SA Interview: Growth At A Reasonable Price Investing With Value Alpha

Feature interview

Value Alpha is an individual investor with 12+ years of experience in strategy, M&A and investment decision making across multiple industries including services, healthcare and telecom. We discussed leveraging professional experience or expertise to gain an investing edge, the types of companies that could actually benefit from a potential recession, and why there is still an opportunity for mispricings in spin offs.

Seeking Alpha: Walk us through your investment decision making process. What area of the market do you focus on and what strategies do you employ?

Value Alpha: One of the reasons I don't write too many articles is because I am highly focused on areas where I have expertise in either due to my professional experience or having followed the space for many years (e.g. service businesses and healthcare). This is something I learned from reading some of the literature from Peter Lynch where he advises retail investors to use their existing knowledge about industries where they are already working in to give them an upper hand over others.

Once I have identified areas of interest, I tend to perform a deep fundamental analysis of the business and fully understand the value drivers (i.e. what is driving the price and quantity of the products and services which the company sells and how will management generate/maximize profits). Over the years, I have gravitated towards over-indexing on the quality of the people who are running the business and spending more time on ensuring their credibility.

SA: To follow up, can you discuss how you identify mispricings and catalysts that are not priced in by the market? Can you give an example?

Value Alpha: Once I have calculated the fundamental value of an asset and determined it is higher/lower than the market price, I like to think about whether there are any near term catalysts which will close the gap between the two. In some instances, it may take a very long time for this gap to close; for example if it's a thinly traded stock where investor interest may not pick up despite a mispricing. I generally find that mispricings are more common in areas which are not as well understood by the investment community. The B2B space is an example of this as most retail investors don't fully understand the criteria which large/complex businesses use to buy products/services from other businesses. For example, in a recessionary environment, a large business looking to cut costs may consolidate its vendors leading to some of their vendors actually generating more business from them while others lose out. Knowing which vendors may benefit from this situation can help investors identify opportunities at an early stage.

SA: Is new management alone a catalyst, or at least a reason to look further into an idea? What specific things do you look for in management?

Value Alpha: As I mentioned above, over the years I have increased my focus on assessing the quality of management teams and talent employed by a company when making investment decisions. In my opinion, this has become the single greatest factor which determines the success of a business in current times. A data point which illustrates the importance of talent is that 90% of the S&P500's assets today comprise of intangibles (IP, customer relationships etc.) whereas this figure stood at 17% in 1975. These intangibles are mostly tied to people who create/maintain them whereas in previous times physical assets (which are generally people agnostic) were a greater determinant of a company's value.

When looking at management, I specifically look for a track record of success and credibility (i.e. do they actually do what they say). It is also important to look at what failures people may have experienced in the past and how they remedied them.

SA: All else being equal, do you think there are more opportunities (or mispricings) in Canadian vs U.S. equities? If so, why do you think that is and how can investors take advantage of this?

Value Alpha: There are factors which lead to mispricings in both markets. Canada is a much smaller market than the US and good assets generally take longer to come to the forefront which can allow investors to take advantage if they identify these opportunities earlier. For example, a lot of smaller Canadian companies may take a few years to list their stock on a US exchange while growing through a hyper growth phase. Having said that, I do think that the sheer size of the US market means there are numerous great businesses that are flying under the radar at any given time and the US also has a much more diverse economy compared to Canada which provides greater opportunities for investors specializing in different areas.

SA: Is there a contrarian buying opportunity for any industries/stocks that will suffer less than the market has priced in (or even benefit) due to a potential recession?

Value Alpha: In my recent article on TELUS International (TIXT) I discussed the historical experience of service businesses which allow their customers to take advantage of rate arbitrage between different countries. In a recessionary environment, large businesses initially look to cut costs however eventually realize that they need a low cost and sustainable way to keep growing in the future. Once this happens, they look to external service providers to provide lower cost resources. I believe the demand for lower cost resources in offshore geographies will keep growing as we see cost pressures in many Western nations (e.g. constant minimum wage increases in Europe).

SA: Can you discuss best practices for doing a peer comp and relative valuation analysis?

Value Alpha: This is an area where I don't think many investors spend sufficient time. In order to perform a reliable comp analysis, we must first ensure that the data we are using is on an apples-to-apples basis. Differences in accounting practices may require investors to make adjustments to the financial figures of some companies in their comp set. Also, investors should account for differences in growth rates and profitability when judging differences between comps.

SA: Do you find mispricings in spin offs, even though this opportunity is so well known? What are traits of an ideal spin off?

Value Alpha: Some of my best ideas have been spin offs so I may be somewhat biased on this one. I do believe spin-offs are not always well understood which allows savvy investors to take advantage of mispricing situations. For example, TELUS International spun out of TELUS Corp which is one of the larger telecom companies in Canada. Most people see TELUS in the company name and assume it's a telecom play thus missing the significant opportunity to invest in areas such as digital transformation and AI. Another great spin-off I have followed over the years is VMD which has performed very well.

SA: What’s one of your highest conviction ideas right now?

Value Alpha: I really like QIPT. I have written about this one several times and have invested in it whenever there has been a temporary downturn in the stock price. I wrote about it in my recent article as well (the stock price is up ~40% since however I believe there is further upside). The company saw a recent weakness in its share price owing to industry wide headwinds which did not deteriorate its fundamental picture hence creating a mispricing situation. I believe QIPT is still undervalued compared to peers and has access to capital to undertake a Multiple Arbitrage strategy towards value creation which I discussed in my article. This is definitely a business whose fortunes took a huge turn when the new management team took over. The company has multiple growth vectors owing to industry tailwinds in the healthcare space, availability of many assets to undertake their consolidation strategy and possibly being a prime M&A target as there aren't many mid-size DME providers in the US.

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Thanks to Value Alpha for the interview.

Value Alpha is long TIXT, QIPT and VMD