Even when it's painful, even when the shares are going down, you've got to be genuinely objective and really ask yourself, have I got something wrong? Or do I still have conviction in this and do I still have belief in this? Human nature doesn't like losing money. There's a massive tendency to sell something after it's fallen in price.
Hello and welcome to a value view from the Merchants Trust. I'm John Cronin and in this episode I'm joined by Simon Gergel, lead manager of the Merchants Trust. One of the hardest things in investing is knowing the difference between a mistake and an opportunity. If a share price falls, is the market telling you something important? Or is it giving you a chance to buy more of a business you still believe in? That's what we're exploring in this episode, what conviction really means in investing. Simon, it's great to have you here in the studio.
Hi John, great to be with you again.
Well, let's just untangle some of this. First off though, I suppose the obvious point to consider here is this is quite an emotional thing to face.
Investing can be an emotional challenge. It can be very uncomfortable if you own a share and it goes down in price even if you think it's worth a lot more than that. And so you have to look at those situations dispassionately and you have to think has something new come out? Is there new information? Is there something that I'm getting wrong? Or actually are the fundamentals, is the business still as valuable as I thought it was and is this drop in the share price an opportunity? And I think that's probably the hardest question to answer in investing is to separate the situations where a share price going down is telling you something seriously wrong in the business and other times when it's actually a big opportunity.
Okay Simon, so build on that idea for me a little.
Conviction is not about blind faith in an investment. It's about continuously challenging yourself and challenging the investment thesis and looking for reasons why you might be wrong to build confidence in why you take that view. But if you've challenged that and if you've really dug into it and you've continued to analyze what's going on and you're convinced that actually there's nothing significantly changed and the shares have got cheaper, then arguably you should even be buying more of that company, investing more money in it because it's offering better value than it was before. But separating the wheat from the chaff, you know, the good from the bad is actually probably the hardest thing.
Okay, let's do a bit of that. Let's separate a bit of the wheat from the chaff. Give me an example of this in action.
One example is a company called Tate & Lyle, which a lot of people still think makes sugar.
It does, isn't it? It's a sugar company. I saw the packet of sugar in the supermarket the other day.
Well, they sold their sugar brand a long time ago in the UK and they've even sold out of the equivalent of fructose corn which they were making for many, many years. They sold out of that quite recently. So they've transformed the business from essentially sugars and sweeteners to much more value-added ingredients. So the business has fundamentally changed and it's much more now about helping food producers change the characteristics of food. So taking out sugar, replacing with low-calorie sweeteners, adding dietary fiber, adding products that make the product feel different, taste different in the mouth, adding other characteristics.
Okay, well, that's a very different company from the one that I thought I knew. I guess what you're saying here is that there's a big difference between perception and reality.
There can be. I think a lot of people still think of Tate & Lyle as a much more commodity type business rather than a company making specialty ingredients. And the difference with that is, you know, commodity ingredients you might sell by the ton, a specialty ingredients you might sell by the kilogram. And you need relatively small quantities but they can make a lot of difference to the end product and therefore be much more valuable.
Why then if a company has improved itself, changed what it does, made itself more relevant, all those things you've just described with Tate & Lyle, why hasn't the market rewarded it?
I think that's a great question. I think there's two real drivers as to why the shares have been weak. So the first is that very transformation process has been quite expensive, quite costly. So if you're imagining you've got a lot of profits of commodity type products which you're selling. So you're giving up a lot of profits and you're reinvesting in a higher value, more specialty areas and so often the amount of profits they're bringing in is maybe slightly lower than the profits they're exiting. So the profits of the business have come down. There's been some downgrades to earnings expectations because of that process. Now we would argue the quality of the earnings is much higher so investors should pay more for those earnings today than they used to but there are slightly lower earnings because of that transformation.
And then the other thing which has happened coincidentally which makes it even more difficult is we're going through a very difficult patch in the end markets. So if you take the American market which is their biggest market, the amount of food sold in supermarkets in America went down last year which is almost unheard of. Consumers were under a bit of pressure from rising costs and rising energy bills and food costs and so they tighten their belts. They actually spent a little bit less or they bought a little bit less volume of food and lower volume is really a problem or a challenge if you're a food producer, ingredients producer because you're selling less product. So the end market was a bit tougher in the year than or quite a bit tougher than we thought or they thought it would be and so again you had another earnings downgrade. So you had two lots of earnings downgrades for a business which is fundamentally getting better in our view in terms of the quality, but the market, the stock market hates earnings downgrades. It doesn't like negative momentum as we sometimes call it. And so the shares have actually gone down and been derated. The valuation of the company is trading at a lower multiple of profits today, significantly lower than it was a couple of years ago, even though the quality of those profits has improved.
