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When ‘go-go’ is ‘gone-gone’

Investors are affected by these cognitive errors, too. It is why a whole generation of investors whose outlook was shaped by the 1960s and 1970s spent much of the second half of their working lives in fear of inflation. For many of them – and I can’t wholly exclude myself from this – that meant opportunity losses since the interest rates that powered their pricing models were higher than they needed to be and, consequently, the values they splurged out were lower than they should have been. Ironically, it is only now there is a generation running the show whose memory isn’t so scarred that policies are being energetically pursued that will permit inflation’s resuscitation. Today’s leaders still understand that money doesn’t grow on trees; they know it is far easier to produce than that.

Similar errors are made in the assessment of internet technology. Some of us whose working lives began clacking away on manual typewriters and using Extel cards for financial information may remain in awe of technology’s information-gathering and processing capabilities and, true, fiercely difficult techie stuff still lies behind it. But the internet itself has evolved to commodity status. It is not just that it’s 36 years since Microsoft (US:MSFT) launched its first version of Windows, it is also 26 years since it released Windows 95, whose interface has a clear connection with today’s Windows 10. Likewise, Amazon (US:AMZN) started trading 25 years ago by which time any number of search engines were up and running (though not Google).

Twenty five years is time enough for the glamour of the brave and new to become familiar and taken for granted. Consider, in other settings, how the technology and the perceptions of motor cars changed between, say, 1925 to 1950 and televisions between 1950 and 1975.

But sometimes perceptions change slower than they should, preferring to cling to the past. In investing, growth stocks seem especially susceptible to this bias. Too often, they retain a fast-growth rating even though their progress has regressed to pedestrian pace; until, that is, it becomes blindingly obvious that they are no longer what they were.

The support-services sector is a neat example. In the 1990s it seemed hard to believe that companies pursuing such low value-added work as cleaning or building maintenance, where barriers to entry were perilously low, could deserve sky-high ratings. Those ratings seemed fully justified when it became clear that organisations of all sorts – but especially those in the public sector – were falling over themselves to jettison peripheral activities via long-term contracts. With the help of a bit of accounting licence, what better way for support-services companies to capture profits – and for their bosses to get rich – than to bid for contracts aggressively and to acquire rivals voraciously? Until, that is, some basic laws of economics and the exigencies of the public purse exerted themselves and low-tech, low value-added services returned to what they always really were. Consequently, any glamour glinting off the likes of Capita (CPI), Mitie (MTO) or Serco (SRP) faded to a dirty, rusty brown.

So, how do we spot when a growth stock has morphed into something completely different and is that necessarily bad? Let’s do this via Moneysupermarket.com (MONY), which is the nearest thing in the Bearbull Income Fund to a growth stock that looks in danger of going ‘ex’. Equally important, of five holdings I bought in a hurry last summer when the pandemic’s effects on company dividends necessitated a portfolio shake-up, Moneysupermarket is the only one showing a book loss.

Moneysupermarket is a child of the internet. Without a consumer-facing web, it would not exist; its main function being, via its web site, to sell financial services (chiefly insurance) to consumers and take a cut for itself. Doing much the same with household utilities adds about another 20 per cent to its revenues, which totalled £350m in 2020. In more or less its current guise it has been doing this for almost 20 years and its shares have been listed for 14 years come July.

So it is no longer a new kid on the block. There has been plenty of time for familiarity to breed indifference and it is not that it does anything very special. Aggregating pricing information for consumers and being the broker between them and service providers is hardly rocket science, although that does not necessarily matter. Amazon’s Jeff Bezos is happy to acknowledge his company doesn’t do anything special either, but that hasn’t stopped it growing into a $1.6trn business. The moral is that by focusing on services that won’t go away, by superior execution and the resulting market presence, strong barriers to entry can be built around an ordinary business, which can then proceed to extract its rents.

That much has been implicit in Moneysupermarket’s share rating pretty well since its listing. Apart from a brief spell following the 2008-09 sub-prime mortgage crisis, when it fell to a single-figure multiple of forecast earnings, Moneysupermarket’s rating has spent almost all its time at 20-plus. Even today, with the share price at 271p, it is just over 20 times the average of 2021’s earnings forecast by City analysts.

Yet, as the chart shows, arguably that rating is at odds with the fact of Moneysupermarket’s slowing growth across some key metrics. In order to extract the trend from the jumpy data, the chart lines show the rolling three-year average of annual growth rates for sales, earning per share (EPS) and free cash flow starting in 2011 (for which the data point is the average growth rate for 2009, 2010 and 2011). Even then, the wild change in growth rates for EPS, which, admittedly, is a residual figure from a lot of pluses and minuses, means its data needs its own scale on the chart. The trends are clear enough. Until 2013, Moneysupermarket was still young enough for growth rates to be on an upwards path. Since then, however, they have been resolutely down.

 

 

That does not necessarily make it a bad company or its shares a poor investment. After all, as the table indicates, Moneysupermarket still does an awful lot right. We might expect a consumer-facing business led by technology and marketing to have high fixed costs and therefore, when conditions allow, fat profit margins. In that respect, Moneysupermarket does what it is supposed to. Even 2020’s 25 per cent margin was achieved in a really odd year when revenue fell 11 per cent.

 

. . . but performance stays strong
 Profit margin (%)Return on Capital (%)Return on Equity (%)Cash flow divi cover5-yr div'd growth rate (%)
201629.542.841.81.616.8
201732.350.843.81.612.7
201832.354.846.71.58.7
201931.155.047.51.07.9
202025.247.634.01.15.1
5-year ave30.150.242.81.4na
Source: FactSet    

 

Implicit in that business model is much spending on developing intellectual property. To the extent such spending is capitalised, that would reduce return-on-capital measures and, indeed, more than half of Moneysupermarket’s £305m of assets at the end of 2020 were of the intangible variety. Despite that, figures for returns on both equity and capital (ie, equity plus gross debt) are really fat.

Cash-flow dividend cover – the amount by which cash profit left over for shareholders exceeds dividends paid – is skinnier. That matters most if, in order to boost cash profits, management has been skimping on such essential spending as developing services. There may be an element of that. It wasn’t so much a surprise that capital spending fell in 2020. The greater concern may be that it has now fallen four years running and was at less than half its level of 2015 and 2016, although those were years of especially high cap-ex.

Meanwhile, the table’s right-hand column raises some concern. It shows how the pace of dividend growth is slowing. Much of this was to be expected. After all, back in 2016 the 9.9p dividend was twice as high as five years earlier. The worry is that if the pace slows much further from 2020’s 5 per cent a year over five years then that will threaten the share price. A repeat of 2020’s payout will generate a 4.3 per cent income return. That’s a nice start, but almost all equity investors would expect more and Bearbull’s target total return is 8 per cent or so. It is hard to be confident that Moneysupermarket is capable of the growth to meet that. Sure, 2021 will be closer to normality, although travel insurance will remain depressed. In addition, some regulatory changes should help, such as making it easier for customers to switch insurers by stopping auto renewal of policies. But Moneysupermarket already has a big share of a crowded and static market. No amount of search-engine optimisation and the like will profoundly change that.

It is for me to decide what to do with the Bearbull fund’s holding in Moneysupermarket. More important, is that readers should cast a similarly critical eye over the growth stocks in their portfolio that might be getting tired.

bearbull@ft.com