A good example is Swiss watch manufacturer, Swatch. In the course of 2016, the percentage of Swatch which was sold short (indicating negative sentiment on the company) was as high as 26.5% of free float and as of January 2017, it is still the fourth most shorted stock in the Stoxx 600. Over the last couple of years, the company lost almost 45% of its value from peak to trough. A violent swing by any account, especially for a company with a ’moat’ (competitive advantage) as wide as Swatch:
Despite its long-term track record, competitive advantage and leading position in the industry, Swatch is currently not even priced to cover its cost of capital over the next five years. Expectations are anchored around the double digit declines in Swatch’s most profitable markets, Hong Kong and mainland China, and around the latest reported company results, which show depressed profitability. Essentially, expectations are so low that when Swatch warned on profits in the last two quarters, the stock went up. We believe that short-term noise
around China, Apple’s iWatch, inventories, exchange rate swings, is just that: short term. The competitive advantage around the business should enable it to get over the cyclical hump and go back to structurally higher levels of profitability. Currently, none of this is priced in, which provides a good margin of safety.
To paraphrase Benjamin Graham, the proclaimed ‘father of value investing’, you do not need to know a person’s exact weight to establish whether they’re under or over weight. With this in mind, forecasting can be a futile (and time consuming) exercise that totally misses the point: the price you pay will ultimately determine the returns you make on an investment. This is why we always look for a margin of safety when we invest. So we’d rather be broadly right than precisely wrong, and spend more time on what really matters – ensuring we understand the business and test the moat sufficiently to make sure it can support growing cash flows and high returns into the future.
As bottom-up stock pickers, this is exactly what our process is designed to do: strip out behavioural pitfalls and focus on finding value in quality companies run by effective management teams. This, we believe, will deliver superior performance to shareholders in the long term.