Lazard's Warryn Robertson shares his checklist for uncovering true value

It doesn't take a genius to see that a market darling's valuations are stretching to the skies. But it does take a genius to resist the FOMO (fear of missing out) and stick with companies that are predictable and highly productive. 

We spoke with Warryn Robertson, portfolio manager for Lazard Asset Management's global equity fund to work out why opportunities are scarce and how you can spot a good stock. He's ditched Aussie staples, banks and miners, in favour of companies with economic franchise.

"When we think about our universe, the types of stocks that we shy away from are because we think they're too competitive or too hard to predict. Banks and insurers, we don't invest in any of those. We won't buy energy stocks or miners," he said. 

According to Robertson, it all comes down to economic franchise, a multi-faceted term which Robertson broke down into six key features: 

1. Predictable earnings
2. Clear monopolies 
3. Seriously high levels of economies of scale
4. Businesses with networking effects
5. Strong patenting
6. Companies with high switching costs.

"We're not really a classic value manager in the sense that we're looking to buy those beaten up companies that are trading on low price to book, with a very low return on equity. We're typically hunting in a space, that has companies that are highly financially productive, generate a great return on assets, but we do it with a value focus" he said. 

In this video, Robertson explores a number of key recent acquisitions and long-standing fund favourites to show how to find a good value stock. 

This transcript has been lightly edited for clarity: 

So we're looking at the world of global equities today. What's a good value buying opportunity and why are they so scarce right now?

Warryn Robertson:
Yeah. Good question Mia, we've had a situation we think where equity markets have generally been bid up to levels that find attractive investment opportunities quite scarce. One that's a favourite of ours at the moment in terms of our portfolio is CVS Health. It's a US-focused business that has three main business lines. 

Traditionally, its core business is the largest pharmacy retail network in the United States. It also has the second-largest medical benefits management business and it's got a second-tier health insurance company and the three of those, we think create quite a potent healthcare offering. 

So the integration of that healthcare insurance business, AIDA, into the group will enable it to sort out two of the problems that they've really had over the last couple of years. It allows them to roll out health hubs, and with an increasing proportion of Medicare provided through those health hubs, we think that provides two distinct benefits for the combined group.

One it brings foot traffic to their core retail pharmacy, and that will in many cases offset the threat that's been overhanging the stock in terms of the online players, and sort of their offering competing against the traditional retail format. And it also enables the health insurance business that's provided medical costs at a lower cost to patients, so when they check into the medical and hospital centre, so integrating all three. 

CVS Health has benefited in the last six months in the US because it's played a critical role in the rollout of the vaccine programme in the United States. The new leadership under a CEO, Karen Lynch and new CFO (following former CFO) Eva Borrato, we think, is very strong. We think the integration of those three, particularly the AIDA health insurance business into the core business is going to be key over the next couple of years. And we've got a lot of faith in those two under their stewardship. 

So that's the story, that's the thesis, but it ultimately comes down to value. And this is one of the great healthcare businesses in the U.S. It's trading on 10 times earnings today, which is pretty definitely a rarity in, global equity markets and expectations are that its earnings will grow by more than 30% over the next three years. 

So in terms of opportunities, we see that as one of the clear cases for a great investment opportunity.

Mia Kwok:
That's a great example of how you look at valuations and PE ratios. Are there any other characteristics of a good value stock?

Warryn Robertson:
Yeah, sure. I mean, part of that is to try and also isolate the way we define our investible universe. So, within the global equity franchise portfolio, we will only look at investing in companies that we deem as having an economic franchise. And what that really comes down to is, it's a business that we think we have a better handle on predicting its earnings or cash flows over the next five to 10 years, plus. So it's, so what we're talking about, there are businesses that have what we call a source of economic franchise. 

Now, it's a term that's used by a number of people to meet many different things, but for us, the economic franchise generation and ability comes down to that predictability of earnings.

Does the company have a certain characteristic that produces this predictable earnings stream? Because ultimately my job is to, define some earnings or pick some earnings forecast, some cash flows and apply a multiple, or a discount rate to it to come up with the valuation.

Now, if I can find a bunch of businesses that are more predictable, that makes my job as a valuer easier. It makes my job as an investor easier. I'm more likely to get those investment problems, right, and we think you're more likely than not therefore to make money for clients. So, when we talk about our value proposition, it's framed in that economic franchise universe. And so, the types of companies we're talking about are natural monopolies. For example, core infrastructure businesses like National Grid of the United Kingdom. 

Companies that clearly have seriously high levels of economies of scale. They're cost leaders, they have scale advantages, companies like Stericycle in the United States that deals with regulated medical waste. There are the classic "networking effect" businesses, like Visa or MasterCard, businesses that the more people use them, the more powerful that business becomes. Wonderful businesses are often trading at very lofty valuations, but occasionally you can get ones that, we think, are a good value. Visa is one that we've bought a position in recently. 

There are the "classic consumer" product firms, such as Colgate-Palmolive, or those companies that have strong patent lists, like Medtronic, which uses their intellectual property to generate that earning stream. And then there are companies that have high levels of switching costs. They're typically businesses that are almost in the background, very much companies like ADP, that do our payroll for myself at Lazard. They also do it for two-thirds of people across America. The companies like Oracle, that are mission-critical software and hardware providers that have very high switching costs. So, yeah, they're the sources of economic franchise. If you like natural monopolies cost leaders, companies that have network effects brands, or intellectual property or switching costs, and it's all around those source of economic franchise driving consistent, predictable earnings.

Mia Kwok:
You have quite a concentrated portfolio. How do you approach that mentality of honing and screening that universe down to, I think it's about 30 stocks, is that right?

Warryn Robertson:
Yeah. It's around 30 odd stocks - 28 today. And that's, it's not a case where we would just say, well we only ever owned 30. I mean, we have a bit of flex into our portfolio diversification, so we can own up to 50. We can own as little as 25. So we're at the lower end of that today. And that is really born out of the fact that we do find a dearth of genuine investment opportunities out there that are attractively priced. So because there are markets we think are generally expensive because there are very few companies that we're comfortable owning, that we think will generate a decent return today. We've concentrated the portfolio in those names. So, as I pointed out before companies that have those sources of economic franchise, we believe are more predictable.

We only concern ourselves with those companies. So, we're not concerned with the five odd thousand companies that are listed in the MSCI World today. We're really only focused on around about 230 odd stocks. And as you, pointed out today in terms of value opportunities, we only own about 28 of those. 

So, the competence to make that sort of concentrated, value decisions really comes down to our confidence around the earnings predictability of those businesses. 

It doesn't mean that the pandemic didn't affect them, but it means if you're a market leader, you can adjust your business when those types of externality events occur to actually navigate those waters better than a company that's highly competitive. So, when we think about our universe, the types of stocks that we shy away from, because we think they're too competitive or too hard to predict, banks and insurers, we don't invest in any of those. We won't buy energy stocks or miners.

So, we're not really a classic value manager in the sense that we're looking to buy those beaten up, companies that are trading on low price to book, with a very low return on equity. We're typically hunting, in a space, that has companies that are highly financially productive, generate a great return on assets, but we do it with a value focus.

Learn more

Warryn's invests in global listed companies which he considers to have an “economic franchise”, meaning companies that possess a combination of a high degree of earnings forecastability and large competitive advantages. Find out more by visiting the Lazard website.