Scottish Mortgage: Tech Stocks are Not Expensive

Hello and welcome to the Morningstar Series
“Why Should I Invest With You?” I’m Emma Wall and I’m joined today by James Anderson, Manager
of the Scottish Mortgage Investment Trust. Hello James.
Hello, pleasure to be here. So, firstly congratulations for winning the
Morningstar Analyst Outstanding Fund Manager of the Year. It was in part due to the performance,
but also to do with the process and I thought we could talk today about your approach to
markets. Because I think it’s quite interestingly contrarian and so far as valuation metrics
that most people use, you don’t think are particularly fit for purpose.
No, we don’t and it intrigues me Emma, because I think the period for which the traditional
metrics or at least the default metrics such as P/E on immediate earnings that people use,
have really not been explaining markets and companies for a very long period of time.
That maybe even more acute in some of the areas that we happen to invest in. But if
you think about it, if you are Jeff Bezos you aren’t trying to generate earnings for
this year. It’s about the decades to come and lifetime consumer value. So, I think it’s
logical that our valuation stresses those long-term categories. I find it quite irritating
in many ways because lots of people say, we don’t care about valuation. We think, we
do, we think we’re looking at the right valuation which is probability adjusted long term cash
flows. And it is incredibly difficult though to have
the scope to forecast the growth that some of these, in particular tech stocks have had,
before the camera started rolling you named for example Amazon (AMZN) and Tencent (00700)
and said if you’d rolled back time would you have been able to envisage the behemoths that
these companies have become? How do you do that now then, how do you ensure that you
are getting these judgement calls right? Well, the first thing is that we try very
hard to focus on that, because I do think there is a huge behavioural issue in fund
management that all that behavioral finance does show that people dislike loss much more
than they enjoy gain. But I think they underestimate how much that’s so for a professional fund
manager who is constantly berated for making mistakes. And at the same time, we live in
a world where in fact equity returns aren’t really explained by the normal company. They
are explained by the huge outliers. So, we try and spend a lot of time in our valuation
trying to work out what the top 5% of outcomes is. So, you are not saying it’s going to happen,
you are saying it’s trying to happen. But even given that frankly your two examples
were extremely good ones Emma. We didn’t get close to understanding the degree of opportunity
those companies – understanding how great a great company can be is truly difficult
but fabulously exciting. Because it focuses you on the opportunity.
And the other thing that we were talking about earlier is the idea that focusing less on
markets as a whole and naturally understanding the importance of just individual stock performance,
because if you are not invested in the whole market it doesn’t really matter what happens
there. I think that’s right. We were terribly influenced
by a paper written by Hendrik Bessembinder entitled Do Stocks Outperform T Bills? which
the obvious answer is No. Because actually your returns are dominated by a very small
number of companies and it’s trying to identify which ones have the possibility of greatness
that matters. The oddity around that is that to be honest you can still be quite diversified
and not capture any of these stocks. And I think that is the lesson that markets need
to think about much more. I still worry that there is a misperception about where returns
come from driven by, as you say, this concept that it is an asset class that delivers the
returns rather than individual companies. James, thank you very much.
My pleasure. This is Emma Wall from Morningstar. Thank
you for watching.

Paul Whisler

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