Know your exits: Maximising profits through a disciplined valuation approach
Five attributes of a selling process that aims to enhance portfolio returns.
In April 2022, PM Capital initiated a position in Flutter Entertainment, a leading global sports betting, online gaming and online poker business. At the time, Flutter, like other gaming stocks, traded well below its peak price due to fears about US gaming competition and UK regulatory uncertainty.
PM Capital believed Flutter had a strong position in a structurally attractive market. We thought the 2018 legalisation of sports betting in the US could potentially provide years of growth for Flutter. Moreover, Flutter’s ownership of FanDuel, a provider of online sports fantasy games, gave it a large ready-made fan base.
Flutter traded below our sum-of-parts valuation. We identified why Flutter’s valuation had fallen, what the market was overlooking and potential catalysts for a recovery. Within two years, Flutter more than doubled from PM Capital’s entry price and confirmed our exit ‘thesis’. In March 2024, PM Capital exited Flutter.
Although we continue to believe Flutter will be the long-term winner in the US and maintain its leadership position in key mature markets like the UK and Australia, this thesis is now the consensus view and its valuation has re-rated.
This brief example reinforces key traits of PM Capital’s investment process and provides insights for advisers and investors. A disciplined focus on valuation, an ability to capitalise on short-term market volatility, and a long-term investment focus are key to selling stocks and maximising profits.
Selling skills are vital. Academic research (Tosin, Jin et al 2022) has found that fund managers with superior selling skills are significantly better at buying stocks, and deliver higher returns over time. In contrast, managers skilled at buying stocks do not always have parallel selling skills. The researchers found ‘strong evidence’ that selling skills are the main driver in fund-timing performance.
Other research (Wulfmeyer 2016: 1) has identified that fund managers have a ‘tendency to sell winning stocks too early and hold on to losers for too long’. PM Capital has long advocated that it can take a full industry cycle (7-10 years) for investment theses to play out, and on the benefits of investing in simple, repeatable ideas.
Although superior selling skills are critical, market commentary has a bias towards stocks to buy and how to do so. The market is awash with ‘buy ideas’, often for attention-grabbing stocks. For some investors, selling skills are an afterthought.
With that in mind, PM Capital has outlined five attributes of its investment process when selling stocks:
1. Start with the end in mind
Before initiating a stock position, PM Capital develops an exit thesis. We understand the market’s view on the stock, the catalysts that could re-rate it, the likely timing of those catalysts, and how the stock’s recovery could unfold. This exit thesis is not just about maximising profits; our theses on stocks help determine if unexpected news changes our view on a company, warranting a sooner-than-expected exit to minimise losses.
Our initial investment in July 2023 in Grupo Mexico, one of Mexico’s largest companies, is an example of how we build an exit thesis. Group Mexico has two main assets: an 89.9% stake in Southern Copper, a US copper producer, and a 70% stake in GMexico Transportes, Mexico’s largest rail-freight operator. We believe the market has misunderstood the true value of Grupo Mexico, its leverage to a rising copper price and its improving position in rail.
PM Capital expects copper demand to rise this decade due to growth in electric vehicles that require the metal. Production supply constraints in copper could also support a higher copper price. In rail, central America could benefit from the global manufacturing trend towards on-shoring and near-shoring, which could support logistics demand. As such, we believe Grupo Mexico could be re-rated by the market and, over time, move towards a top-quartile valuation. Should that occur, our exit thesis would be confirmed.
2. Valuation focus
PM Capital’s investment process is built on buying stocks that trade on bottom-quartile valuations and selling when they achieve top-quartile valuations, based on their historical valuation ranges. Often, this means buying deeply unpopular stocks and selling after the investment ‘in-crowd’ arrives.
Our position in European banks highlights this approach. In 2020 and 2021, we increased our position in European bank stocks when they traded at bottom-quartile valuations due to market concerns about the risk of European recession and the Russia/Ukraine war. European banks have rallied this year but can still be a long way from top-quartile valuations. By sector, European banks remain the largest position in the PM Capital Global Companies Fund1.
3. Patience
PM Capital’s investment process is built on long-term investing. Often, it can take years for an out-of-favour company to regain market confidence, then years more to consolidate those gains and for a bullish consensus view on the stock to form. That’s why we think about companies over a full industry cycle.
Not all stocks follow this pattern. Some recoveries happen quickly. In late 2023, PM Capital initiated a position in Newmont Corporation, the world’s largest gold producer, as gold equities lagged gains in the gold price. Over the last two months, Newmont shares have rallied about 30%2. PM Capital still owns Newmont stock.
Our position in Cairn Homes, a developer and builder of residential homes in Ireland, is a different example. We invested in Cairn in 2015 and 2016, taking advantage of a structurally undersupplied housing market. After strong price gains, we sold a large part of our position in 2017 and 2018. When Cairn shares almost halved in 2019, we rebuilt a position, attracted by Cairn’s lower valuation and a dividend yield around 4%. Cairn has rallied this year, confirming our view of stronger growth in Irish housing starts and the need for investment patience as some recoveries take years to play out fully.
4. Resist selling winners too early
In our experience, investors often exit profitable stock positions too early, in pursuit of quick gains and a short-term boost to fund performance. Through 26 years of investing, PM Capital has seen stocks fall further than the market realises, and rise further than investors expect. Markets move much faster than company fundamentals. It takes time for companies to conceive and implement recovery strategies that yield results.
PM Capital’s investment in Airbus is an example of letting recoveries play out. We initiated a position in Airbus, the world’s largest aircraft producer, in late 2021 after its valuation slumped amid COVID-19 travel restrictions. Airbus shares rallied strongly in 2023 and now trade near a record high3. We maintain a position in Airbus, believing its recovery potentially has further to run due to the production ramp-up of its A320 family of aircraft and growth in Asian air-travel demand.
5. Capitalise on volatility
After selling profitable stocks, some investors quickly move to the next position. They overlook opportunities that can re-emerge in previous winning positions during volatile periods. In our experience, some of the best opportunities re-emerge in stocks we have owned and sold, and know well.
PM Capital’s position in Wynn Resorts, a leading owner and operator of casinos in the US and Macau, is an example. Like other large casino stocks, Wynn Resorts’ valuation has been volatile. Three times over the past 10 years, Wynn’s share price has fallen 50-80%, peak to trough. This volatility has created opportunities to lighten or exit our position after price gains, and rebuild or add to it during price weakness.
Capitalising on market volatility, when equities are irrationally oversold or overbought, is key to delivering attractive real returns (after inflation) this decade. That is, having an active approach to selling and buying shares, in the context of a disciplined long-term investment framework.
References
Tosun, O. Jin, L., Taffler, R and Eshraghi, A. (2022) ‘Fund Manager Skill: Selling Matters More! Review of Quantitative Finance and Accounting, forthcoming. Available at SSRN: https://ssrn.com/abstract=4087534
Wulfmeyer, S. (2016). ‘Irrational Mutual Fund Managers: Explaining the Differences in Their Behaviour.’ Journal of Behavioural Finance. 17(2) pp 99-123.
Notes
1 At end-March 2024
2 To 8 May 2024
3 At 1 May 2024
This insight is issued by PM Capital Limited ABN 69 083 644 731 AFSL 230222 as responsible entity for the PM Capital Global Companies Fund (ARSN 092 434 618), the PM Capital Australian Companies Fund (ARSN 092 434 467) and the Enhanced Yield Fund (ARSN 099 581 558), the "Funds". It contains summary information only to provide an insight into how we make our investment decisions. This information does not constitute advice or a recommendation, and is subject to change without notice. It does not take into account the objectives, financial situation or needs of any investor which should be considered before investing. Investors should consider the Target Market Determinations and the current Product Disclosure Statement (which are available from us), and obtain their own financial advice, prior to making an investment. The PDS explains how the Funds' Net Asset Value are calculated. Past performance is not a reliable guide to future performance and the capital and income of any investment may go down as well as up.
