Five things investors should consider in 2017
Looking ahead to 2017 plenty of uncertainties await, not least on the political front: Donald Trump will become US president, there will be several important European elections and Brexit negotiations will continue.
Meanwhile the outlook for economic growth, inflation, currencies, commodity prices and interest rates remains as difficult as usual to fathom.
Our aim is to protect investors from a wide range of political and economic outcomes rather than make big predictions about the short-term future. As the great investor Philip Fisher once put it, an analyst must learn the limits of his or her competence and tend well the sheep at hand.
In this spirit, as we look ahead to 2017, here are five key factors that will be occupying the Evenlode team as we tend to the flock of companies we analyse and follow:
1. Think long-term:
When investor time horizons shrink, as they have done at several points over the last year (and inevitably will do again in 2017), it is worth remembering that shares are part stakes in real companies not just prices on a screen. Ultimately, if a company can deliver long-run growth in per share cash flows and dividends, the share price will follow. Patient, business-perspective investment is more relevant than ever in a world that sometimes feels overly obsessed with short-term noise, momentum trends and sector rotation.
2. Focus on free cash flow and dividend growth:
The outlook for dividend growth remains relatively muted in the UK market, though much will depend on the outlook for sterling and inflation over coming years. Our focus as we head into 2017 will as usual be on asset-light companies with sustainable competitive advantages and long-run growth potential. These characteristics tend to help produce sustainable dividend streams (thanks to healthy, growing free cash flows) and equip companies to cope relatively well in both deflationary and inflationary conditions.
3. Manage balance sheet risk:
Over the last few years, revenue growth has been hard to come by but debt has been cheap. This has created a temptation for companies to borrow money, which can produce a short-term benefit to earnings but ultimately increase risk for long-term investors. We have been actively managing balance sheet risk in the portfolio over the last two years, and have a strong preference for management teams that take a conservative approach to a company’s capital structure.
4. Support self-funding businesses:
We call a certain type of company a ‘self-funder’. This is a business that is able invest fully in its long-term organic futures, whilst also paying a healthy dividend and still end the year with more cash in the bank than it started. They are surprisingly few and far between at present, and are therefore worth cherishing and supporting. Though long-term organic investment costs money today, these investments are the lifeblood of any business and will ultimately drive a company’s long-term competitive strength and cash flow growth.
5. Be valuation aware:
In terms of new additions to the Evenlode portfolio, we often find the best valuation opportunities in quality businesses facing short-term industry headwinds, but where cash generation remains strong and long-run growth prospects are good. Or sometimes they may simply be sold off as a result of changing investor sentiment and sector rotation. As the market inevitably gets buffeted around in 2017, we’ll keep an eye out for these opportunities. For the patient investor, unfashionable investments in fundamentally attractive businesses can be some of the most rewarding in the fullness of time.
Hugh Yarrow is manager of the Evenlode Income fund