Investment Commentary & Outlook – Q3 2020
In the third quarter of this year, North American stocks continued their rise from the depths of the March lows. In the face of ongoing uncertainty poised by COVID-19, an acrimonious US election contest, risks surrounding Brexit, and ongoing trade tensions between China and its western trading partners, equities confounded many skeptics, driven by low interest rates, incredible technological and social leaps forward in reaction to the pandemic, and optimism that the economy is well positioned to rebound in 2021 and beyond. While growth stocks generally fared better than value stocks over the past three months, the equity markets have begun to wrestle with the high valuations being accorded to high-growth companies versus the lower valuations ascribed to high-quality, but potentially more cyclical businesses. Pembroke’s investment team is asking the following:
- Are our more cyclical, pandemic-affected holdings selling must-have products, such as surgical equipment? If not, is end-market demand still expected to grow over the next three to five years, as is the case for recreational vehicles / campers?
- Are the end markets of any holdings, or prospective holdings, structurally challenged? Are enticing low price to earnings multiples really value traps as long-term earnings power continues to trend lower?
- Are the valuations associated with our high-growth holdings supported by large end markets, significant earnings potential, and demonstrable competitive moats?
- Finally, given the uncertain backdrop, are the holdings’ balance sheets unimpeachable, allowing the companies to manage through another period of economic disruption?
With those questions answered, the firm continues to run diversified portfolios centred on growth, but which are not overly exposed to momentum stocks with unsustainable, or at least highly risky, valuations. In essence, Pembroke is investing in companies that it believes offer a combination of quality and growth, but also reasonable risk-reward profiles. That discipline is informed by the current investment team’s experience through multiple economic cycles as well as by data and analysis collected over the firm’s 52-year history of investing in growth equities. With discipline and historical perspective in mind, we trimmed some stocks or sold them after they enjoyed large price increases, while others with less appreciated growth profiles were added during the third quarter of 2020.
While the market has run far ahead of what most investors would have expected six months ago, the universe of investable companies remains plentiful. The pandemic is creating new opportunities for innovative businesses adapting and catering to the new reality of a more digital economy. Some consumer discretionary companies offering their customers leisure activities closer to home are booming and are offering robust outlooks for the next few years. Others are offering low-cost products to consumers who find themselves facing tighter household budgets. On top of these trends, the market’s volatility and short-term focus is providing attractive entry points into proven companies that are facing short-term headwinds but have exciting multi-year growth opportunities. Some examples from our portfolios include a provider of back surgery components and a manufacturer of video systems to replace dangerous and ineffective mirrors on large trucks. The fact that Pembroke’s team continues to find new investments in this environment reflects our optimism for equities over the next several years. Risks, such as a disappointing recovery in 2021 or more political upheaval, are present and underline the importance of the firm’s balance sheet discipline; however, the unrelenting forces of change and innovation are also present and offer patient investors a chance to compound their wealth on a multi-year basis.
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This report is for the purpose of providing some insight into Pembroke and the Pembroke funds. Past performance is not indicative of future returns. Any securities listed herein, are for informational purposes only and are not intended and should not be construed as investment advice nor is it a recommendation to buy or sell any particular security. Factual information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Pembroke seeks to ensure that the content of this document is correct and up to date but does not guarantee that the content is accurate and complete and does not assume any responsibility for this. Pembroke is not responsible for decisions or actions taken or made on the basis of information contained in this document.