real incomes rose, the share of food and clothing produced at home declined sharply. New types of processed food were invented … Many American men had their first experience of canned food as Union soldiers during the Civil War”
This was one of the biggest breakthroughs in history. But it posed a huge problem. Consumers, for the first time in documented history, were disconnected from the production of their stuff.
In times gone by, a bad product was either your own fault or could be taken up face-to-face with a local merchant. But canned food was batched together by dozens of regional suppliers, none of whom customers knew or could even identify. Without accountability, the quality was horrendous. Harper’s Weekly wrote in 1869: “The city people are in constant danger of buying unwholesome [canned meat]; the dealers are unscrupulous, and the public uneducated.” No one knew who to trust.
And this is when brands came in. It all started with the William Underwood Company which made a meat spread called Deviled Ham. People loved Deviled Ham. But the disparate pro-duction of canned meat gave the whole industry a reputation for inconsistency – some-times rotten, sometimes watery, no two cans alike.
Underwood fixed this by creating a flaming red devil logo consumers could recognize. It added a tagline: “Branded with the devil, but fit for gods.”
The logo (brand) in essence recreated the familiarity that face-to-face commerce provided for most of history. No matter what part of the country they were in, consumers who saw the devil logo knew they were getting a specific product made by a specific company under specific quality standards. Consumers came to associate the devil logo with something they previously had none of consistency.
In 1867 Underwood took the logo to Washington and filed the first federal trademark. It was the first brand.
From the above glimpse into history, it is important to know what a brand is. A brand does not necessarily mean a product is good, it means that consumers know exactly what to expect from them. Underwood didn’t have the best product in the market but built a powerful brand due to consistency. Knowing what to expect. That’s the essence of a brand.
The big insight on brands is that consumers hate surprises more than they enjoy the chance at perfection. Truly amazing companies combine perfection with consistency.
The concept of knowing what to expect is powerful. Julia Child – a multimillionaire author, chef, and television personality – once asked her host to take her to the local McDonald’s. The host was horrified.
Child explained: “I like McDonald’s. It’s always consistent.” McDonalds has a powerful brand. Likewise, you know exactly what to expect with every bottle of Coca Cola you open or every cup of coffee you have from Costa or every diamond ring you buy from Tiffany & Co.
Unilever’s success over the years has come from its strong stable of brands. In many of the categories it operates in, it might not necessarily have the best products, but the reason it often has the no 1 or no 2 product in its category is because of its strong stable of brands. Bands offer more than just consistency these days; customer recognition, customer loyalty and enhanced credibility. All these factors lead to companies with a strong stable of brands to have a huge advantage. Looking at Unilever, it has 13 brands that generate revenues in excess of one billion a year!
Take Cornetto Ice cream for instance. On a hot summers day, a person walks into a shop and opens the ice cream freezer to see a Cornetto priced at £2 or another cone ice cream priced at £1.60. A person knows what a cornetto tastes like but have no Idea what the other non-branded ice cream tastes like. If the person buys the Cornetto for £2 they know they haven’t wasted their money, but the purchase of the £1.60 ice-cream could be hit or miss. People natural gravitation to what they know, in this case a Cornetto, ensures Unilever gets a sale ahead of its competitors. But not only that, due to the higher prices one can charge for strong brands, Unilever gets a wider profit margin as well.
Putting my investors hat on, it is this pricing power that determines if a company has a brand consumers are willing to pay for or not.
As an investor, I often look to see if a company has an economic moat. Having an economic moat or competitive advantage is a sign of a high quality company. But how do you deter-mine if a company has an economic moat? One leading indicator is pricing power.
Pricing power is the ability of a business to raise prices higher than inflation without impact-ing sales or losing existing customers — very few businesses are able to do this. Businesses that can raise prices make higher profits, which means that they have more money to rein-vest or distribute as dividends. If companies don’t have pricing power, they face margin challenges as costs of goods rise. Furthermore, companies with pricing power also tend to survive economic downturns and recovery quickly.
There is no better person to channel when talking about economic moats than the person who coined the term, Warren Buffett.
In a 2011 Financial Crisis Inquiry Commission (FCIC) interview, he said:
“The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.”
Speaking at a university lecture, Buffett tried to explain it in layman:
“A couple of fast tests about how good a business is. First question is ‘how long does the management have to think before they decide to raise prices?’ You’re looking at marvelous business when you look in the mirror and say ‘mirror, mirror on the wall, how much should I charge for Coke this fall?’ [And the mirror replies, ‘More’.] That’s a great business. When you say, like we used to in the textile business, when you get down on your knees, call in all the priests, rabbis, and everyone else, [and say] ‘just another half cent a yard’. Then you get up and they say ‘We won’t pay it’. It’s just night and day. The ability to raise prices — the ability to differentiate yourself in a real way, and a real way means you can charge a different price — that makes a great business.”
So why is pricing power important?
Pricing power is often the difference between a company that succeeds and one that fails. It is important because raising prices allows the business to overcome the effects of inflation and increased costs. Without adequate pricing power, the business may not cope with rising expenses.
Having pricing power also ensures that a business is able to generate higher levels of profits than its competitors. This should be music to an investors ears.
The Power Of Brands
If a company has a strong brand name, consumers are more willing to pay the extra price for it as opposed to buying any other similar product. Starbucks is an example of a company with a strong brand name. Let’s be honest, Starbucks coffee is terrible, yet it has queues outside the door with people waiting in line to buy its overpriced coffee. That is why the company has higher operating margins than any other coffee chain.
It is this pricing power that has allowed consumer staple companies to achieve market beat-ing returns over the long term.
Consumer staple companies sell products that are essential to everyday life, such as food, beverages, tobacco and household items; goods that people are unable or unwilling to cut out of their budgets regardless of their financial situation. Companies in this sector have one major attribute that enable them to achieve high rates of returns over time – they have high brand loyalty which is a huge competitive advantage.
Consumer staple companies are artists when it comes to creating strong brands. They have used brands to create monopolies – they are able to create products that nobody else can legally produce. Coca Cola has a monopoly on Coca Cola products. Trust me, to a coca cola drinker, having a ‘coke’ is very different to having another fizzy drink. Mondelez has a monopoly on Cadburys Chocolate. I for one will only eat Cadburys Dairy Milk as opposed to any other milk chocolate. Nestle has a monopoly on Nespresso coffee. Trust me, its important to coffee drinkers.
The product is protected by trademarks, patents, and copyrights, allowing the company to price higher than it otherwise could, accelerating the virtuous cycle as it generates higher free cash flow that can then be used for advertising, marketing, research and development, and promotions. Most people don’t reach for the knockoff Dairy Milk bar or Coca-Cola bottle. They want the real thing, with the price differential being small enough there is no utility trade-off on a per-transaction basis. This leads to companies with established brands within this sector to command above average Returns On Capital Employed backed by real cash flows. And the result? Outsized returns year over year.
For proof, look at a study conducted by Dr Jeremy Seigel to find the best performing stock between 1957 and 2003. To save you the hassle, 11 of the top 20 best performing stocks came from the consumer staple category. Looking at another stat, over the past 50-plus years, consumer staples has had an annualized return of 12.9% . That’s 2.0% per year better than the technology and consumer discretionary sectors, and it also beat the broad stock market (as measured by the Russell 3000 Index) by a similar margin. And this outperformance occurred with lower volatility- consumer staples had the second-lowest volatility of any market sector since 1962, meaning it has produced more consistent returns from one year to the next.
The sector is a breeding ground for wealth creation. Nobody seems to notice or care for this outperformance except a handful of managers (E.g. Nick Train and Terry Smith) and rich families. And that is why they have done so well over time.
Talking of Terry Smith, did you see his latest Fundsmith annual meeting? Around the 40 minute mark, he produced a slide that showed what P/E ratio you could you have paid for various consumer staple companies in 1973 and got the market return i.e. 7% CAGR.
For L’Oreal, you could have paid 281 earnings and beaten the index! For Altria it was 241 x earnings, for Colgate 126 x earnings, for Coca Cola 63 x earnings and so on. You could have paid all these outrageous valuations for consumer staple companies and still beat the index!
This shows two things. The first being consumer staple companies have such wonderful underlying business economics – strong brands, repeat and consistent sales, resilience, growth potential, low leverage – that they were able to not only burn off the excess valuation but were also able to outperform. The second is that consumer staple companies are perennially undervalued.
Whilst I can wax lyrical about the fantastic past returns of consumer staple companies, investors are interested in the future and what returns can be achieved from here in out. The key criterion for predicting Unilever’s future returns is an assessment of the strength of it’s brands and the role of brands in general.
The Death Of Brands – Have Brands Become Less Important ?
Much has been said about the death of brands. In years gone by, it has been an undisputed fact of investment that people tend to prefer having big-name brands in their kitchens, bathrooms and elsewhere. But it seems consumer preferences are changing. The internet and increased private label penetration, particularly in developed markets, is hurting many companies in the consumer staples sector. Market share is being lost by the big incumbents and operating margins are being eroded as a result. The argument is that the majority of consumer staple stocks will not provide the same historic performance as they once did.
In the modern information age, we can get reviews instantaneously and this allows us to try new things. Take McDonalds as an example. As a child, whenever I used to go for a day out to a different city with my family, we would always end up eating at McDonalds. The rea-son? It was familiar and we knew the food would always be as expected. There would be no disappointment. We wouldn’t even think of eating at the local dinner or restaurant as we didn’t know the quality.
But today, the opposite has occurred. Due to trip advisor, google reviews and countless blogs, I am more willing to try small niche eateries. McDonalds is not the only choice. The internet has assimilated information to such an extent that it is no more a case of trial and error at eating at a new place.
The same can be said of the areas Unilever operates in. Whereas before, the only ever detergent we would use is Surf or the only ever soap used would be Dove, today, due to re-views, we are more willing to try new products.
Furthermore, the internet has allowed these smaller brands to gain distribution channels like never before. In years gone by, the only way to buy household or grocery products was to go to the local corner shop or a supermarket. And often, the big players such as Procter & Gamble, Unilever, etc would buy shelf safe to ensure their product was displayed most prominently. This distribution advantage ensured the big players could not be displaced. But with e-commerce and new ways of reaching the end user, this looks set to change.
So what types of brands are still relevant?
I’ve written about the problems facing consumer staple industry before and that is why it is important to buy into the right companies. Factors you need to look out for when investing in this industry are as follows:
- Exposure to categories where private label is less entrenched (consumer health, beauty, personal care, beverages etc.) – I’ve always believed that with items you ingest or put on your body, people prefer brands whilst with other consumer goods items which doesn’t af-fect you, like bleach, people will gravitate towards the cheaper private label. So it is good to see Unilever has a high proportion of its sales in the Beauty & Personal Care and Food and Refreshments segment. In fact, in the beauty and personal-care market Unilever is in third place with a 7.8% share of the market behind L’Oréal and Procter & Gamble.
- A willingness to be flexible, adapt and invest consistently in the future – The recent vote to unify the dual-headed structure of Amsterdam and London, that dates back to 1929 is a seminal moment. This simplification will allow Unilever to be more nimble and will give them the flexibility to carry out acquisitions and disposals at ease.
- A well entrenched position in emerging markets – non branded goods in emerging markets are not trusted due to lower trading standards in these countries. Consumers in these economies trust brands more than private label as they do what they say on the label; brands deliver.
Furthermore, emerging markets are where the people are and where the growth is and Uni-lever is one of the best placed consumer staple companies to capitalise on the increasing prosperity of people in these geographies. Approx 60% of Unilever sales are generated in Emerging Markets, with significant exposure to India (approx. 10% of total sales), China (5%), Brazil (5%), and Indonesia (5%). With its unique heritage, Unilever is so well embedded in certain geographies that it could be hard for it to be dislodged by competitors. In Indonesia, for example, Unilever’s distribution network is larger than the country’s postal system. These extensive distribution and sales networks giving a huge advantage over competitors and also enables the company to know more about its customers and launch new products more easily.
Now the question might be why don’t I invest directly in emerging market stocks – they are plenty consumer staple companies in these markets. Indeed, emerging markets offer the rare prospect of attractive demographics, rising productivity and a soaring middle class – all factors that should drive growth above that of developed markets for years to come. Ac-cording to the IMF, emerging markets contributed almost 75 per cent of global growth in 2019 and will represent two thirds of global GDP by 2024.
I am aware of the opportunity that lies in developing economies, yet I prefer to invest in quality growth businesses that are listed in Western Europe or Unites states. The reasons being it mitigates certain risks such as weak, or inexistent, rule of law (just look at the re-cent proposed IPO of Ant Group), political and economic stability risks (capital controls etc) and country risks. I much prefer to get my exposure to emerging markets via large listed multinational corporations such as Unilever than invest in those geographies myself.
- A portfolio of very strong brands that could be exploited using digital channels – c85% of Unilever’s portfolio, for instance, is comprised of brands that are number 1 or 2 in their cat-egory. And this is really important as we shift to online
A big distributor like Amazon can have hundreds and hundreds of different products. But I ask you a question, how often do you scroll to the 2nd, 3rd or 4th page, let alone the 10th or 50th page. I bet very little. And this is why big brands still matter.
Go to Amazon today and search for deodorant. You will find Sure and Dove on the 1st page. Type washing powder and you’ll find Persil and Surf. Type bleach and you will find Domestos. Type shampoo and you will find Alberto Balsam and Tresemme. All Unilever brands. Being on the first page of an ecommerce site matters. And the first page is usually dominated by the big incumbents.
Apart from being on the front page through high reviews, brand name recognition and product placements, another big advantage Unilever has is its brands have become category’s in their own right. For someone that loves marmite, they will not search ‘yeast extract’ they will search Marmite. A similar argument could be made for Vaseline – no one will ever search ‘petroleum jelly’. And what do you even search for if you want ice cream in a cone with chocolate at the bottom? All I have ever known it as is a ‘Cornetto’. And don’t even get me started on ‘Brylcreem’! Unilever’s innovation over the years has allowed their brands to become verbs and this will be a huge advantage as the world moves online. Even more so with the rise of smart speakers as you say what you want – normally a brand- as opposed to the type of product. If any evidence is needed, Unilever grew its e-commerce revenues by 60% last year to make up 9% of group sales. Not bad for an old economy company!
A good way to judge the quality and demand of a company’s products is to see how they do in an economic downturn. It is fair to say, last year was as good a year as any to see the resilience of many traditional businesses. For tech, it was a huge tailwind, but for ‘traditional businesses’ a combination of lockdowns, restrictions, supply chain issues, depreciating emerging market currencies and lack of unemployment support in emerging economies made in a particularly challenging year.
Covid-19 was an overall net negative for Unilever. Even though certain homecare products like soaps and disinfectants did well, categories such as Beauty & Personal Care sales were generally lower due to fewer usage occasions and closure of retail outlets. In Foods & Refreshment, In Home sales were up but Out of Home sales were down, due to consumers staying at home
Looking the numbers, in 2020, on an adjusted basis, turnover fell 2.4%, EBIT fell 5.8% (with margin contracting 60 bps) and EPS fell 2.4%. Excluding currency, the P&L was stable, with Turnover rising 1.9%, EBIT rising 0.7% and EPS rising 4.1%.
2020’s underlying sales growth was 2.9% in Developed Markets and 1.2% in Emerging Markets, reversing the historic pattern of mid to high single digit growth figures.
Free Cash Flow was €1.5bn higher year-on-year, having benefited from €0.7bn of working capital cash inflows (after a focus on receivables) and €0.5bn in lower capital expenditure.
Net Debt / EBITDA was 1.8x at 2020 year-end, below the 2x target and 1.9x in the prior year.
Return On Invested Capital was at a very credible 18%.
The final dividend was increased by 8% – after three unchanged quarters. The company justified the increase by noting an acceleration in Q4 sales growth in India and China.
Looking at Unilever results, the company seems to have passed on the resilient test. This is the benefit of selling repeat purchase items No matter the market environment, you still need to brush your teeth, wash your clothes, eat and shower.
Looking ahead, Unilever looks set to return to mid single figure growth rates. This level of growth may seem low or the face of it and a number of investors may shout pass! But you don’t need high growth to have a successful investment. Over the past 20 years, Unilever has not had the most amazing growth rates, yet it has produced returns of 11% a year – far outpacing the market! You don’t need high growth to succeed. You need consistency, which Unilever has in spades.
The next test for Unilever will be rising inflation. All the market commentary today is about this topic. Unilever themselves are expecting a mid-to-high single-digit commodity cost inflation in H1 2021 and this has spooked investors.
In general , inflation is bad for equities. But a broad brush statement such as this can be mis-leading. As always we need to look at the data. If we look back several decades we’ve got data for two 10-year periods when inflation was high or relatively high: the decades to December 1982 (when US CPI averaged 8.7%), and December 1992 (CPI average 3.8%).
During these periods, earnings from the consumer staple companies beat the market: annual growth in real terms of 4.2% in the first decade, compared to just 0.5% for the market, and 7.8% annually in real terms over the second decade, versus the market’s 2.6%. If any-thing, the advantage of high-ROIC, low capital-intensity businesses should become even more important in inflationary periods.
While high inflation will be a net negative for a company like Unilever, it will be a whole lot worse for competitors who don’t have the same brand power and ability to raise prices that Unilever has. It Unilever plays it smart, it could take share from non-branded consumer staples in the years to come.
Unilever shares have so far performed terribly this year. They have fallen over 10% since January 1 2021 and more than 20% from highs achieved last year. There are a number of reasons for this; rising bond yields, the threat of inflation, the move by investors towards cyclical and value oriented shares. We can debate this all day long but as investors we need to focus on what we have been dealt with.
At the time of writing, with the Unilever share price just under £40, at 3,955p, relative to 2020 financials, UL shares are trading at a 18.2x P/E and what I calculate to be Free Cash Flow Yield of just over 5%.
The Dividend Yield is 3.8%, with the dividend raised by 4% to €1.71 per share (the payout ratio was 69%), continuing a record of consistent increases.
To me, at these prices, Unilever is an attractive investment, especially considering the environment we are in.
To take it further, looking at the Bloomberg consensus 2021 earnings per share forecasts of £2.49, at a share price of £40, Unilever trades at a forward P/E of 16!
Looking at other similar consumer staple companies such as Nestle, Colgate, Clorox, Procter &Gamble, Pepsi and Mondelez, they all have P/E ratios in the mid to high 20s.
In the February 2021 Lindsell Train Monthly report, Nick Train does a fantastic breakdown of the Unilever business. Doing a conservative sum of the parts calculation for the three divisions within Unilever – Beauty and Personal Care, Home Care, Food and Refreshments – he finds that the business should be trading at a market cap of close to £127 billion, not the £100 billion it is trading at now; a 27% uplift! He further goes on to say that if Unilever were valued at the 4.5x annual sales rating enjoyed by global peer Procter & Gamble, Unilever would have a market cap closer to 180 billion!
Why Unilever trades at a discount to not only other consumer staples company but the market is general is a head scratcher. Just look at what Nick Train had to say previously:
“Unilever has a listing on the S&P500. It listed as long ago as 1964. Between 1964 and 1991, Unilever hare price went up 100x. It was a 100 bagger over that 27 year period. Not bad for a steadily compounding defensive business. Admittedly, or importantly during a period of strong rising inflation. Since 1991, Unilever price in Sterling is up a further 12x (without reinvested dividends). By contrast the FTSE All share index is only up 3x. This just shows what a winning company Unilever is. Over the past 5 years, Unilever is up about 65% In the same period the FTSE Alll share is up just 1.5! Why would any one be selling shares of this proven value creating business when evidentially there is still much more to come from this business? Run your winners.”
To add to the above, Unilever’s strong share price run over the last 5 years is due to it’s market leading exposure is India. Unilever has its exposure from the 70% owned Indian subsidiary, Hindustan Unilever, which is India’s biggest consumer goods business. Over the last 5 years, Hindustan Unilevers’ share price is up about 270% in Sterling Pound terms. As a result, Unilever’s stake in Hindustan Unilever now represents just shy of 30% of its entire market cap! I would expect over the next 5 or 10 years, Hindustan Unilever to be an even bigger business as the Indian economy gets even wealthier.
I share the view of Nick Train. Why would anyone want to be selling a company like Unilever with has delivered terrific returns year after year. Why would anyone be selling shares in a high quality business at a sub 20 P/E rating in today’s market?
Make mistake, Unilever is a truly wonderful business. It is fair to say that while quality is subjective, most investors would agree that for a high quality business, there needs to be an enduring enterprise that is earning extraordinary returns for extraordinary periods of time. The sustainability element is critical as it implies the business has some sort of competitive advantage or economic moat. The competitive advantage allows the business to protect its above average returns from the unrelenting assault of its competitors. In Unilevers case, it is the brands its has together with super-efficient distribution channels it uses in many geographies that result in the hard-to-replicate economies of scale it possesses.
Apart form generating sustained above average returns, another less talked about ad-vantage of sustainable business models is that it has predictable cashflows – figures that can be calculated far into the future due to them being defensible and more repeatable. The importance of being able to predict future cash-flows cannot be underestimated as it helps in calculating intrinsic value. (For businesses that produce lumpy or cyclical cash-flows, it is far harder to calculate intrinsic value and this leads to many an individual investor overpaying for shares in cyclical businesses). For Unilever, due to the nature of its business, selling repeat use every day items, its business is predictable and resilient as discussed earlier.
The qualities Unilever possesses means that it should be trading at a premium to the market, not the level it is doing so now. Sure Unilever may be classed as a bond proxy hence its lowly valuation. But Warren Buffett described the US long bond as “an entity on 40x earnings with no growth”. In comparison, Unilever valued at less than 20x earnings and growing at 5-6% per annum looks a real bargain.
So what valuation is right for a business like Unilever?
The recent Fundsmith annual shareholder meeting illustrated that since 1973, for Unilever to simply match the market, it needed to trade at the lofty valuation of 31x earnings.
In a research paper by LindsellTrain, they come to a similar conclusion. The paper looked at Unilever data for the period 1997 – 2007 and found that Unilever delivered returns of 11.3% per annum compared to the 6.2% per annum returns delivered by the MSCI world index. In short, for Unilever to have simply matched the world index, it would have needed to be trading at a P/E of 46x in 2017!
Even if LindsellTrains verdict is too optimistic, it is fair to say that with a P/E under 20x to-day, Unilever is mispriced and a steal.
Why Is Unilever Mispriced?
Secondly, quality companies like Unilever are perpetually misprices due the paradox of modern finance. In short, market participants are increasingly intelligent and sophisticated yet the market as a whole is collectively short termism and the levels of irrationality are in-creasing.
To put it another way, it’s fair to say the markets develop over time and it is also fair to say markets participants get cleverer over time i.e. if you look at investors today, each individual is a bit more smarter, has more educating and is more sophisticated via computers etc than those in years gone by. They also have countless pieces of information, books and white papers showing the historical returns of companies and industries. It is why I was able to show you the fantastic returns of consumer staple companies earlier on.
If it is common knowledge that consumer staples outperform over time so why isn’t every one investing money in these types of companies. Sure one should just follow the data and bet on a sure thing? And this is the big paradox as short termism and irrationality of the market seems to be increasing. Forget about the last 10 years, just look at what has happened over the past three months with meme stocks, spacs etc. It doesn’t look like the people making these decisions are a lot cleverer than people in the past.
So what does that mean for investors who recognise this. For bad stocks, those with low P/E, P/B ratios, a lot of them are cheap for a reason. Today they are a lot of computer models and asset managers screening the world for these type of assets and mispricing gets picked up more quickly today than they did in Buffett’s era. That’s the bad news, traditional value investing no more work due to no information arbitrage.
The good news is that pricing of sectors have gotten very homogenous. So when a sector goes in to fashion everyone buys in and all share prices go up together (analysts based valuations on peer comparisons). On the other hand if sector is out of favour everyone leaves. This presents opportunities to rational investors to buy shares in quality companies when their sectors are not in favour.
The other thing is short termism. Reading academic papers shows the average holding period today has decreased consistently over time. It is now only a couple of month. Yes we all know about the short term day traders but they make up a tiny part of the market. The main culprit for short termism is hedge funds and the way they operate. Hedge funds are short term by nature and as they provide 50% of revenues for Wall street, analysts are forced to focus on short term prices. This couples with leverage leads to increased collective irrationality.
So what does this all mean? Simply, due to the short term focus of many investors, companies that don’t necessarily perform in the top quartile of each performance period are over-looked. By being long-term in ones thinking, we are able to look out further into the future instead of thinking what will this pay off over the next quarter.
The best performing stock over the period studied by Dr Jeremy Siegel mentioned above was Philip Morris. But I can assure you that it didn’t look interesting on a quarter to quarter basis. And that is why a lot of investors would probably have missed the stock. It can be a temptation to skip over these companies when looking to build a portfolio. They never seem to do anything, causing impatient investors to sell their stock after a few years of seemingly non-movement. These firms are the tortoises of the finance world. While everyone else is paying attention to the hare, they just keep putting one foot in front of the other, churning out fresh cash for their owners as the majority of spectators ignore them. They are consistent. They are overlooked. They are usually mispriced. And they provide patient investors with wonderful returns over time.
My Purchase Of Unilever Shares
The first time I bought shares in Unilever was back in early 2016 at prices under £30. I added to this initial purchase by buying in December 2016 at a price of £32 a share.
Since then Unilever has continued to execute and traded at elevated levels touching a high of £50 in the intervening years. Throughout this time, as I saw the share price continually tick higher, I kicked myself for not buying more in 2016. I always knew Unilever was one of those stocks you could simply buy and hold forever and told myself if Unilever ever reaches striking distance of my fair value estimation, I will pounce at the opportunity.
Staring in December 2020, when the rotation from quality growth into cyclicals and value was underway, the opportunity to accumulate a significant stake in Unilever occurred.
I started building my stake in the fast moving consumer goods giant by buying shares using my monthly stock purchase programme. Because dealing charges for this programme are £1.50 a trade, I can invest small amounts at a go. The catch is I can only use the monthly stock purchase programme once a month at a specific date. On the other hand, outright purchases are charged at £10 a trade so with these you need to commit much more capital as you don’t want dealing fees to make up a large percentage of your investment.
In December and January, with Unilever trading around the £43 mark, I started off building my stake slowly using my monthly stock purchase programme. But as LON:ULVR stock continued to trade downwards, I became more aggressive with larger purchases. When the stock went under £40, I made a big outright purchase. And when the price continued to drift and hit prices in the £37 range, Unilever became a no-brainer; to me at least. I bought as many Unilever shares in the £37 – £38 as I could my hands on.
All in all, over the past 4 months I have bought 214 shares Unilever at an average price of around £38.50 each. That is a capital commitment of over £8,000! No small feat, especially for a person in my situation. To put it in to context, it is 75% of all fresh capital I have added to my investment savings account in the current tax year!
I am a true believer that quality companies rarely get attractively priced. If a great company was available at a low valuation, every investor would want to buy it and no owner would want to sell it. The price/valuation would have to rise until buyers and sellers reconsidered. That is why the greatest companies almost trade at high valuations. And even when they do, they are still mispriced as mentioned earlier. The stock market is rigged for the patient investor and that is exactly the approach I will take with Unilever. Even if Unilever stays as this price, I will not add to the paradox of modern finance. Instead I will be patient and let the price follow value creation over time.