The courage of your convictions: investing through market discomfort

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In this episode of Value View, Simon Gergel explores why successful investing requires discipline, objectivity and conviction. Using Tate & Lyle as an example, he explains how long-term investors can look beyond market sentiment and behavioural biases to focus on business fundamentals and identify opportunities amid uncertainty. 

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Simon Gergel (SG): Even when it's painful, even when the shares are going down, you've got to be genuinely objective and really ask yourself, have I got something wrong? Or do I still have conviction in this? And do I still have belief in this? Human nature doesn't like losing money. There's a massive tendency to sell something after it's fallen in price.

Jon Cronin  (JC): Hello and welcome to a Value View from the Merchants Trust. I'm Jon Cronin, and in this episode I'm joined by Simon Gergel, lead manager of the Merchants Trust. One of the hardest things in investing is knowing the difference between a mistake and an opportunity. If a share price falls, is the market telling you something important? Or is it giving you a chance to buy more of a business you still believe in? That's what we're exploring in this episode. What conviction really means in investing. Simon, it's great to have you here in the studio.

SG: Hi, Jon. Great to be with you again.

JC: Well, let's just untangle some of this. First off, I suppose the obvious point to consider here is this is quite an emotional thing to face.

SG: Investing can be an emotional challenge. It can be very uncomfortable if you own a share and it goes down in price, even if you think it's worth a lot more than that. So, you have to look at those situations dispassionately and you have to think, has something new come out? Is there new information? Is there something that I'm getting wrong? Or is the business still as valuable as I thought it was and is this drop in the share price as an opportunity? I think that probably the hardest question to answer in investing is to separate where a share price going down is telling you something is seriously wrong in a business, and other times when it's actually a big opportunity.

JC: Okay, Simon, so build on that idea for me, a little.

SG: Conviction is not about blind faith in an investment. It's about continuously challenging yourself and challenging the investment thesis and looking for reasons why you might be wrong to build confidence in why you take that view. But if you've challenged that, and if you've really dug into it and you've continued to analyse what's going on and you're convinced that actually there's nothing significantly changed and the shares have got cheaper, then arguably you should even be buying more of that company, investing more money in it, because it's offering better value than it was before. But separating the wheat from the chaff, you know, the good from the bad is the probably the hardest thing.

JC: Okay, let's do a bit of that. Let's separate a bit of the wheat from the chaff. Give me an example of this in action.

SG: One example is a company called Tate & Lyle, which a lot of people still think makes sugar.

JC: It does, isn't it? They’re a sugar company. I saw the packet of sugar in the supermarket the other day.

SG: Well, they sold their sugar brand a long time ago in the UK, and they've even sold out of the equivalent of high fructose corn syrup in America, which they were making for many, many years. They sold out of that quite recently. So, they've transformed the business from essentially sugars and sweeteners to much more value-added ingredients. So, the business is fundamentally changed, and it's much more now about helping food producers change the characteristics of food. So, taking out sugar, replacing with low calorie sweeteners, adding dietary fibre, adding products that make the product feel different, tastes different in the mouth and adding other characteristics.

JC: Okay, well, that's a very different company from the one that I thought I knew. I guess what you're saying here is that there's a big difference between perception and reality.

SG: There can be, I think a lot of people still think of Tate and Lyle as a commodity type business, rather than a company making speciality ingredients. And the difference with that is commodity ingredients you might sell by the ton, speciality ingredients you might sell by the kilogram and you need relatively small quantities, but they can make a lot of difference to the end product and therefore be much more valuable.

JC: Why then, if a company has improved itself, changed what it does, made itself more relevant, all those things you've just described with Tate and Lyle. Why hasn't the market rewarded it?

SG: I think that's a great question. There are two real drivers as to why the shares have been weak. The first is that the transformation process has been quite expensive, quite costly. So, if you're imagining you've got a lot of profits of commodity type products, which you're selling, you're giving up a lot of profits and you're reinvesting in higher value, more speciality areas. And so often the amount of profits they're bringing in is maybe slightly lower than the profits they're exiting. So, the profits of the business have come down. There's been some downgrades to earnings expectations because of that process. Now we would argue the quality of the earnings is much higher. So, investors should pay more for those earnings today than they used to. But there are slightly lower earnings because of that transformation. And then the other thing which has happened coincidentally, which makes it even more difficult, is we're going through a very difficult patch in the end markets. So, if you take the American market, which is their biggest market, the amount of food sold in supermarkets in America went down last year, which is almost unheard of. Consumers were under a bit of pressure from rising costs, rising energy bills and food costs. And so, they tighten their belts, they actually spend a little bit less, or they bought a little bit less volume of food. And lower volume is really a problem or a challenge if you're a food producer or ingredients producer because you're selling less product. So, the end market was a bit tougher in the year than or quite a bit tougher than we thought or they thought it would be. And so again, you had another earnings downgrade. So, you had two lots of earnings downgrades for a business which is fundamentally getting better in our view in terms of the quality. But the stock market hates earnings downgrades. It doesn't like negative momentum as we sometimes call it. And so, the shares have actually gone down and been de-rated, the valuation of the company is trading at a lower multiple of profits today, significantly lower than it was a couple of years ago, even though the quality of those profits has improved.

JC: So like you say, you can have a better business but worse sentiment.

SG: Yes, absolutely. The sentiment has got worse as the quality of the business has improved.

JC: I just want to build on this a little bit more Simon and is a phrase that many people have used over the years, and that's having the courage of your convictions. what does that mean in practice for you?

SG: It means in practice that even when it's painful, even when the shares are going down, you've got to be genuinely objective and really ask yourself, have I got something wrong? Or do I still have conviction in this? And do I still have belief in this in this investment case? And if you do have conviction, then actually the right thing to do very often is to buy more of that company, to build your position back up, to reflect the greater opportunity there is from a lower price. That's the challenge is to have that conviction. It's very easy to say in principle, it's actually very hard to do in practice.

JC: And I guess it's a bit counterintuitive as well. The instinct surely must be; it's down, I just want to get rid of it.

SG: Human nature doesn't like losing money. It doesn't like things that are going against you. There's a massive tendency to sell something after it's fallen in price and to want to buy things that are going up in price. And that's what makes cycles in markets. That's what leads to periods of overvaluation and undervaluation. So as a value investor, you have to train yourself to potentially go against that natural instinct and be almost rushing in when people are rushing the other way.

JC: Well, let's dig into that, that reference to human nature there. What would you say to investors who find it just very hard, from an emotional perspective to do exactly what you're describing?

SG: It is hard. I either don't try to do it yourself. So you can…

JC: Get a professional.

SG: You can employ a professional who has spent a long of time training themselves and being trained to do that. Or some investors simply buy passive funds and just track the whole index because they don't want to have that emotional rollercoaster. But, if you want to do it yourself, then you really have to practice and train yourself and try to be objective all the time, right? One of the good things to do is write down your investment case and ask yourself what has really changed. And it may well be that things have changed. Clearly there are things that have changed in any investment from time to time, but if you write it down and go back to that and ask yourself, has something really changed or not? That's a really good way of checking whether there's your emotions are driving your decisions or whether you're still being objective.

JC: And I guess when it comes to the market, Simon, what you're saying is that share price is information, but it's not the whole story.

SG: No, I mean, it can be an important clue. It can be a pointer that something has changed, but it can often get it wrong.

JC: Okay. Well, it's a fascinating conversation. Fascinating thoughts. Simon, any final thoughts that you have on this?

SG: I think the final point is simply that as an investor, you have to try to be as objective as you can, try to be as disciplined as you can, and work out where your personal strength is in your personal emotional behaviour. If you're not the sort of person who can be contrarian, you shouldn't try to adopt a contrarian investment philosophy, and you might be better off with a very different approach. There are many, many ways to invest in the markets. But if you want to follow the type of approach we follow, then you have to be really disciplined and sometimes go against the initial behavioural response.

JC: Okay. Well, Simon, thank you so much indeed for your time. Great to have you here in the studio.

SG: Thank you, Jon. It's great to be here again.

JC: And if you enjoyed this episode of Value View, do subscribe, comment below and share it with anyone interested in how long term investors can make decisions when markets get uncomfortable. And you can find out more about the Merchants Trust, and read and watch Simon's latest investor notes by going to Merchants Trust.co.uk Next time we'll be talking to Simon about his 30 years of experience and what it's taught him.