Is beating the pros possible? Yes! In this six-part series, Jason Del Vicario, CFA, portfolio manager, and Steven Chen, MBA, analyst, at HillsideWealth | iA Private Wealth Inc. will explain why - and how - a concentrated portfolio of global high-quality stocks gives the long-term investor the best chance to outperform both broadly diversified indexes as well as professional money managers.
By now, hopefully you have had a sense of our investing approach – that is, looking for businesses generating highly predictable, superior returns on capital, buying their shares at reasonable prices, and holding them for the long run.
Sustainable growth is only meaningful to shareholders if the incremental capital can be deployed at a high rate of return to deliver that growth. If not, the rational investor should require management to return excess capital through dividends and/or share repurchases. In such a scenario, the yield would likely represent the majority of total, long-term shareholder return.
How to beat the pros, Part 1: Choose the right number of stocks to hold
How to beat the pros, Part 2: Simplify by focusing on stocks of high quality
How to beat the pros, Part 3: Identifying high-quality stocks
How to beat the pros, Part 4: A Canadian stock we think will continue to outperform
Value-generative growth vs. high yield – we prefer the former, for the following reasons:
1) For the yield to meet our demanding total-return requirement, the price multiple would have to be really attractive, which is rare for high-quality companies;
2) In contrast, the power of long-term compound growth tends to get under-rated, and hence, undervalued;
3) For many, dividends are taxable;
4) In essence, high dividends pass on the obligation to deploy capital from the management to the shareholder, who would need to keep looking for high-return opportunities herself.
To achieve business growth, a few trajectories exist: e.g., gaining market share from peers, entering new geographies, launching adjacent business lines, M&A. The most appealing growth scenario to us, as quality-focused investors, would be market domination in an under-penetrated but increasingly important industry. We look for two key factors here:
1) Essentially, a legal monopoly that persistently owns a nearly or over 50% of the market, which strongly signals high durability of competitive advantage;
2) One or multiple secular trends that expand the industry on a sustainable basis.
Think about this investment theme for a minute from a predictability perspective: one would not need to worry much about reactions from aggressive competitors, economic viability of new products, or regional fit for current business models. There are fewer variables possibly preventing winning businesses from continuing to win for their owners.
To illustrate in more detail, let’s take a look at two of our portfolio companies below. (Both are foreign-listed stocks but have ADRs that can be bought in the U.S.)
Evolution Gaming (Listed as EVO in Sweden)
The Sweden-listed company mainly provides live-casino games technology and content for online casino operators worldwide. Evolution Gaming has established its market dominance through a laser focus on the live-casino space while its major competitor pursued a one-stop-shop strategy embracing too many different areas from the early days. In addition, the management emphasizes widening the competitive gap every year by reinvesting retained earnings into new games and studios. As of last year, Evolution Gaming owned more than 70% of the B2B market in Europe and close to 100% in the US.
Unlike more traditional slot games, live casino incurs substantial upfront and fixed costs to construct studios and hire/train staff, leading to a high barrier to entry and scale advantage for the incumbent. Moreover, live-casino games generally offer richer, more entertaining experiences than slots. This is why we believe that live casino will continue to penetrate the online-casino market, where RNG (random number generation) games are still the largest vertical. The management expects in-person casinos to become a very small portion of the total industry in the end. Even if we apply a discount to that expectation, the growth runway would look massive for Evolution Gaming given that online casino and the live casino sub-market account for only 22% and 7% of the total casino market, respectively, according to our calculation.
Kaspi.kz (Listed as KSPI in London)
Kazakhstan-based, UK-listed Kaspi.kz is the only “super app” (think about a mobile app that covers all main functions of Amazon, Paypal, Booking.com, Yelp, and so forth) in its home country. A powerful two-sided network effect (where a large user base attracts more merchants, which, in turn, enlarge the user base) has helped convert the company’s first-mover advantage into an ever-widening economic moat for shareholders. The app’s market-dominant position is reflected by its role played in people’s daily life. Based on our calculation, the MAU (monthly active user) base captured more than 55% of the internet population in Kazakhstan as of last year. Meanwhile, Kaspi.kz was responsible for over 60% of total online merchandise value, nearly 70% of digital payment transactions, and more than 30% of consumer loans in the country.
Despite the above high-flying figures, we believe that the company still has its best days in front of them thanks to market under-penetration across several verticals that the super app involves. For instance, e-commerce only represents 5%~7% of total retail market in Kazakhstan, compared to almost 30% in China; consumer loans contribute to less than 7% of the country’s GDP, compared to nearly 24% in China and 18% in Brazil. Low penetration is also observed in more niche areas such as B2B payment, e-Grocery, OTA (online travel agency), where Kaspi.kz has been quickly building a market leadership through its super-app strategy.
As a little caveat, it is worth pointing out that even with a top dog from an emerging, rapidly-growing space, other business-quality factors still matter: e.g., repeatable sales model, healthy balance sheet, superior business economics in terms of profitability, cash conversion, CapEx requirement. So do not hold your breath waiting for Telsa, arguably the top dog in the emerging, important EV (electric vehicle) market, to appear in our portfolio.
Stay tuned for our sixth part in this series, in which we’ll highlight another stock we believe is worth holding.
The authors of this column own the foreign-listed shares of both companies in their fund