Equity investors often exhibit behaviour that would seem counterintuitive to a Monopoly player: the game requires an unwavering focus on intrinsic value as a function of earnings potential, a long-term view, and a calm and rational approach to decision-making. As in Monopoly, so in investing.
By Shaul Rosten, Equity Analyst with Redwheel
It is estimated that thousands of British prisoners of war (“POWs”) were able to escape Nazi prison camps by using Monopoly board escape kits secretly marked by an extra red dot – printed as if by accident – on the free parking space. The game had varied enough contents to disguise the many items needed to escape, e.g. compasses and files were passed off as playing pieces, the fake Monopoly money had real European bank notes stored in amongst it, and the silk map (overcoming the problems associated with paper: torn easily, dissolves in water, heavy to pack, conceal and carry and rustles noisily during use) was hidden inside the game’s famous board.
This was all possible because one person who could still print on silk, Mr John Waddington of Leeds, also happened to be the UK distributor of the game Monopoly.
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Monopoly, apart from its less-well known history as a wartime escape kit, is a globally recognised game with the objective of becoming the wealthiest player through buying, renting and selling property. This aim aligns closely with the object of investors who seek to grow their wealth through buying, renting (being paid a regular cash return on invested capital) and selling companies.
When it comes to the purchase and sale of properties in Monopoly, prices are initially set by the board, and then negotiated between players. Typically, these prices will be closely determined by the ability of those properties to produce cash flow for the owner. Someone with two properties out of three in a colour group will pay more for the third than it is worth than someone without those matching assets, as they can complete a colour set, build houses and hotels, and earn higher rental yields from their investments.
Shares represent real interest in a set of cashflows
When buying shares listed on public markets, investors seem to forget that, like properties in Monopoly, the shares they are purchasing represent a small but very real interest in a set of cashflows, and that the price of those shares, must, over time, be a function of those cashflows. Instead, the price movement of shares – and, by extension, of companies – seems to often fluctuate on short-term directional shifts, such as changes in business momentum or sentiment surrounding reported earnings.
Any businessperson with a degree of experience will recognise the irrationality of such an approach. Viewed logically, the true value of a company is a simple calculation that evaluates all the likely cashflow a company can produce and when it can produce it, before putting a present value (i.e what all future cashflows are worth today) on those figures. This, what is termed, ‘intrinsic value’, should be the north star of corporate valuation, and is unlikely to changed materially as a result of short-term news flow.
UK stocks: the cheapest in the world?
The recent events in the UK corporate market, which the team view as among the cheapest in the world, support this point. As valuations are ground lower and lower, by short-term pessimism, calmer actors with a longer-term view – corporate buyers – have stepped in to take advantage.
In the first half of 2024, the UK saw a significant increase in M&A activity compared to the same period in 2023. Globally the increase was only 5% year on year, but at a 66% year-on-year increase, the UK far outstripped the global level – the unsurprising result of its low valuation. This has been reflected in Temple Bar Investment Trust’s portfolio, where several holdings – Currys LON:CURY, Direct Line Group LON:DLG and Anglo American LON:AAL – have fended off bids. (Indeed, one of the companies held in the portfolio has now had to fend off two bids in less than a year).
What seems obvious in board games often goes unheeded on the stock exchange. Traders furiously transact on tidbits of news, share price momentum and narratives that dominate the headlines. Meanwhile, these same companies whose shares are being traded continue to plod along, generating cash, investing in growth and building businesses. An outcome of this fixation with incremental developments is how they impact share prices when news is released: instead of rationally considering how a company’s announcement may impact the sum of future cashflows discounted to present value, share prices seem to react sharply, jumping or collapsing on good or bad news, respectively. Such movements in price rarely seem to consider the starting point of the company valuation.
The team prefer to invest irrespective of the market sentiment, buying sound businesses at low prices. The challenge is in remembering what was set out to be achieved and thinking about the north star: buying companies for less – ideally, substantially less – than what the team think they are truly worth. As in Monopoly, so in investing.
