Playing the Long Game

The Value Fund was up +1.6% net of fees and expenses in the second quarter, is up +11.5% year to date (YTD), and +19.3% over the past 12 months. The US dollar added about +1.0% to our returns for the quarter.

The Value Fund’s first-half performance beat both the S&P/TSX (+6.1%), and the DJIA (+8.2%), and trailed the S&P 500 (+19.1%). (1)

We note that a few large technology companies have driven most of the S&P 500’s gains in 2024. Just five companies—Alphabet (GOOGL), Amazon (AMZN), Meta (META), Nvidia (NVDA) and Microsoft (MSFT)—accounted for 63.2% of the index returns YTD. By contrast, the equal-weighted S&P 500 Index (RSP) is up only 5.0% YTD.

Given its capitalization-weighted nature, the S&P 500 index has become highly concentrated (see chart at right). The five stocks mentioned above, along with Apple (AAPL) and Tesla (TSLA), known as the “Magnificent 7,” now represent over 30% of the index.

We concede that most of these are good businesses. However, capital flowing into these names, driven by indexing and momentum traders, has resulted in many of them trading at frothy levels. It is worth remembering that Icarus was once a high-flyer, too.

(1) Index returns are for the total return indexes, including dividends and measured in Canadian dollars, the Value Fund’s reporting currency.

For example, NVDA is currently trading on 99x FY24 EPS. Analysts expect the company’s rapid growth to continue, with earnings projected to increase nearly 5x from $1.19 in 2024 to $5.49 in 2028. While not impossible, given AI’s pace of adoption and NDVA’s dominant position in the GPU market, we believe significant risk is embedded in NVDA’s current valuation. Markets have started to recognize this risk, with the stock down -12.6% in the past seven trading days (as of writing).

At GreensKeeper, we will stick to buying high-quality companies at valuations that provide our clients with a large margin of safety. “Must-own” AI stocks are not for us: we are immune from the FOMO virus. When markets are frothy, we are comfortable patiently waiting for opportunities to present themselves.

Portfolio Update

Our top contributor in the second quarter was Alphabet Inc. (GOOGL) +20.7%. The company posted 31% adjusted operating earnings growth y/y in Q1, bolstered by double-digit revenue increases across all its major segments. GOOGL’s search revenues continue to advance at a healthy rate despite investor fears that they will begin losing search market share to emerging AI competitors like ChatGPT. ChatGPT4 has been accessible to the public for 16 months now, and GOOGL’s search market share stands at 91%, down marginally from 93% at ChatGPT4’s launch. Importantly, GOOGL also continues to make progress in developing its own AI capabilities. We highlight that GOOGL’s compute costs for its AI search platform fell 80% y/y, along with an increase in queries driven by its Search Generative Experience.

Our second largest contributor in Q2 was Vertex Pharmaceuticals (VRTX) +12.1%. VRTX’s cystic fibrosis (CF) portfolio continues to generate robust revenue growth, and on July 1, the FDA announced approval for the improved Vanza Triple therapy. This new CF therapy is subject to meaningfully lower royalty payments compared to the rate payable on the current CF portfolio. During the quarter, the company also announced positive results for a pipeline therapy, VX-880, a stem-cell therapy that can potentially restore the body’s ability to regulate glucose levels and reduce or eliminate the need for insulin injection in type-1 diabetics.

Our third largest contributor in the quarter was Elevance Health (ELV) +4.5%. ELV continues to perform well despite headwinds from fewer Medicaid enrollees following the unwinding of government-funded Medicaid programs in response to COVID-19. Elevance’s conservative approach to underwriting policies has allowed the company to avoid the margin compression experienced by some of its major competitors. ELV’s earnings grew 15.5% y/y in Q1.

Our biggest laggard in the quarter was Berkshire Hathaway (BRK.B) -3.3%. Berkshire’s railroad and utility segments continue to struggle due to weakening volumes and wildfires, respectively. Despite these challenges, operating income continues to grow steadily, aided by acquisitions. Book value per share also continues to compound yearly, and we remain confident owning BRK.B as a core position in the Value Fund.

Our second largest detractor in the quarter was Visa Inc. (V) -6.0%. Visa continued to chug along with revenues increasing +10% y/y on payment volume growth of +8%. In March, Visa announced it had reached a settlement on a long-standing antitrust lawsuit that would result in slightly lower credit interchange rates and cap fees at current levels for five years. However, in June, the judge informed Visa that she deemed the changes inadequate and rejected the settlement. A potentially more costly settlement, combined with concerns of payment volumes decreasing as the American economy softens, have weighed on the stock price. However, we remain convinced that Visa’s growth algorithm will continue to drive double-digit earnings growth for the foreseeable future.

In Q1, we made one new addition to the portfolio: The Hershey Company (HSY). Our top 10 holdings are shown in the table on the next page. Additional portfolio disclosures, including performance statistics, can be found on the pages immediately following this letter.

* As of June 30, 2024. The Value Fund’s holdings are subject to change and are not recommendations to buy or sell any security

Is Now a Good Time to Invest?

We get asked this question a lot. An entertaining story we shared with clients at our recent Annual Meeting provides a different perspective and is worth repeating.

Tennis

Suppose you are introduced to tennis at a young age and become pretty good at it. You handily beat all the neighbourhood kids, winning 80% of your points. Eventually, you advance to playing in tournaments with other high-quality amateur players. You still win most of your matches, but your points won percentage decreases to 70%, given the tougher competition.

Fast forward a few years, and your childhood dream comes true—you are playing professional tennis for a living. Competing against the best in the world, your points won rate naturally declines. But you still manage to win 54% of all points played over your professional career. How do you think your career turned out?

It may surprise you to learn that you would be on par with Roger Federer, arguably one of the greatest players ever to play the game. That 54%-point win percentage led to Federer winning 82% of his matches over his entire career and 20 Grand Slam titles (2). Compare Federer’s record with that of Andy Roddick, who won 53% of his career points (1% fewer than Federer) but only 62% of his matches and a single Grand Slam. (3)

The lesson? A tiny edge, consistently compounded over a very long time, leads to amazing results. Casinos work on the same principle.

(2)   Source: atptour.com. See also Roger Federer – 2024 commencement address at Dartmouth College. https://home.dartmouth.edu/news/2024/06/2024-commencement-address-roger-federer

(3)   Source: atptour.com.

Casinos

Casino games of chance are structured to give the house a slight edge of just a few percent over its customers. But over long periods, the house is guaranteed to come out ahead despite fluctuations in their daily profits and losses. That small edge on every roll of the dice and spin of the slot machine resulted in US casino gaming revenues of $49.4 billion last year. (4)

Do you think that casino operators think about the best days to open the casino to the public or which games they should offer? Do you think Roger Federer ever woke up in the morning and asked himself if today was a good day to play tennis? Obviously not. In both cases, these professionals knew the odds were in their favour. Despite the occasional bad day, exceptional results were sure to follow over the long run. The stock market is no different.

Source: ChatGPT

The Stock Market

Stock markets increase over time primarily due to earnings growth (companies generally retain a portion of their earnings) and inflation.

Measured daily, over the past 50 years, the stock market has been positive 53.6% of the time. (5) A win rate very similar to our prior examples. And like Roger Federer and casino operators, that slight edge compounds.

A study of the US stock market over the past 152 years (1871 to 2023) showed that the market was positive in 69% of those years. (6) Over rolling 10-year periods, that figure increases to 89%. Over rolling 20-year periods—100%. In other words, over those 152 years, the US market has never declined over any 20-year period. Market crashes trigger fear and panic in our primitive brains and lead investors to make poor short-term decisions. But zoom out (per the chart on the following page) and see those pullbacks for what they are: mere blips in the market’s long-term rise.

(4)Source: American Gaming Association. https://www.americangaming.org/resources/aga-commercial-gaming-revenue-tracker/

(5)Crestmont Research. https://www.crestmontresearch.com/docs/Stock-Yo-Yo.pdf

(6)Robert Shiller and Yahoo Finance. https://themeasureofaplan.com/us-stock-market-returns-1870s-to-present/.

Takeaways

On a recent safari in South Africa, I was reminded that evolution is an exemplar of this concept. Over hundreds of thousands of years, small advantages compound over generations, leading certain species to adapt and thrive at the expense of others.

The valuable takeaways for investors:

• Day traders are playing a game with very narrow odds (possibly negative after factoring in trading costs and taxes). Even a casino can lose big in a single game or have a losing day but will always win over the long term.
• No one knows what the market will do over the next year or two. No one.
• Value investing, done right, stacks the odds even more in your favour than these historical market statistics.
• Equities are a winning game if you have a sufficient time horizon and can handle the volatility. The secret is to just keep playing. Use your long-term funds that you don’t intend to touch for years and get invested as soon as possible. Like Federer and casino operators, play the long game!
• Once invested in the market, stay invested. Investors who think they can consistently predict when to exit and reenter the equity markets are delusional. Market timers deliberately forgo playing this wonderful game.

A Better Question 

Instead of focusing on the ideal time to invest, we posit that intelligent investors should ask themselves a better question: What is the stock I am contemplating buying worth?

 

All the effort that goes into unknowable questions comes at the expense of things we can know. 

— Shane Parrish, Farnam Street

 

For certain businesses with sustainable competitive advantages (e.g., Value Fund holdings Fiserv (FI), Richemont (CFRUY), Vertex Pharmaceuticals (VRTX), Visa (V)), that question is answerable.

With that answer in hand and knowing that stock prices tend to fluctuate around intrinsic value, the decision to purchase or not becomes apparent very quickly, based on the market quote. If the stock is undervalued, buy it. If it isn’t, then look for bargains elsewhere.

Firm Update

Thanks to the 40+ people who attended GreensKeeper’s 2024 Annual Meeting last month. You can find a video recording of the event here.

Our firm’s growth continues, with assets under management (AUM) up over 50% over the past year and a new full-time employee joining us next month. However, our goal as a firm has never been to hit a certain level of AUM or employee count.

Our goal remains to deliver attractive returns to our clients while prudently managing risk. GreensKeeper’s growth is a natural byproduct of delivering on that mission.

Every one of our employees has their entire investment portfolio invested at GreensKeeper. In my case, it represents over 70% of my household’s net worth. We invest in the same stocks as our clients, and our approach is one of partnership.

If our partnership approach resonates with you or someone you know, please give us a call.

Michael P. McCloskey

President, Founder &

Chief Investment Officer