February 04, 2019

David Kirk’s Blog - The Tide is Turning for Relative Return

By David Kirk, Bailador Co-Founder

You may be aware that Trade Me, the New Zealand based online classifieds and marketplace business is likely to be sold to global private equity fund Apax Partners in May this year. The board of Trade Me, of which I am the Chairman, has recommended that, in the absence of a better offer, Trade Me shareholders should accept Apax’s offer to buy Trade Me. The company is now proceeding through the Scheme of Arrangement process.

Apax has offered to pay NZ$6.45 per share for Trade Me, valuing the company at NZ$2.7 billion. Trade Me was listed on the NZX back in December 2011 at NZ$2.70 per share. Shareholders who invested in Trade Me when it was floated in December 2011 and who reinvested dividends along the way, have received a 17.8% annual return on their investment. That’s a great return over more than seven years but not so surprising, given Trade Me is a very high-quality business.

What is surprising however is that the NZX50 has returned 15.3% per annum in the same period. It seems strange that over seven years an Index of 50 companies, amongst which there must inevitably be a few great businesses, some good businesses and lot of mediocre businesses, only under-performed a truly great business by 2.5% per annum.

How can that be? In my view the answer is a rising tide of cheap money has lifted the valuations of a lot of businesses beyond their true worth. Over the past seven or eight years, investors have been able to invest in an Index or a group of ordinary companies and achieve more than acceptable returns. The long-run annual after inflation return on an investment in equities in New Zealand has been about 6.5%. The inflation rate in New Zealand from 2011 to 2018 has been about 1.5% per annum, which makes the after inflation annual return on the NZX50 for this period 13.8% — more than double the long run average!

I have no ability to forecast the future so have no idea when this highly unusual period in equities markets will change but the last quarter of last year was notably more volatile than we have seen for many years.

My point in setting out the above is to make it clear that the days of being able to make good returns by simply tracking an Index or investing in a mediocre group of businesses will come to an end sometime and that time may be soon.

How should investors respond? The answer to this will of course depend on each investor’s personal circumstances, but an important component will be an increased focus on absolute, not relative return. That is, a focus on the fundamental, underlying market position and sustainable growth prospects of individual companies.