Managing an Equity Portfolio in the 'New Normal' and the Vagaries of Stock Selection

2020 will be set in peoples’ minds for a variety of reasons. For those in employment, the impact on their working lives and ability to perform their jobs will be at the centre of those thoughts. For me, the years spent on equity research and building a robust stock selection process, and running an active portfolio from 2019, culminated in the launching of my core portfolio in UCITS format in May 2020.

As we know the impact of the COVID-19 pandemic on global equity markets was profound. The velocity of market movements and the broader volatility was unprecedented. With it came behavioural shifts, some predictable and some less obvious, and a huge dispersion in single stock performance from markets around the globe. The working from home rules, the lack of travel and leisure, alongside an increase in stay at home tech, supermarket sales and delivery services etc, played their part in influencing stock performance.

The process I have developed creates an accumulated score for a stock based on many factors, including their ESG credentials. It has no preference towards particular sectors or countries. The score associated with a stock varies over time with a bias towards high quality, financially robust firms that are deemed to be at favourable valuations. This ‘bottom up’ selection fared well in 2019 and proved defensive with controlled losses (as my research had suggested) through the eye of the market storm in February and March.

However, ‘the path of science runs not smoothly’ as was demonstrated after the storm had passed. Investors, more particularly private investors, en masse, forced many tech stocks to new highs. Most of these stocks are far too risky for our portfolio since the quality factors are yet to be established and the valuations extreme, requiring years of strong growth and perfect execution to justify. Interestingly our tech exposure has increased over the last 3 months as the methodology has picked up on earnings and momentum performance of this sector however several of the additions have been out of favour established tech companies.

One of the portfolios holdings is Intel Corporation, a company dominating its field with historically robust economic performance and growth. Intel is attractive for many reasons, and has recently gained entry into our top 10 list of global stocks. It’s wide moat, growth and most importantly valuation, in my opinion offers a significant margin of safety. I believe the post earnings fall based on 7nm delays has created a good buying opportunity. Our model’s score for Intel is high, and there are still significant positive developments such as Tiger Lake, accelerated share buyback, Mobileye, AI, 5G and the autonomous revolution. I try to put not too much weight on the short term news and noise generated from announcements but focus on the long run fundamentals. Historical earnings and free cash flow yield are two factors which I look at and are charted below.

Intel Corp: 20 years of earnings growth, coupled with a current Free Cash Flow Yield of 10.24% are what Intel offers.

Many investors flocked to AMD after the Intel announcement; the growth/market share story sounds good, however the historical earnings volatility and the extremely rich valuation (see charts below: earnings yield 0.70%) are just 2 reasons why AMD stock doesn’t come close to qualifying for our portfolio.

Advanced Micro Devices Inc:

Our portfolio is dynamic and we remain cautious on all positions, however in a zero interest rate environment Intel’s free cash flow yield of 10.24% looks good value, especially when coupled with 20 years of decent earnings growth.

No stock selection process is perfect, so even after the specific stock price volatility of Intel in July, we remain confident in our models. Managing an equity portfolio presents regular challenges, even more so in the current climate.

By Mark Ellis, CEO Nutshell Asset Management

28th September 2020

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