16 stocks GMO is backing right now

Let's face it - global investing is a tough nut to crack right now. Between the war in Ukraine steering the Eurozone straight into a recession to the US Federal Reserve's "whatever it takes" policy to fight inflation, to the unfolding property crisis in China, making solid returns in faraway lands is just that - far away. 

So how does a global fund manager tackle these trying times? For Kim Mayer at GMO, his process is simple: create a universe of quality investments and own them at attractive valuations. While that philosophy is consistent, what may be surprising is that the GMO Focused Equity fund is weighted heavily toward the US. In fact, 75% of its portfolio is US-domiciled.

In this latest edition of Expert Insights, Kim discusses the landscape for global equities right now. Plus, he also shares which sectors are best positioned for the rest of 2022, what themes the GMO team wants to harness, as well as 16 of their top stock picks (and 1 on his watchlist). 

Note: This interview was recorded on 16th August 2022. You can watch the video or read an edited transcript below.

EDITED TRANSCRIPT

Ally Selby: Hey, how are you doing and welcome to Livewire Markets. I'm Ally Selby and today we'll be discussing where you can find value in the market right now. To do that, we're joined by Kim Mayer from GMO who joins us all the way from Boston today. Thank you so much for joining us today, Kim, it's such a pleasure to speak to you today.

Kim Mayer: Thanks Ally. It's a pleasure to be here.

Ally Selby: There's a lot going on in the US at the moment. From where we are on the other side of the world, it does feel like we're watching the crumbling of an empire. That said your portfolio has a 76.5% weighting to US-based companies. Why are you feeling so bullish about the US right now?

Kim Mayer: Wow, Ally, I thought we had good relations between our two countries! But I take your point. Things are not perfect here in the United States, but where are they perfect in the world today? 

I think you almost need to invest extra terrestrially if you're looking for a perfect investing environment. When we think about the chance of Europe not being able to turn on the lights this winter or heat their homes, think about what's going on in the UK with the change of regime. China with its lockdowns, et cetera. So there's no perfect place to invest in the world today and certainly, the US is not one of those.

The reason we find such strong opportunities in the strategy today, as you said, roughly 76% of our weight in the strategy is invested in companies that are domiciled in the US, is that so many quality companies are found in the United States. When we think about what we're looking for in a quality company, we're looking for companies that are able to produce high and stable profitability to do so with low leverage. 

When we apply those quantitative screens to the global opportunity set, somewhere between 70 to 75% of those quality business models happen to be found in the United States.

Now we get a little bit more weight than that in the United States, because actually since we are valuation-aware investors, in other words, we are very concerned about the price that we're willing to pay for a business model. Quality companies in the United States are actually, on average, a little bit cheaper than quality companies elsewhere. There are plenty of quality companies all around the world, but we want to own those quality business models that are also attractively priced. So that's why today, just as on average, we tend to have roughly three-quarters or so of our portfolio invested in companies that are domiciled in the US.

Ally Selby: You're also overweight in tech and healthcare at the moment. They are two sectors that have been really out of favour in the first half of 2022. What do you think's on the cards for these sectors going forward?

Kim Mayer: So the market hasn't been particularly friendly to any sector so far in 2022 with the possible exception of energy. Healthcare and tech have not been immune to some pretty serious rerating, some multiple compression. That's been most true in tech, less so in healthcare.

When we look at our healthcare exposure, which tends to be divided into three main sub-industries, we own a lot of what we call managed care companies. We also have big pharma exposure as well as medical device exposure. Those parts of the healthcare market have held up better than the part that's been pummelling the most, which is the biotech industry. We struggle to find really high-quality business models within biotech. So relatively speaking, healthcare has actually been a pretty strong performer for us so far in 2022.

Within tech, if you think about the areas of tech that have been hammered the most, it tends to be those areas that are the most speculative that have had the highest multiples. So think about those companies that may be pre-profit, but have very little in the way of cash flow. We don't tend to find those to be very high-quality business models. 

If you look at our exposure within tech, we have some of those strong growth champions. Think about Microsoft (NASDAQ: MSFT ), Apple (NASDAQ: AAPL), Alphabet (NASDAQ: GOOG) of the world. Those companies have been able to deliver strong, sustainable growth over the course of at least the last decade.

Kim Mayer: We also have companies within our tech exposure that are less "growthy", but are continuing to pump out very strong profits. So those are almost more at the value end of tech. Names like Cisco (NASDAQ: CSCO), or SAP (NASDAQ: SAP), for instance, Oracle (NASDAQ: ORCL). So names that didn't have as high multiples coming into the downturn and therefore their multiples have not collapsed to the extent that the rest of tech has.

Ally Selby: I wanna stick with tech now. From what I can see from your top 10 you have exposure to two different semiconductor companies. There have been some really bad supply chain issues over the past few years. Are those starting to ease? And why are you feeling so bullish in this sector?

Kim Mayer: Yeah, so overall the semiconductor supply chain has certainly struggled in 2022. The names that we have held have not been an exception to that. Coming into 2022, if we snap back to looking at what was impacting the sector in 2020, and 2021, it was very much those supply chain disruption issues. It's actually probably a separate set of issues that are beginning to drive performance within the semiconductor supply chain today. It's concerned about where do we sit today in the overall semiconductor cycle. In other words, are we on the verge of having actually over capacity? Within certain parts of the semiconductor industry, that's certainly a risk.

Think about memory chips - the chips that go into smartphones, and computers. There's a real potential now actually for a glut in those types of chips. So those types of concerns with the possibility of a recession looming very closely are beginning to weigh heavily on the sector. 

The way that we play semiconductors is a little bit different. We play up and down the supply chain. 

So we have some designers and manufacturers, Texas Instruments (NASDAQ: TXN), for instance, but we also have names at the very tippy top of the supply chain. We own companies like Lam Research Corporation (NASDAQ: LRCX)  or KLA Corporation (NASDAQ: KLAC)  that build equipment that semiconductor manufacturers use. The foundries, the TSMCs of the world used to build these chips for the designers.

We look for companies that have differentiated business models. In other words, those companies that have been able to build a moat around their businesses cannot easily be duplicated. We feel that those names can hold up better and because they are much more exposed to analogue semiconductors, less sort of commodity memory chips, there's less likely to be a glut and they should be much more resilient, whether we're talking about inflation or recession or whatever the environment that we are exposed to next.

Ally Selby: As I mentioned earlier, investors have witnessed a major rotation out of tech, healthcare and consumer discretionaries over the past six months, all the way into financials, energy and materials. We've just started to see kind of a reverse on this. Which stocks have you been buying in these recent selloffs and why do you think they look attractive right now?

Kim Mayer: Yeah, so what we tend to do with our portfolio is we're constantly on the lookout for new opportunities within the overall quality opportunity set. Those are pretty few and far between. It's a pretty sticky universe. So what tends to drive more of our trading activity throughout the year is rebalancing around those valuation opportunities. So if you think about what's led from a relative standpoint within the quality universe so far in 2022, it's tended to be those most defensive sectors. Pharmaceutical companies, consumer staples companies, and names like Merck (NASDAQ: MRK)  and Coca-Cola (NYSE:KO). Names that are very defensive, very inflation resilient.

Some of those names have started to trade rich versus their fundamentals. They've done so well on a relative basis that they're beginning to look expensive to us. We're beginning actually to move our portfolio back towards some of those battered down quality tech names where the multiples have compressed the most and where we feel some of that sell-off has gotten ahead of the long-term fundamentals. So examples of those types of trading would be back into names such as Salesforce Inc (NYSE: CRM), Adobe Inc (NASDAQ: ADBE), Microsoft, Apple, et cetera.

Ally Selby: Are there any stocks that are on your wishlist if they were to drop further?

Kim Mayer: Occasionally we find an opportunity to buy a really high-quality company that almost never trades cheaply enough for us to be able to buy in good conscious as valuation-aware quality managers. So a recent example of that would be, a recent buy of ours would be Intuitive Surgical (NASDAQ: ISRG). Also, ASML Holding (NASDAQ: ASML) is one of the highest quality companies within that overall semiconductor space. There are other examples of potentially some luxury goods companies that almost never trade at valuations that we can quite stomach as value-aware quality investors. So a name like Hermes International (EPA: RMS) could be added alongside an LVMH (EPA: MC), which we currently own.

Ally Selby: Well, thanks so much for your time today, Kim. I really enjoyed that chat. If you enjoyed it too, give this video a like and remember to subscribe to our YouTube channel. We're adding new content every week.

Access a portfolio of high-quality companies

Kim and the team believe that companies with established track records of historical profitability and strong fundamentals are able to outgrow the average company over time and are therefore worth a premium price. To learn more about GMO's Quality Trust, please visit their website.