When is it too good to be a long term investor?

I allocate up to 20-25% of my portfolio to cyclical stocks when markets are extremely risk averse. When investors expect tough times ahead and cyclical stocks tend to get beaten down, those stocks usually trade at very cheap multiples. I prefer to look at price-to-book valuations, as estimating book values for cyclical stocks is easier than estimating earnings.

Some ask why I would invest in cyclicals in the first place rather than stick to quality long term growth businesses? Casinos are a great example of very profitable, long term growth businesses. Some of you might know that the first Sands China casino in Macau (a subsidiary of Las Vegas Sands) was set up in 2004 at a cost of US$400m and had a cash payback of 18-20 months. Reflect on that for a moment – a massive investment with a cash payback dynamic of less than two years! Who wouldn’t want to own a business like that!?

Investors have flocked to Macau casinos stocks in the past few years as growth in gaming revenues exploded. However, since 2013, we’ve seen concerns about China’s greater economy intensify. From early 2014, we witnessed a crackdown on corruption and a slowdown in credit formation in China. There now seems to be no end in sight to the negative news affecting Macau as growth has reversed while significant capacity for tables and slot machines will be added in the next three years.

I sold out of Sands China in late 2013. Sands China is in my view, one of the best-managed companies in Macau. But even for a fantastic business like this, when the fundamentals change not only do we get earnings downgrades, but also a significant de-rating.

Macau gaming revenues are rolling over

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