Investment Matters

Does size matter?

“Almost every day we see examples [globally] of Telco’s restructuring their businesses, laying off employees, selling business units and in other ways seeking to adapt to this unprecedented disruption… It is sobering indeed that of the top 50 companies in Australia by market capitalisation in 1980, only 10 remain in today’s top 50.”  (John Mullen, Chairman, Telstra at the AGM Presentation 16-Oct-18.)

We concur

Telstra’s issues certainly include external disruption from technological change (fixed line decline, the dodo Yellowpages, and mobile data/generation progression through to 5G, etc).  It also includes a journey from bureaucratic government department (in effect), to a standalone listed entity but still with monopoly ownership of infrastructure, to now having to operate in a highly competitive environment without a significant infrastructure or other meaningful competitive advantages.

At some point, Telstra may become an attractive investment. We don’t consider we are there yet.

But this week’s IM focus is on the very valid point that Mr Mullen makes.  It can be easy to focus on short term developments; changes on a daily, and monthly basis.  But these can increment to major shifts in the investment landscape over time.  Being invested for the future – not looking at the past, or in the short term, is something we try to focus on.

A focus just on the top 10

Let us consider the top 10 companies on the ASX today, versus 40 years ago.

Top 10 Market constituents by market capitalisation

Source: 1978 data –InvestSmart, Nov-18 data  IRESS

Missing in 2018:

  • Coles Group
  • Conzinc Rio Tinto: Now named Rio Tinto (#12 by market cap)
  • MIM: Taken over by Xstrata in 2003, now part of Glencore Xstrata.
  • Hamersley: Now part of Rio Tinto
  • Bank of New South Wales: Merged with Commercial Bank of Australian in 1982 to form Westpac
  • CSR: sugar sold in 2010, focussed on building products now
  • Australian Guarantee: Provider of equipment finance, car and personal finance and cashflow finance - operations split into Westpac and GE Capital in the early 2000s.

But perhaps more significant than what is missing is the change in the sector makeup.  Mining/ resource companies have significantly declined as a presence in Australia’s 10 largest listed companies.  And finance companies now dominate, although their domination is trending down.

Other thoughts

The Australian economy is quite narrow – Australia doesn’t have a big exposure to manufacturing or digital companies for instance.  Thus the changes we have seen at the top of Australia’s market indices are actually quite limited when compared to, for instance, the disruption associated with the FAANGS in the US.

Company size should not be a determinant of investability.  A company that grows its earnings over time will grow its size over time – although not usually in a purely correlated manner or over a predictable timeframe.  Therefore, seeking investments with growing earnings is key (excepting those that are a price-to book investments).

The little companies that become big

One mantra that we have when investing is to try to identify small companies that will become big ones in time.  To many, this may sound quite esoteric, or unrealistic.  But we are serious about this.  A case in point is CML Group – a company whose expertise is factoring (invoice financing), and fairly recently expanding into equipment finance.  It isn’t a big company yet.  But it is getting there.  With earnings growth expected to continue, we consequently expect this will translate to further increases in the company’s size.

 

* net debt as at 30-Jun-16

Source: IRESS, Company Annual Reports, First Samuel

Note: Enterprise value is a measure of the size of a company.  It is market capitalisation (# shares on issues * share price) + net debt.

Conclusion

Telstra’s Chairman makes a valid point – the constituents of the market, including at the top end, do change markedly over time.  Investment success does not come from buying shares in a company because it is big.  Rather it comes from buying shares in companies that can grow their earnings. 

Hopefully, these will be one of those in the upper echelons of the index in 40 years time – or certainly much larger than when the initial investment was made.

- Fleur Graves