Paul Moore on why having an exit strategy is crucial with markets at all-time highs

With equity markets around the world at all-time highs, very few investors are thinking about pulling the rip cord.

But at some point, markets will correct—and those who have a proper plan for managing an orderly exit will not only lock in gains but stay well capitalised to buy again when things look more attractive.

To be clear, I do not hope or believe markets are on the cusp of an imminent decline. But I am cognisant that they won’t keep going up forever—for no other reason than they never have.

With that sentiment in mind, I recently contacted a handful of managers to quiz them about how they are viewing equity markets in the context of all-time highs, how readily they are finding opportunities, and—most importantly—what their plan is for when the inevitable happens.

First up, I spoke to PM Capital’s Paul Moore. Moore recently posted an article on the PM Capital website titled Know your exits: Maximising profits through a disciplined valuation approach, some of which we touch on below.

Valuation above all

Moore is unequivocal regarding the most important factor for both buying and exiting stocks – valuation.

PM Capital’s investment process is built on buying stocks that trade on bottom-quartile valuations and selling when they achieve top-quartile valuations, based on their historical valuation ranges.

Subsequently, Moore has always wondered why people are so concerned with forecasting index level earnings, “because it’s just too hard”.

“I haven't found anyone in my 40-year history that is consistent in doing it.

The funny thing is, you get these events, and if you are positioned on one side, you look like a genius, and if you’re positioned on the other side, you look like a mug - and sometimes it's actually the other way around.

The only true test is when you look back over a long period of time; who got through the tough times and built capital? That's the real test, but we all get lucky and unlucky in the short term”, says Moore. 

Moore sees valuation as a longer-term protection, an idea he expounds upon throughout the conversation. He also believes that, with markets at all-time highs, some investors have taken their eyes off the ball.

“Everyone needs to assess where they’re investing at the moment, because I'll guarantee you, people are making lazy decisions”.

“They're being influenced by what they've experienced, as opposed to what the outlook is in the next few years”.

Any concerns about all-time highs?

Given his focus on valuation above all, Moore isn’t particularly concerned about markets at all-time highs – or a pending reversion.

“There's always something that comes out of the blue, so it's really difficult. You can't predict those sorts of things… the only thing that'll protect you in the long run is valuation”, says Moore.

That said, he acknowledges that it is the right question to ask.

“Markets are at an all-time high. We got interest rates down to zero, but they're now normalising. We've had huge fiscal stimulus. Normally I'd say, "Forget about it. Don't waste your time. It's like roulette, red or black."

In terms of valuation for the market, however, Moore sees it as “around the bottom of the first quartile - what you've got is a lot of sectors that are actually cheap, and then you've got the top 10 that are really expensive, which is partly the great earnings”.

He adds that in this environment, it is wise to “take it down a notch” and by that he means have some spare capacity, so that whatever happens “you’re not backed into a corner”.

“Wherever you've got your capital invested, are you absolutely confident that the risk-reward profile will give you a satisfactory return longer-term?”, asks Moore, adding that he is worried that some investors have been chasing the good returns seen in the last few years, expecting them to continue forever.

“You can't compound at that rate forever, because we'll all be billionaires”.

Finding opportunities in today’s markets

Given Moore’s focus on finding companies at compelling valuations relative to their history, I was keen to understand if finding opportunities is challenging given the lofty levels of the markets.

Moore admits that it’s a bizarre situation at the moment, noting that amid the all-time highs, the P/E valuation of the portfolio “is as low as it’s ever been”.

“There are pockets the market has discounted because they’re either cyclically exposed or have a poor track history, etc. At the same time, you've got Tesla, NVIDIA, Microsoft, etc, all selling at historically high valuations relative to the multiple they’ve sold on over the longer term”.

Moore cites the European banks as an example of the former, noting that PM Capital increased its position in them when they traded at bottom-quartile valuations due to market concerns about the risk of European recession and the Russia/Ukraine war.

European banks have rallied this year but can still be a long way from top-quartile valuations. By sector, European banks remain the largest position in the PM Capital Global Companies Fund.

Five attributes of a selling process

In the article Moore penned recently on exits, he highlighted five key attributes. They are listed below, followed by some commentary on certain elements.

1. Start with the end in mind
2. Valuation focus
3. Patience
4. Resist selling winners too early
5. Capitalise on volatility

Start with the end in mind

Anytime PM Capital takes a new position, it has already planned for the exit.

“When we buy stock, we've already decided what we think it's worth under normal conditions”, says Moore.

He adds that having been in markets for nearly 40 years, he has a pretty good understanding of what certain businesses have sold for under different conditions – “So that's one of the benefits of being around a long time”.

Crystallising the idea, Moore points to an investment the team made in global brewers back in 2003. Moore had a history in US markets, where he observed Budweiser (EBR: ABI) and Coca-Cola (NYSE: KO) selling on 20x earnings, whilst Heineken (AMS: HEIA) and other European brewers were selling on 10x earnings.

“It was the first time I'd really looked at them, and I'm kind of scratching my head and thinking “Well, that's odd."

Moore had the foresight to see that the European brewers had a similar profile to Bud and Coke and that, eventually, they would sell at the same valuation.

"10 years later, that's exactly what happened”, says Moore.

Patience

Having explained the importance of valuation and the science behind PM Capital's exits, I quizzed Moore on whether there is any art in the process.

This part of the process, according to Moore, is the experience that accumulates over time in the market, particularly as it concerns the evolution of a company and the market’s understanding of it.

“It takes time for the market to really accept these companies, and how they have to prove themselves first, and then there are technical issues over the journey.

“If you were looking with shorter-term vision, you'd probably end up selling, and you get spooked out of these things just at the wrong time”.

“At the start of the process, you've got to say, "Look, along the journey, this is going to be thrown at me. I've just got to have the discipline to be patient."

Capitalise on volatility

This last idea really intrigued me (because I have been guilty of it too many times to count). Investors will do an incredible amount of work on understanding a business inside and out, make an investment that yields a result, and then walk away from all that research to find the next opportunity.

As Moore points out, investors can sometimes “overlook opportunities that can re-emerge in previous winning positions during volatile periods.

“In our experience, some of the best opportunities re-emerge in stocks we have owned and sold, and know well”.

So how is this playing out right now for Moore? Funnily enough, those brewers that he bought back in 2003 that went from 10x to 20x earnings, are now “starting to sell between 10-12x again, so we're looking at them again”.