Rewarding mediocrity: A participation trophy for investing
Investors are chasing consistently average businesses, ostensibly for “safety”, with the idea that if you don’t expect much, you won’t be disappointed.
Take AMD1 vs. Intel for example
Advanced Micro Devices, Inc. (AMD) has been outperforming for the last 5 years under the leadership of Lisa Su – growing at an accelerated pace and continuing to gain market share on its competitors… trading at an estimated Forward Price/Earnings Ratio (P/E) of 28.3x.
Considering its growth, AMD has a Forward Price Earning to Growth Ratio (PEG) of 0.86x with a strong balance sheet – Net Cash of $2.9B and $4.B expected free cash flow in 2022. And it has an expected Long-Term Growth (LTG) of 33%, but the stock is down 24% so far in 2022.
Intel is a well-known brand but is a mature business that has repeatedly failed to execute and has been losing market share for years. The new CEO is trying to catch lightning in a bottle again with an ambitious plan to reinvigorate growth – however, the hurdle is very high to successfully navigate such a transition.
Trading at an estimated Forward P/E of 12.9x, Intel (INTC) is not so cheap when considering its growth. With a forward PEG of 2.1x, Intel’s dividend offers a healthy yield, but has a weakening balance sheet – Net Debt of $3.9B and little or no expected free cash flow in 2022. With an expected LTG of 6%, INTC is down 13% so far in 2022.
Punishing companies for seeking growth
For example, in the spirit of delivering more consistent results, oil & gas exploration companies have been forced by institutional investors to become “green” and forsake production growth. Devon Energy’s CEO, Rick Muncrief, recently stated as follows:
“With fundamentals signaling maturing demand dynamics for our industry, we fully recognize the traditional E&P model of prioritizing only production growth is not the correct strategy going forward. To optimize value creation in the next leg of the energy cycle, a company must deploy a financially driven model that prioritizes free cash flow generation over production growth.”2
A participation trophy for investing
Choosing financial engineering over real growth doesn’t bode well for economic growth. Expect business investment to lag since it will not be rewarded. Continuing this point from above, Devon is planning to limit top-line production growth from 0-5%, according to Muncrief. Lower levels of business investment would have a significant impact on the US economy since it is an important driver of GDP growth. It’s kind of like a participation trophy for investors.
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All performance numbers and statistics are from Bloomberg as of 3/2/22
¹ As of publication date of this article, Validus owned AMD in the Validus Global Growth Separately Managed Account.
² Source: “Devon CEO Urges Lower 48 E&Ps to Focus on Generating Cash, Limiting Oil, Gas Production” (May 5, 2021). The Natural Gas Intelligence (NGI)