Talking about equity with Diego Franzin (Plenisfer)
27 SEPT, 2024
After a disappointing 2023, equity seems to have recovered this year, rekindling the interest of many investors in this asset class. In this context, we interviewed Diego Franzin, Head of Portfolio Strategies, who explained the company's approach to equity investments, as well as discussing the possible rotation of multiples from the technology sector to other sectors.
At Plenisfer, you use an approach not tied to indices. How does this translate into your equity strategy?
We have chosen to overcome the constraints imposed by benchmarks, for example sector or geographical ones, in order to select individual opportunities globally, always analyzing the entire capital structure and taking into account the macroeconomic context in which the companies we examine operate.
It is therefore fundamental for us to define the characteristics of the businesses we look at, evaluating the life cycle of companies, growth opportunities and ongoing structural changes.
With this approach in equity, we try to identify opportunities that we define as "compounders", where the predominant element is the sustainable growth of the business.
We also look at companies that are in a mature phase of the life cycle, characterized by high cash generation and limited opportunities for reinvestment in the business, which we therefore expect to distribute significant dividends or invest in buybacks.
Finally, we analyze "special situations", or companies that we believe can structurally change and improve their business, with a consequent significant revaluation by the market.
What role does geographical diversification play in your equity strategies?
Our equity strategies tend to be concentrated and high conviction so the geographical dimension is integrated into the business analysis. For each company, we examine both the specific component of the corporate strategy and the geographical markets in which they operate. In particular, for compounders it is essential to deeply understand the macroeconomic dynamics of the geographical areas in which these companies are active.
How do you think a cycle of interest rate cuts could influence equity investment?
Interest rates can influence both the overall equity sector valuations and the environment in which companies operate. The impact largely depends on which rates change, whether short or long term. In general, a reduction in short-term rates tends to be positive in the short term for the stock market, as it favors conditions of greater liquidity.
However, the most relevant interest rates for business operations are medium-long term ones, such as 5 or 10 year rates, in addition to credit spreads. This is because companies tend to finance themselves on these terms and, therefore, a decrease in long-term rates reduces the overall cost of capital, potentially improving their profitability. Moreover, medium-long term rates reflect macroeconomic expectations, indicating the environment in which companies will find themselves operating. We must not forget the importance of the reason why rates are reduced. Currently, markets seem to discount a "soft landing" scenario, that is, inflation control without entering a recession, at least for the US market. Inflation dynamics have moderated and the labor market shows slight signs of slowing down, but overall it holds up. In this context, a rate cut should be interpreted positively by stock markets.
As for Europe, we expect it to follow the short-term dynamics of the United States, even though in the medium term the structural challenges of the old continent are more relevant. Economies like the German one need to rethink their growth strategy.
It should be noted, however, that valuations in various market segments remain high. Therefore, we do not foresee large upward movements and maintain a cautious and very selective approach.
The technology sector is one of those that is attracting the most attention from equity investors. Do you believe that the high multiples of tech companies are justified by their growth potential or has a speculative bubble been created?
Talking about a speculative bubble, in our opinion, is often excessive. Valuations are undoubtedly high: multiples in the S&P500 in the next two years are expected to be 18-20 times P/E and such a level generates a rather substantial downside risk that could occur if earnings expectations driven by the relentless expansion of margins prove too optimistic. If we look at Europe instead, two-year multiples are expected at more modest levels, or at 12-13x P/E for Stoxx600, and even drop to 7-8x if we look at China, a country where caution and stock picking are even more essential. However, even though they trade at high multiples, many companies have highly profitable and rapidly growing businesses. For example, Microsoft, which trades at almost 30 times earnings, has seen its revenues and profits double in the last five years. The real question is whether this growth is sustainable in the long term.
We are instead very cautious about single-product companies mainly exposed to artificial intelligence. We generally prefer to look at "enablers" of the transition, which trade at decidedly more accessible valuations, or industrial companies that are already benefiting from digitization.
Earlier we were talking about the normalization of interest rates, one of the factors that could push towards a rotation of the technology sector multiples towards other sectors. What other factors could trigger a significant rotation of the technology sector in the future?
In our opinion, the market is ready for a broadening of performance. We have witnessed a very concentrated performance in the "Magnificent 7", which have come to weigh more than 30% in indices such as the S&P 500 and are now considered the new "staples". Certainly many of these companies, like Microsoft or Apple, are solid businesses, but we believe that the change in monetary policy can act as a catalyst in other sectors of the market. Looking beyond the short term, we think that rotation is inevitable because the beneficiaries of digitization and, in the future, of artificial intelligence, will not only be technology companies, but increasingly those of the real economy that will benefit from progressive increases in productivity resulting from the digitization of many processes.
Digitalization, the evolution of artificial intelligence, and the phenomenon of so-called reshoring or near-shoring are already influencing the cyclicality of some sectors. We believe that sectors such as advanced industrial and infrastructure, both digital and physical, will see an extension of their cycle and will benefit from a demand and investments more prolonged than traditional paradigms.
