Sell first (ask questions later…)

The Markets

This week: ASX v Wall Street

FYTD: ASX v Wall Street

This week, we continued to see the volatility that has characterised this year in investment markets.

Yes, there are some very broad measures you can look at to see this. Many will point to elevated levels of the VIX in the US (the volatility implied by options on the S&P 500 index) or our own XVI (the volatility implied by options on the ASX200 index).

But, in our humble opinion, these broad measures don’t quite capture the full picture. The market is exhibiting much more volatility, fickleness, ephemerality or skittishness (feel free insert your adjective of choice), particularly when we look at the movements of individual stocks.

We have always looked to invest with a view beyond just the next years earnings. Those that visit our office will often hear the question “would you own it forever?” thrown around as a retort (of course, there is some hyperbole in this statement, but the point is made – we don’t own a company in anticipation of next year’s earnings!).

Yet increasingly, we are finding a disconnect between our time horizon and the market. Our sense is that investors’ time horizons are becoming truncated and tolerance for uncertainty is low.

Consequently, we are seeing some huge price swings based on changes in short term earnings. While frustrating, we feel this short-termism is in itself an opportunity for the patient.

The Origin story

Our suspicions have their grounds in some empirics.

We have recently seen large swings in multi-billion-dollar stocks as they have released earnings. For example, US stocks Walmart (-11%), Target (-25%) or Netflix (-35%).

Now immediately, savvy readers will be yelling: “those stocks were overpriced anyway!”.

This may be so. But we feel this validates our point. The three stocks are victims of their own success, there was a focus on near term earnings that were “pumped up” by COVID, with disastrous results. We can point to several charts of several stocks that show the same.

Another case in point is no doubt the elephant in the room at this point: we had a disappointing update from Origin this week.

The gist of it? The company has been unable to source the coal volumes for its coal-fired Eraring power plant that it anticipated. The company pointed to issues with a nearby mine that has been the primary supplier for the plant.

As a result, Origin has reduced its forecast earnings for its Energy Markets segment (electricity and gas retailing) by $115m or 22% (at the midpoint).

Offsetting this, favourable gas prices internationally have increased its expectations for Integrated Gas (wholesale gas and LNG) earnings by $175m or 11% (at the midpoint).

However, much of the consternation is around next year’s earnings. Uncertainty around coal supply (and how it may manage this while continuing to deliver output to the market) has caused the company to withdraw its guidance for earnings in FY-23.

Yes, we were disappointed with the announcement (particularly as we had discussed this risk extensively with the company quite recently).

However, what surprised us the most was the magnitude of the share price reaction.

The news saw Origin, a $11.2 billion company, lose more than $1.5 billion in a matter of hours.

Now, we won’t say that this news means a loss in future cash flows of this magnitude is not “in the realm of possibility”. But we found it incredibly difficult to justify on a probability weighted basis.

It was very much a case of sell first, ask questions later.

“Would you own it forever?”

We were happy to buy Origin after it fell. Disappointed as we were, we see it is unlikely that the long term value of the company has been impacted by more than the fall in its share price has implied.

Should the impact on earnings be temporary and not structural (as we suspect), this will prove to have been “good buying”, as we say.

The following day, we found that several long tenured brokers agreed with us, cutting their price targets by less than 4% (uncharacteristic – given price targets often linger around a company’s share price like a bad smell).

Origin’s share price subsequently rallied by almost 3% the next day (on a day where the market was down close to 1%).

The moral of the story? Heightened volatility can be uncomfortable. And we feel that during this time of uncertainty, we are seeing the market’s time horizon being compressed, with a strong focus on next year’s earnings, and little patience for the longer term.

Yet, a short-term focus on earnings is welcome news to us – if it means the market is throwing companies out at discounted prices.

We expect to capitalise on more of this volatility in the near term, through new positions, as well as topping up existing positions.

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