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David Kimberley
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Updated 15 Sep 2023
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Disclaimer

This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.

A few years ago I was tasked by a former employer with writing up a short analysis of Domino’s Pizza stock. Other than knowing that the consumption of its product was likely to make you feel as though you had been poisoned, I didn’t know much about the company and ultimately ended up buying the cheesily named autobiography – ‘Pizza Tiger’ – of the company’s founder, Tom Monaghan.

Contrary to my expectations, it ended up being the best ‘business’ book I’ve read. Written long before the current cult of the tech entrepreneur, it is a very no nonsense approach to starting a small business and turning it into a huge conglomerate.

Despite being a staunch catholic, Monaghan had a truly Weberian work ethic. He appears to have taken just two days off per year for at least two decades and was truly fanatical in his attempts to make the business a success, whether it be secretly taste testing every competitor in the towns he was expanding into, fist fighting a franchisee that wasn’t delivering or inventing his own delivery box so that pizzas would not lose their consistency on the way to the customer – a process more complex than one would imagine.

My reading of the book took place just before covid and, although 2021 was probably its peak, we were arguably already in stock-market bubble territory long before that. So many companies were coming to market at hugely inflated valuations, nearly always justified by the fact they were developing some sort of novel technology. Reading Monaghan’s autobiography felt like a breath of fresh air. It was proof that you did not need to bluster about technology to be a good business. That Domino’s has delivered dollar-based total share price returns in excess of 6,000% in less than two decades is proof of that.

That came to mind when reading the latest missive from Bellevue Healthcare (BBH) managers Paul Major and Brett Darke in their monthly factsheet (always worth reading). Brett and Paul note that across markets, returns are being driven more by memes than reality. In the market as a whole it’s artificial intelligence, but in the sector they specialise in it has been obesity drugs.

With regard to the latter, people are already predicting a slowdown in heart operations and kidney problems, as obesity plummets due to these new wonder drugs. Maybe it’s a sell signal for Domino’s pizza as well. But Paul and Brett note that, behind the narrative, a pricing war is already taking place and that the efficacy of these drugs is already hugely questionable. For instance, less than half of the participants in one study achieved weight loss of more than 5% over two years. Nonetheless, the narrative has already taken hold and driven up share prices in companies that sell these drugs.

On the AI side of things, it is indeed plausible that this technology will do something that will prove profitable to some companies. Picking what exactly that will be and which company seems like a difficult task. Some people will obviously disagree and may have some kind of edge in picking the big winner in this sector. Good luck to them.

For the rest of us, it can be reassuring to invest in things that are slightly more predicatable but which have a clear business model and meaningful cash flows. Last week we looked at Greencoat UK Wind (UKW). The trust invests in infrastructure that generates energy via wind power.

It makes money from selling that energy and has lower operating expenses than ‘normal’ energy providers. The trust’s current discount rate, combined with the discount to NAV, imply potential total returns for investors of c. 12% annualised (assuming the discount to NAV narrows), with half coming from dividends and half coming from reinvestment.

Similarly, with Rockwood Strategic (RKW), manager Richard Stavely looks to invest in a concentrated portfolio of c. 20 companies, with a more value-driven approach to markets. Lots of these companies are not the most exciting in the world, whether it be burger chain TGI Fridays or the aptly named fluid power products supplier Flowtech Fluidpower.

But they typically have strong cash flows and margins or are in a position to have them, with Richard aiming to see their value double over three to five year periods. Given share price total returns for the trust since he took up his role in September 2019 have been in excess of 80%, compared to a return of less than 25% on the FTSE Small Cap Index, it’s a process that shows promise.

It’s also a reminder, much like the fabled Pizza Tiger, that you don’t need to reinvent the wheel or be part of the ‘current thing’ to generate good returns on your investment. Good cash flows, growing earnings, and strong margins tend to work well enough.

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