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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Frequently Asked Questions about this Article…
Investing in cyclical stocks can be advantageous when markets are extremely risk-averse. During such times, these stocks often trade at very cheap multiples, making them potentially lucrative investments. By focusing on price-to-book valuations, investors can find opportunities in cyclical stocks that might be undervalued.
Long-term growth businesses, such as casinos, can offer substantial returns. For example, the first Sands China casino in Macau had a cash payback period of just 18-20 months, demonstrating the potential for quick and significant returns on investment. These businesses can be very profitable over time, making them attractive to investors.
Since 2013, concerns about China's economy, including a crackdown on corruption and a slowdown in credit formation, have negatively impacted Macau casino stocks. This has led to a reversal in growth and a challenging outlook for the sector, affecting investor sentiment and stock performance.
The author sold their shares in Sands China in late 2013 due to changing fundamentals in the Macau gaming industry. Despite being a well-managed company, the negative economic factors in China led to earnings downgrades and a significant de-rating of the stock.
Price-to-book valuations are significant for cyclical stocks because they provide a more stable metric for assessing value compared to earnings, which can be volatile. This approach helps investors identify potentially undervalued stocks during periods of market uncertainty.
Macau casinos are facing challenges such as a slowdown in gaming revenue growth and an increase in capacity with more tables and slot machines being added. These factors, combined with economic concerns in China, create a challenging environment for the industry.
Investors can approach volatile markets by allocating a portion of their portfolio to cyclical stocks when they are undervalued. By focusing on metrics like price-to-book valuations, investors can find opportunities even in uncertain times.
The de-rating of Sands China stock was influenced by changing fundamentals in the Macau gaming industry, including economic concerns in China, a crackdown on corruption, and a slowdown in credit formation. These factors led to earnings downgrades and a less favorable outlook for the stock.
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