The long-term compounders Hyperion is backing for a better tomorrow

Hyperion Asset Management, which runs three equity funds managed by Mark Arnold and Jason Orthman, recently held a webinar discussing the importance of earnings per share growth, a recent trip to Asia, and some of the stocks Hyperion has been buying. The insights are summarised below. 

A focus on earnings per share growth

The Hyperion team focuses on earnings per share growth, seeing it as a clear driver of long-term stock returns. 

"We think the key share prices and the performance of the funds have been well supported by better-than-expected earnings per share growth, including a stabilisation of interest rates and the promise of artificial intelligence", says Deputy CIO Jason Orthman. 

"Focusing on the Hyperion Global Growth Companies Fund (Managed Fund), you can see the earnings per share in the blue bars has been incredibly strong over the last three quarters and has actually been accelerating" he adds.

Orthman goes on to point out that one of the key drivers of the stronger-than-expected earnings per share growth has been a moderation in employee number growth; "you can see that in the red line that's been moderating." 

"So if you have dominant companies that have the ability to take market share, their revenue growth rates tend to be pretty consistent at high double digit levels" says Orthman

Orthman adds that if a company shows more discipline around costs, "you tend to get these positive jaws (gross income growth exceeding expense growth) and an increase in operating leverage - and we're certainly seeing that over the last three or four quarters for Hyperion".

Looking longer-term, Orthman - again focusing on the Hyperion Global Growth Fund, notes that "the majority of historical returns have been driven by earnings per share growth in the dark blue (on the chart below)

"So as we look forward, the returns are really going to be dictated by that earnings per share trajectory", adds Orthman. 

Asia learnings

The Hyperion team recently traversed Asia, which served as "a good reminder that capitalism is incredibly destructive", notes Orthman, adding that "competitive intensity is high globally and particularly through Asia". 

In order to be successful, Orthman ardently believes that a business needs to have something special about it, and something that is defensible. 

"Profit pools can tend to be competed away to zero. 

We really want these dominant companies with a strong value proposition, a strong, sustainable competitive advantage that can actually produce double-digit growth over a long period of time and high returns on capital. 

Without something unique to the consumer, it's very difficult to do that". 

Orthman goes on to highlight two ASX-listed businesses, in Dominos (ASX: DMP) and Goodman Group (ASX: GMG), that Hyperion spent time with whilst in Asia and hold in the portfolios. 

Please note the commentaries below are direct quotes from the webinar.

Dominos Pizza (ASX: DMP)

"We spent five hours in Tokyo with the key executive of Domino's seeing some of their key stores, and we do think the offering is good, but through COVID-19 and the shutdowns dominoes expanded aggressively beyond Tokyo and across Japan.

We still believe it's an above-average business, and it should be able to grow sustainably over time in a global sense". 

Goodman Group (ASX: GMG)

"We also completed our due diligence on Goodman Group, and that's been a new holding to the Hyperion Australian Growth Companies Fund. And so we spent time with the key executives across Brisbane, Sydney, Shanghai, Hong Kong, and Tokyo. 

We believe that it's got a unique set of assets, that are extremely difficult to replicate, around data centres, warehouses, and logistics. 

They have the land bank and the development pipeline to grow at double-digit rates over time. So it's been good to add that position to the fund".

A focus on innovation

Another key focus for Hyperion is on companies that are innovative, with CIO Mark Arnold saying that "innovation creates uniqueness".

"Pricing, power, cost advantages, and superior returns are derived from uniqueness".

Arnold goes on to explain that the ultimate sustainable competitive advantage is born from innovating at rates above competitors and the overall economy. 

He also believes that whilst innovation can be costly in the short term, because it depresses short-term profits and returns, it is essential for value creation and higher returns in the long term. 

"Innovation is core to our investment process. 

We will allocate capital to where the innovation is occurring because this is where the future attractive return opportunities are found". 

Arnold adds that Hyperion constructs portfolios that contain highly innovative businesses, which create unique products with large addressable markets and have business cultures that are likely to lead to the creation of new products in the future. 

"These businesses are valuable because they can grow by taking market share over time", says Arnold.

He continues, saying that innovative and creative businesses tend to be undervalued by the market because the market underestimates the future sustainability of their innovation-driven growth. With this focus on innovation, Arnold provided the following theses for some companies in the portfolios that are delivering innovation in spades. 

Please note the commentaries below are direct quotes from the webinar

Tesla (NASDAQ: TSLA)

"We believe Tesla is currently transforming from a hardware-based auto business to a predominantly software robotics and energy business. 

Over the next few years, this transformation is likely to create significant value. 

We believe Tesla is rapidly approaching an iPhone moment when its cars will become smart enough to drive themselves without human supervision ".

Amazon (NASDAQ: AMZN)

"The investment thesis for Amazon is also being validated by recent results. 

There was a lot of scepticism in the market largely because of a recency bias where people question whether they could actually expand their margins and earnings. 

They've shown they've been able to rightsize the business and reduce the cost to serve". 

Spotify (NASDAQ: SPOT)

"We're particularly excited with the outlook on Spotify. 

We're seeing revenue growth accelerating and are starting to reflect the strong historical acquisition of monthly active users. 

In our view, the recent results have validated the investment thesis and we were always of the belief that Spotify would dominate and win the global streaming space across music and audio. 

We believe they can grow revenue sustainably at around 20% per annum. And we believe the earnings per share growth should be significantly above that". 

What about some local names?

Not to let international companies have all the limelight, the Hyperion team also highlighted a handful of Australian companies delivering innovative products and solutions. 

Pro Medicus (ASX: PME)

"We added [PME] to the Hyperion Australian Growth Companies Fund in November, 2023 when there was some share price weakness. 

What we like about Pro Medicus is we think it has a really unique place in the market where it has a streaming technology which allows radiologists, particularly in North America to view those images quickly and remotely. 

Pro Medicus is taking share from the incumbents that tend to have legacy technology. And when we look at that broader North American hospital market and have a look at the amount of US exams done annually, we think the penetration for Pro Medicus is around 7%.

With the market leading offering, we think they can take significant market share over the next 10 to 20 years". 

Lovisa (ASX: LOV)

"Lovisa has a unique offering where it's focused on specialised fast fashion accessories and jewellery. All the incumbent players have a more generalised, broader offering. And so it allows Lovisa to have more sales per square metre.

The offering really resonates with the consumer, typically younger females, and it's just as effective as it in Brisbane, as London as Los Angeles.

As we focus on our intrinsic value in 10 years time, we think they have the potential to have thousands of stores including across China. So, regardless what's happening with consumer, consumer strength, consumer sentiment, we think this business will be significantly larger in 10 years time". 

Price is what you pay, value is what you get

Hyperion has looked back over its performance and recognised that "portfolio management has added between 35 to 50% of our excess returns", notes Orthman. 

And whilst the number varies, depending on which portfolio you focus on, it shows the importance of portfolio management.

"Hyperion is obviously leveraged into long-term earnings, long-term compounding, but over short-term periods, we tend to be negative momentum or contrarian", notes Orthman. 

"By taking advantage of non-fundamental share price moves, that has allowed us to add additional alpha over time", says Orthman.

He goes on to explain that the market is so short-term driven, and by having a long-term lens, Hyperion can take advantage. 

"Share prices shouldn't be a signal. You shouldn't defer meaning to share prices. 

You should be focused on the fundamentals and the inherent earning strength of these businesses looking forward".

Orthman goes on to say that innovative companies tend to produce large levels of sustained profit growth over the long term. 

Final thought from Hyperion

To be an investor, you need to believe in a better tomorrow. And we think that holds true today more than ever. 

Investing isn't about what happened in the last five years, last two years, yesterday, next month, next year... it's really about being able to find those companies that are able to compound their success over long time periods.

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