Investing in undervalued securities worldwide

Weekly Update 5 December 2022

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Stocks rose last week after the US central bank again indicated it was prepared to slow down the pace of interest rate increases.
www.ft.com/content/fd118019-1cd4-442d-b3e4-f9cc8164d0d0

We are invested in Value stocks, specifically European banks, because we feel the global economy has stabilised to such an extent that banks are again investable, while investors remain pessimistic. If the economy holds up, we see 50%+ upside for many of the positions in the portfolio.

Take the German banks $CBK.DE (Commerzbank AG) and $DBK.DE (Deutsche Bank Aktiengesellschaft) . German banks acquired a bad reputation over the past decade because there were too many players in the German banking market, leading to low industry profitability. The big German banks had to deal with their own unique problems, as they had overextended themselves before the 2008 Global Financial Crisis and had to retrench during the 2010s. Commerzbank and Deutsche Bank never earned adequate returns on their capital, and many investors gave up on the hope that they would ever improve.

This year, however, the environment has changed for the banks. Both Commerz and Deutsche benefit massively from higher interest rates, and as interest rates have moved higher, so have estimates of the banks’ future earnings. Commerzbank has seen its 2024 earnings estimate increase 40% since the beginning of the year. The shares have returned +20%, underperforming the increase in earnings estimates, because of the deteriorating economic situation.

If the economy does hold up in 2023, we could see a re-rating. The shares currently trade at 5x 2024E earnings, a distressed level: a normal bank trades at 10x earnings. Analysts who follow the company and have a bullish opinion on the stock think the shares could reach 12 euros next year. That would be a 50% return. We believe this is reasonable in a positive economic scenario.

A similar story could be told about many other European banks. The large French bank $BNP.PA (BNP Paribas SA), for example, trades at 6x 2024E earnings, while a normal valuation for this company since the Global Financial Crisis has been 9x. 50% upside is thus possible – provided, again, that the economy holds up.

What if it doesn’t? Banks typically fall 50% in recessions, so the downside if there is a 2023 recession leading to credit losses for the banks is also substantial. The idea of our strategy is to take higher risk for higher returns, so we accept this risk. To manage the risk (though it cannot be eliminated), we monitor the Germany-Italy interest rate spread, and have also not bought banks in countries where housing markets are at risk of a significant correction (Poland, Norway, Australia, Finland, Sweden, Canada).
andreassteno.substack.com/p/real-estate-watch-the-equity-market

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Disclosures

eToro is a multi-asset platform which offers both investing in stocks and cryptoassets, as well as trading CFD assets.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 81% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.

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eToro (UK) Ltd. is authorised and regulated by the Financial Conduct Authority (FCA) under the license FRN 583263.

Your capital is at risk. Other fees may apply. For more information, visit etoro.com/trading/fees.

Pietari Laurila is not a registered investment advisor and does not offer investment advisory, fund management or wealth management services.

Triangula Capital is a brand name, not an incorporated entity.

This page is provided for information purposes only. It is not a recommendation to copy the Triangula Capital strategy or to invest in any fund or security.

2009-2020 performance figures are from Pietari’s personal Interactive Brokers account. They are time-weighted returns calculated in accordance with the Global Investment Performance Standards (GIPS).

From 2021, performance is calculated by eToro.

Past performance is not indicative of future results.

Track Record

It is often said that past performance is not a guarantee of future performance.

That is true. But there is also some evidence indicating that portfolios that performed better in the past, do perform better in the future.

“[…] top-decile prior-alpha funds produce annual future alphas of about 150 bps, net of fees” Source

Risk warning: That is only one study. In general, past performance is not indicative of future results.

Aligned Incentives

Pietari invests the majority of his net worth in the strategy. This ensures that his interests are aligned with investors who copy the strategy.

“Funds with high-incentive contracts deliver higher risk-adjusted return, and the superior performance remains persistent. The top incentive quintile of funds outperforms the bottom quintile by 2.70% per year” Source

Risk warning: Pietari holds accounts with multiple brokers and may therefore have a conflict of interest when deciding which accounts he should trade in first.

Unconstrained Investments

The strategy has fewer constraints on its investments than traditional mutual funds.

The strategy portfolio can be invested in stocks, bonds or cash and these allocations can vary over time.

Compared to traditional mutual funds, the strategy also:

  • holds fewer securities
  • trades more
  • avoids following the index

Each of these points has been shown to be an important predictor of portfolio performance.

“We […] find that portfolio concentration is directly related to risk-adjusted returns for institutional investors worldwide” Source

“A one-standard-deviation increase in turnover is associated with a 0.65% per year increase in performance for the typical fund” Source

“We find that truly active funds significantly outperform closet indexers. Further, we find that the truly active funds are able to outperform their benchmarks on average by 1.04% per year” Source

Risk warning: Concentrated portfolios with few positions can suffer large losses if bad news arrives about any of the companies in the portfolio.

Higher Risks for Higher Returns

The aim of the strategy is to maximize returns, even if this means taking more risks than usual.

The strategy invests in countries and sectors where values have collapsed due to macroeconomic problems.

Within these geographies and sectors, the strategy overweights stocks that trade at low valuations on measures such as price-to-earnings or price-to-net asset value.

Every stock in the strategy portfolio must also be a good company, with no obvious red flags or long-term threats to its business model.

Risk warning: The strategy portfolio tends to be concentrated in risky stocks, which means that its losses in any market downturn will likely exceed those of the market index.