Welcome to Inside Active, a podcast about active managers that goes beyond sound bites and headlines and looks deeper into their processes, challenges and philosophies and security selection. I'm David cone, I, lead mutual fund and active research at Bloomberg Intelligence. Today my co host is Laurent Dulier, senior equity strategist at Bloomberg Intelligence. Laurent, thank you for joining me today.
Thank you for inviting me.
So you published last week your stock six hundred earnings outlook. What can we expect for the rest of twenty twenty five based on what you're seeing?
I mean, I would say overall it's not that great because the earning groups of the index has now for them to lose single digit for twenty twenty five. At the beginning of the year it was around seven percent. And two main reason for this downgrade in growth expectations are further than certainty on US tariffs given that the initial rate and on the by tramp at twenty percent
was much higher than initially expected. And also we have seen significant cuts to the forecast of some of the commodity related sectors in Europe, black energy and also the mining industry, despite the announcement of the five hundred billion euros fiscal stimulus in Germany and also all the rumors about the ramp up in defense spending. I think it will take some time for all the shovels to be put into place and to really have an impact on
the earnings level. So I think that is more twenty twenty six rather than twenty twenty five stories what the impact of US stariff are likely to play in the second half of the year. So one of the main
reasons why we have much lower growth expectations. Whoever investors are looking through I would say is a short term earnings weakness and now are really focusing on the recovery potentially in twenty twenty six, and that's the main reason why the shop I saw now back to where they were before the announcement of Liberation Day.
Okay, we'll be interesting to watch. I think we should hear from our guest on the topic. I'd like to welcome David Sama, founding partner of the Artists and Partner's International Value Team. Thank you for joining us, David Well.
Thank you for having me. David and Laurent so.
I'm sure you're looking at European companies. What are you seeing in terms of earnings for the year.
Well, there are only two large liquidity pools outside the United States, both Europe and Japan, and so of course our portfolio is heavily invested in Europe. And I think what Laurent referred to in terms of earnings growth the year backstopped by the stimulus spending by the German government. So the headline number was about five hundred billion dollars,
which is about ten percent of Germany's GDP. But I think you've got to think about that in slightly broader terms because you're also seeing other European countries stepping up with a little bit of stimulus spending. You saw Canada come out with some numbers also that will support some GDP growth, albeit a lot of that spending in less
productive parts of the economy, but it is supportive. But I think a lot of the growth, you know, interestingly enough, is coming from widening spreads at European banks, which has little to do with what's going on with deficit spending and a lot to do with what's driving the underlying equity markets in Europe so far this year. With respect
to the tariffs. It's it's really sort of interesting as you go through the earnings results announced during the first quarter, which is sorry post the first quarter, which was in the middle of the Liberation Day announcements, what you saw from most companies was an itemization of the impact that tariffs would have on their twenty twenty five earnings. So it's already embedded in whatever estimates the broker dealers or
the cell side are putting out there as consensus. What is not fully baked into the earnings are whatever teriff rates are eventually settled between the European Union and other parts of the world. The other thing that's not baked in there are what are the economic consequences of those tariffs, because that's much less of a linear outcome, so it's harder to get analysts to bake that into the earnings estimates.
And I also say that there is a fair amount of speculation on the parts of corporates and temporary tactics that have been deployed on the part of corporates to diminish the impact of the tariffs in twenty twenty five, the most common one being the acceleration of purchases of certain raw materials or inventories or shipping inventory into the United States ahead of the tariffs, and of course you know in twenty twenty six, you know that will anniversary
and will have an impact that none of the companies have yet to quantify.
And is less likely to be embedded in earning.
So I think just in terms of, you know, what is built into consensus From what we can see, it's still unfinished business.
Okay. Is there a process that you go in terms of, you know, when you find ideas or you know, for instance, can you tell us how an analyst's idea could make its way into the portfolio?
Well, we have so it's very important I think for any successful long term active investor to have a certain discipline, as implied by the name of our strategy, the Artists and International Value Strategy. We are value investors and as a result, the price that we pay is a very large determinant of our investment outcomes.
So we look to.
To find businesses out in the marketplace that are trading at a significant discount to what our research is telling us that a business is worth. Those are the fundamental concepts behind value investing. You know, it's I love two for one deals. Value investing is sort of a two for one deal because, on one hand, if you're able to find an asset worth a dollar and you're paying sixty cents for that asset, you get excess return, especially if it's a decent business that grows that dollar slowly
but surely over time. You capture that underlying growth, and you capture the unwind of the discount from sixty cents all the way up to a dollar. Now, the second part of the two for one deal is, let's say you make a mistake, or the rules change, the government does something like put a stimulus package, or does the opposite, and the value of the business ends up being eighty cents instead of a dollar. Because you've paid sixty cents, you've built an emergin of safety, and you've avoided a
permanent loss of capital. So value investing, the fundamentals of value investing allow you to effectively have that too for one deal. Now we take it a step further. We take a more thoughtful approach in terms of the types of businesses that we want to be involved in. So not only do we want to find a business where there's a big spread between where it's trading and what our research is telling us it's worth.
But we also want.
To have good businesses, that business where that dollar is growing over time. That's because usually in order to get a good deal out in the stock market during let's say normal time periods like today, something has to be wrong with the business. People don't give away a share price at a cheap price when there's nothing wrong with the business. When there's something wrong, the stock market generally.
Doesn't like it.
People don't like bad news, people shy away from it, would prefer to be involved with companies that have good news and maybe with share price momentum. As a result, it takes time usually before the market is able to recognize the fact that the security is significantly undervalued, and during that time period, you want the underlying value of the business to be growing that way. When you finally get that revaluation, inflation which as we all know is
ever present, doesn't erode your purchasing power. So we not only focus on securities that are undervalued, but we focus on securities that are undervalued that are attached to very good businesses. Now stopped there. We are very particular and that we're also looking for companies with strong balance sheets.
So why do we do that.
You know, most of the market is focused on companies that have an appropriate amount of leverage. We don't think there is an appropriate amount of leverage. We actually prefer no leverage and companies with very very strong balance sheets. That way, if something goes wrong or we have some bad luck, or if the company needs to repair a problem, that they have the resources available to them to be able to fix that problem, invest back in the business,
create competitive advantages, and grow over the long term. And the fourth thing that we look for is a management team that has a track record and history of building per share per share shareholder value over time. And if you think about the combination of an intelligent manager with a strong balance sheet that knows how to effectively allocate capital, what that can do, if executed well, is actually accelerate value. You know, instead of you know, buying company at a
dollar and it's growing at five percent per year. So in normal time periods you go from a dollar to a dollar five of underlying value. If you take excess capital and you invested, you could accelerate that value creation to a dollar ten or a dollar fifteen. And that is a very powerful driver of return. So if you think about what we're trying to do is we're trying
to stack the odds in our favor. Right, we want an undervalued security, a very good business in the hands of a great management team with a strong balance sheet to try to maximize the potential for us to.
Have a very successful investment. And our process is one where we focus on.
Companies that have that characteristic, those characteristics in combination, and then take our time to do intensive first hand research. So we don't use any sell side research. We don't use any databases we build. You know, we're sort of like pre ai dinosaurs. We build all of our own financial models. We use firsthand data because we need to exercise judgment on the underlying economics of this business. We can't outsource our judgment to an algorithm or of course
we use these tools for data gathering. But once we get that data, we analyze it firsthand. We talk to management teams, we talk to competitors, we talk to customers, we talk to former employees, we talk to anybody who will help us understand the long term underlying economics of that business. And we use all of that information along with the data that we gather to create an estimate of intrinsic value, and then we look to purchase shares only in the case where there is a meaningful discount
to intrinsic value, and that's our process. We have a group of seven very experienced securities analysts on our team. We are all generalists with regional responsibilities, and we're all investors. We don't really have analysts here. We have investors who can allocate capital across multiple industries, across different geographic locations,
in both develop markets and in emerging markets. So I think David and Laurent that gives you a pretty good sense for the way that we think about the world and how we approach finding securities.
We talk a little bit about the intrinsic value. You know, you mentioned you have a bunch of different information that's kind of going into that. Are there metrics that you use as well or is it kind of you've got like a proprietary system to determine its intrinsic value.
Well, you know, I don't think there's any magic to you know, the value of a business is the present value of its future cash flows, and you learn that in your first finance class. And we haven't really varied from using a very simplified diskind of cash flow model to perform our let's say, formal valuation of the business.
Most of the stuff you could.
Do on the back of a napkin, you know, and when you know, when we think about metrics, there's shorthand that comes from the analytical process.
You know, pe ratio is ev to e bit pre.
Cash flow multiples, all of those are sort of shorthand methods to evaluate the attractiveness of a company. And of course everything is relative, right, So if you think about the quality of let's say LVMH, which is a large luxury goods company, the quality of that business relative to let's say BASF, which is a large German chemical conglomerate.
Of course, those are two different businesses, one with significant brand value that results in very high levels of profitability, and the other one that operates and commoditize, you know, businesses that are tough competitively and they operate with unionized labor, which is a much more difficult, capital intensive, lower return business.
They're not worth the same thing.
If they were both at eight times earnings, of course you'd far prefer to own LVMH. Then you would prefer to own BASF. And you know, I don't use those two companies to pick on them, but I use them to point out that, uh, you know, we we can look at shorthand metrics, David, to help us put shorthand valuations on companies. But everything has to be taken into context based on the type of business that you're looking.
At, David. I mean in terms of marketing efficiencies, I mean, based on your long experience. Where do you think the market or the saleside get it wrong. Is it more in understanding the underlying value or the interesting value of the business, or is it more in how it should be valued? How your experience I mean, is making you look for more opportunities in one way or the other.
Well, I would say, broadly speaking, the non US market or less efficient than the US market. So first, there's a lot less liquidity outside the United States than there is in the United States. So that's one. Two, you have the complexity associated with you know, various currencies that you're dealing with. Three, you have complexity with respect to cultures. You know, what does it mean to be invested in a French company versus an Indonesian company versus a Japanese company.
And then you have different corporate governance structures, right, different.
Rules of the game.
What does it mean to be a shareholder of a South Korean company versus a shareholder of a Swiss company? You know, what is the construct of a board of directors in Japan versus the construct of a board of directors in the United Kingdom. So then you have different time zones, you have different languages, you don't really have different There's a little bit of accounting differences that exists today, but they're not.
Nearly as as big.
But they're they're out there, right, and and that level of complexity makes it much more difficult for the average investor to truly understand what they're getting themselves involved in.
So that's that's step one.
Uh.
Step two UH is with respect to the cell side. The cell side, you know, they make their money on the corporate clients, right, So their clients are the LVMH's of this world, not the David Sammers of this world.
And uh, and they have over the years realized that in terms of brokerage commissions, their their their bread is buttered by fast moving hedge funds, and so they love to have you know, short term movements based on earnings estimates and things like that, and has nothing to do with the long term in during intrinsic value of a business. And so the cell side tends to be very short
term oriented, which is an advantage for somebody who's actually investing. Right, So let's let's talk about investing to build wealth over time, which is a very different concept than just owning a security to take advantage of a trend. Now, what else is also driving in efficiency is the advent of ETFs. ETFs have become you know, have played into the gamification of investing. It has sort of dumbed down investing and provides things like exposure to financial advisors and broker dealers.
I think if you, you know, go over to your friend's house and ask to see their statement from their advisor, you know it's likely to have ten or fifteen ETFs in there. And so what do they own, Well, they own, they own products, they don't own businesses or investment investments.
And all of these inputs into the way that the equity markets operate today, plus the added inefficiencies of investing out the outside the United States, that's what creates opportunities for long term investors, and David and Laurent let's use you know today is a really good example, because it's really interesting to see, you know, the European markets rallying
so significantly in the first part of this year. And it is fantastic that you know, some of the banks and the defense contractors and the utilities are likely to have growing earnings on the back of what's happening. But if you think about the relative quality of those businesses compared to you know, other potential long term compounders, those aren't fantastic businesses. You know, that's not like Google or Facebook.
You know, you know, these.
Long term fantastic compounders rising very rapidly because their earnings are growing and they have a very bright future.
These are pretty.
Ugly businesses that went from horribly undervalued to now still undervalued.
But they're not, you know, they're not long term compounders.
I mean, the banking industry and in Europe is is fragmented and it needs to consolidate. And you know, the regulatory environment, though less hostile than it has been over.
The last decade, is still reasonably unhelpful.
So you know, you're not and and what's being left behind during this rally, are uh, you know, some of the better businesses that are out there, which creates opportunity for long term investors. So that gives you a sense, Laurent in real time, you know how stock markets can be, you know, incredibly short term oriented and as a result, inefficient in our view.
I just wanted to ask you about you know, you were talking about, you know, the fundamental aspects and balance sheets, and I guess, in your opinion, what is the best indicator of a business's you know, what is their their quality?
I should say, yeah, well so that's a good question.
In fact, I along dialogue with somebody yesterday about this. You can see in the financial metrics, the historical financial metrics of a business whether or not it has historically been a high quality business, so it shows up in return on capital employe. There are other things to look at, you know, if it's a financial would be an ROE you have to You can look at operating profitability, you can look at in the rate of growth, and so you can see it generally speaking in the historical financials.
But that is just the beginning of the analysis rather than the end of the analysis. Of course, you have to make because the value of the business is the present value of the future cash flows, not the past cash flows. It is imperative that you are able to make some level of determination as to whether or not the conditions that allowed for that fantastic level of profitability and returns in the past will continue to exist in the future.
And that's that's what we're here to do.
You know, that's what separates, at least today, the difference between an algorithm and a human being is that, you know, we have to take the information that's available to us and make some judgments around that information. And that's what fundamental research is for. We're looking at the competitive position of the company, the quality of the management, the quality of their products, who their customers are, whether or not their customers will still have the capability and the desire
to buy their products. What are the raw material inputs, what are the substitute products, what is the status of their competitors' products and their competitors' strategy. And when you bundle in all this analysis, you make some assessment as to whether or not this business will still be able to grow and create strong levels of profitability without having
to put so much capital in the business. Where the returns of the business might decline over time, in which case it's worth far less than you know it was worth in the past when it did not have to do that. And so it really is that that last step, that fundamental analysis step, which we'd call last but certainly not least, part of the process that helps us determine whether or not this business is actually a quality business.
One question. I mean, sometimes some of your investment in the initial stage may turn out badly, I would say, I mean, how do you review I mean for them, I mean positions which are not going the way you fought it could go. I mean, because of antc in as cutting glasses early is one way to avoid disasters. So how do you process the review of investment which unfort can it be observed stage I'm not going in the right direction.
Yeah, it's a very good question, and it's something that we call reinvestment risk, and it's sort of the bane of the value investor generally speaking. Is a value investor, you're selling securities where the news is very good and the share price is going up and everybody's happy and people are jumping on the bandwagon, and you're getting involved in securities where the news is very bad and people
are selling. Now, there are a couple components to your question, Laurent, and so that you use the word disaster, and we try to avoid disasters by some of those fundamental characteristics that we spoke about. I mean, generally speaking, if you're buying a pretty high quality business with a strong balance sheet, very hard, not impossible, but very hard to have a disaster associated with the business that looks statistically cheap, that has a strong balance sheet and is fundamentally a pretty
good business. The other thing that to sort of internalize about what value investors do is that we're very aware of this reinvestment risk. So you make a certain level of assumptions around what the trajectory of the business should look like, and as long as the business is moving in that direction, and we are able to separate the facts and circumstances that are dictating how the underlying value of this business is moving over time from the noise
in the marketplace. Because you know, there's there's you work at Bloomberg, there's a lot of reporters, and reporters like to put out headlines and say lots of things, which is fun, and but you have to be able to separate yourself and look at what's on a sober realistic basis, what's happening to the underlying value of the business, and as long as that moving in the direction that's pretty consistent with your underlying assumptions, there's no reason for.
You to change.
You know, your expectations and value investors as a result, are very good at averaging down. You know, it's it's part of the process.
You're you're there early. The news is likely to continue.
To be bad if you've if you've baselined your expectations properly, you understand the business deeply, You understand what the trajectory of the business is likely to be, and the business is following in that trajectory, and the share price continues to go down. That creates an enormous opportunity and is also an you know, part of that process. You know that we talked about earlier in terms of the market
being inefficient. You know, if the underlying business is improving and the share price is going down, that makes no sense, right, But it is very very common when you're getting involved with a company that's having some sort of issue, where there are headlines being created where the share price is going down, yet you know the changes that the management team are making are all very positive in the companies headed in a much better direction.
In one of your earlier questions answer, you mentioned about understanding the culture of the country you invest in, the different style of corporate governance. So I think for me, Japan or Japanese equities is a good business case of there is so much open the market that changes, structural changes happening in this market with a return of inflation, apparently corporate changes in corporate governance making the market much
more shareholder friendly. I mean, what is your view? I mean, do you think this is for real and it offers really good investment opportunities for value investors, or do you think that given the readies that we saw in Japanese equities over the past two and three years, in fact most of it is already priced in. So what is your view on this market?
Japan's an interesting place.
I've been investing there for thirty years, and for most of that time period.
The country offered extraordinary valuations.
You know, net nets companies trading blow cash value, and some of that still exists, although as you said, there have been at least in yen terms, right, and I have to think of dollars. My shareholders are American and I have to make money in dollars and so and yen terms. There has been a significant rally in Japanese equities, but in US dollars it hasn't been nearly as as positive as market commentators make it make it seem to be. You know, I can't, I can't offer my clients returns
in Turkish lera. You know, it just doesn't, It doesn't work. But Japan has been a fascinating place to invest in over the years. There was a Prime Minister came into office five or six years ago named Shinzo Abe who made a number of positive changes to Japan. There was some legislation pass that started to improve corporate governance. He changed the dialogue around where shareholders sit in the pecking
order of priorities for companies. So traditionally the shareholder was last, it was, it was society, it was customers, it was employees, and then shareholders in the pecking order, and and the way that that displayed itself practically speaking, David and Laurent was in the boardroom and with respect to the shareholding structure,
of the companies. So the board of directors was traditionally all employees, and the chairmen and the CEO were the same person, and all the rest of the board members, as I indicated, were employees will all owed their job to the chairman and the CEO. So if the company wasn't operating as effectively as it could be, it was basically a waiting game for the chairman or the CEO to retire, and then you had to hope that the
next person in line, you know, was better. Now why would the outside shareholders, who presumably have a vote.
Put up with this?
Well, first of all, there was a culture for domestic shareholders, domestic Japanese shareholders of cohesion and if this is the way the company wanted to operate, then we as shareholders are aligned with what they want to do. And in
addition to that, you had cross shareholding. So there was a structure, a historical structure that was put in place after World War two called a CORRETSU structure where there were groups of businesses that are all held together by a parent treating company and a parent bank, and they all had cross shareholdings with one another, and so a large part of the voting block was within the group
that also protected the board and foreign shareholders. The result had you know who who were the most likely cohort to complain about poor returns or a very small force in this equation and sully but surely and accelerated based on the reforms that shinzo Abe had put in place, these structures are starting to unwind, so you see some of the very large companies now will have a majority
of their board will be independent directors. Even many of the smaller companies will have a couple of independent directors on the board. The vast majority of the board still
are employees. You've also seen reforms at the stock exchange, which is not normally the part of the market where you're expecting reforms, where you know the exchange has put out certain return hurdles and valuation hurdles, where you know you can be on the first section of the Tokyo Stock Exchange if you meet certain price of book and return on equity hurdles, and if you don't, you're off. And you know that of course has liquidity and valuation implications.
And then that you know the third thing is you know the willingness on the part of companies to create incentive compensation that's equity based, and typically there have been bonuses, but people have been paid seventy or eighty percent on fixed in fixed salaries and very small bonuses that were largely paid every year, you know, because there's nobody on the board that's not going to pay the president and CEO. Right, So you know, all of these changes are happening. It's
created excitement, some justified, some not. And it's also one of the other changes that Abe has allowed for is consolidation, is so there's more private equity, there's more consolidation. I think that there's one final step that he was unable to finally execute on, which is labor reform. The ability and the cultural willingness to actually reduce employees.
You know they have.
The Japanese system was one around loyalty.
Where you you know you and there's a lot to be said for this.
It's it's nice you take a job somewhere and you work there for the rest of your life and you're devoted to that company. It creates a very loyal family like environment at working at a company, and.
You know, the longer you were there, the more.
Responsibility that you got no matter if you were good or bad at it. So it definitely had its downside.
And the downsides are worse than the upside.
I mean, companies were horribly inefficient, overmanned and it's still to this day that's the case. And in order to generate very good returns and the way that we as Americans think about, you know, we want companies that have twelve, thirteen, fourteen, fifteen percent return on equity. You know that's rare in
Japan to get those sort of returns. And if you sort of internalize, and I'm going to sort of bring it back to our strategy, if you internalize, you know what our strategy is, which is to own very good businesses. You can imagine that over the course of many years, it's been a difficult market for us, even as value investors, to find a preponderance of businesses that we find to be very attractive. Over the last few years, it's been virtually impossible.
We've only owned a.
Couple of companies because of the end based appreciation of securities in that market. But this year it's actually been much better with that market again in yen terms coming off and we're starting to see some larger better businesses starting to trade at valuations that we're finding more attractive, so we can be a little bit more productive there. But I think that sort of embeds you know, what's happened in Japan, and now that's spilling over into Korea.
You've seen that we've had a new election recently and the interestingly, the the you know what we would call in the United States a democratic party or the more liberal leaning party is coming into power and as part of what they're doing is they're implementing reforms that in the end will create better returns for investors over time in a similar manner to Korea has different issues than Japan had, but it's sort of a very similar path to what Japan did to try and get companies to
improve their returns.
Okay, I mean another market which I think is also quite interesting as an international investor is China because there was about a year ago the question is China equities in uninvestable or not? I mean, the market is still cheap. I mean what is your view on that? I mean, do you think it is a market that you are avoiding at all costs because of lack of transparency or the geopolitical risk or do you think, in fact, it may offer some good value investments.
I think that market is unquestionably the cheapest market in the world. I think the Chinese economy under different leadership definitely has the ability to be the dominant economy in the world. Unfortunately, this leadership has imposed a government control structure that will impede their ability.
To get there.
However, you have the cheapest valuations and some of the best businesses in the world in China. Now, if laurent I was sitting where you're sitting, as a European, I would have no problem having fifteen or twenty percent of my portfolio invested in Chinese securities. But given that my clients are American, we have a geopolitical rivalry that could at any moment be subject to an executive order barring us from owning Chinese securities.
And you know, that's.
That's a risk that is hard to handicap and one that puts us in a position of severely limiting our exposure to Chinese securities. And I you know, because America is the largest source of capital invested in almost every stock market outside the United States, I think that's part of the reason why valuations there are far lower than they than they are in other parts of the world.
It's it's an opportunity for people who live and who live and are domiciled and invest from outside the United States.
Okay, interesting, My last question will be on European iniquities. I mean, you did mention about many of those businesses not being high quality, but they are a nice run over the past two to three years. So what is your latest view, I mean, what are the sectors or industries that potentially you think are still good to invest in Europe?
Yeah, you know, we we as value investors, we generally find, you know, markets to be very attractive to us when there's some sort of pain that's going on.
And today it seems like.
Equity markets have chosen to focus on two things. One is the dramatic potential of AI, which is fantastic. And you know, we we spend a lot of time trying to understand what's happening and what the impact could be to the many businesses we own about forty businesses, the many businesses that we own, in addition to other companies
that we don't own. The market has has preferred to focus there, and the market has preferred to focus on, especially in Europe, the short term implications of lower interest rates, higher spreads, and the stimulus that's mainly coming.
Out of Germany, and so markets are pretty buoyant.
And as a result, you know, we don't find any particular country, we don't think by country anyway, but any particular industry to offer seriously attractive outcomes. The opportunity set in markets that aren't in distress generally comes from, you know, companies that are having their.
Own particular issues. Right.
So in our last shareholder letter we outlined the purchase of two securities. So one is an Irish company called Icon, which is in the contract research business, and you know, it's having its own particular issues based on problems with its customers and customers spending less, and that's creating an opportunity to buy what is a fantastic business at a very attractive multiple company with a strong balance sheet and a experienced and value creating management team, and they're actively
buying back their own shares. And it really the opportunity set for value investors like us in an environment like this comes from particular companies rather than any broad swath of the market, geography, or industry that is offering a big opportunity set aside from the China, you know, opportunity set that I mentioned earlier, which we effectively can't take advantage of.
Well, this is great. I really appreciate you coming on, David.
It was nice to be here. David and Laurent. It was a fun conversation.
Thank you very much, and Laurent, thank you for being my co host.
Oh welcome.
If you enjoyed this episode, don't forget to subscribe if you want to, if you're interested in our research, don't forget to go on the terminal either b I Fund or b I Stocks until our next episode. And this is David Cone with Inside Out.
Mm hmm