Markets continued to exhibit significant downside volatility as central banks rapidly raise interest rates to bring down inflation. This in particular impacts ‘growth’ companies, even the highly profitable ones that aren’t as impacted by inflation – the type of companies that Insync holds. These forms of growth companies are delivering strong earnings today and are still poised to do so for many years into the future, even if economies contract in the near term. In times like these however markets are temporarily blinded to this reality, and so patience is required.
From an investors’ perspective, the factual scoreboard across history points out that predicting future inflation is as much a fool’s game as trying to guess when to be in or out of various industries, or even equities overall.
Over time, what we do know, is that stock prices follow the earnings growth of their businesses, thus this continues to be our core focus. Businesses with very high levels of sustained profitability, reinvesting into runways of growth backed by megatrends, deliver consistently superior earnings growth! Investors wanting a more certain way of growing their wealth must stand firm in times like now to benefit from this proven observation. It means riding out transient event-based situations, such as Russia’s terrible war and the recovery from Covid’s disruption to global markets. It also probably means turning off the news.
Companies you own are doing well
We invest in businesses (not markets). They sell differentiated products, offer value added services and aren't particularly resource or input intensive.
They benefit from pricing power and very high margins, and so rising inflation has less of an impact. They enjoy high cash generation and rock solid balance sheets (low debt). This enables them to strengthen their businesses during times like now as their weaker competitors struggle or even collapse (e.g. Estee lauder v Revlon). In fact, some will earn even more income on their billions of cash reserves as interest rates rise.
A good number of the companies in the portfolio are down between 20% to 30% - for no fundamental reason. Many continue to post very strong sales and earnings, reporting growth between 10% to 15%. So, we're certainly not going to sell them because their stock price went down 30%. If anything, we want to own more.
Adobe is a prime example.
There are 3 reasons making it an excellent investment:
1. Consistently strong earnings growth
2. Structurally growing market
3. Powerful balance sheet.
Adobe is highly profitable. It has a very high Return On Invested Capital, with gross margins of 88%. It’s a dominant force in the creative digital content industry with 50+% of the creative software market. Everyone is familiar with PDF, but the company’s suite extends far deeper with professional creative Cloud products like InDesign, Illustrator and Premier Pro, amongst others. When you view an image, video, website, magazine or even an app, there’s a good chance Adobe was involved.
Sales have grown by 75% (2018–2021), to $15.78 Bn (USD) in 2021. Yet, there is still a very large, long runway of growth left. The total addressable market for its Creative Cloud products is $63bn, and $32bn for its document Cloud products. 92% of this comes from existing happy customers and their subscriptions.
We don’t know if Adobe’s stock price will fall further in the near term, and this doesn’t trouble us. What we do know is that it is a dominant player in its industry with projected earnings compounding between 10%-15% p.a. This equates to superior and highly attractive earnings growth, followed of course by the eventual stock price rise. The current market price drop in Adobe drives a widening gap in its valuation versus its short term price.
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