market folly

Continuing our notes from the London Value Investor Conference 2013, the next speaker is Gary Channon of Phoenix Asset Management.  He talked about portfolio construction and presented a long idea: Glaxosmithkline (LON:GSK).


Channon's Investment Approach

Gary Channon is strongly influence by Warren Buffett and Phil Fisher. Phoenix is long-term, focused,  looking for great businesses run by shareholder aligned managers, companies with strong pricing  power, generating a high returns on capital. In short, they look for long-term greats.

The Phoenix  portfolio usually has around 15 stocks with the top 5 making up >60%. All the stocks are UK listed.  They carry out detailed research with extensive fieldwork and monitoring. Since inception in 1998  Phoenix has returned 9.6% net annualised or 290% in total. On a total return basis the UK market  has returned 4.6% per annum during the same time period. Phoenix have a high win/ lose ratio with  78% winners against 22% losers.

Channon talked about “Finding Opportunities in Flawed Heuristics”. A heuristic is a mental shortcut  that allows people to solve problems and make judgements quickly and efficiently. Channon argued  that investment heuristics like P/Es, price to book and EBIT lead investors to oversimplify and  misunderstand companies. At times these commonly used heuristics fail to identify stocks that are  really cheap creating opportunities for informed value investors.

Channon used the homebuilder, Barratt, as an example of how heuristics can fail. Historic cost  accounting creates a distorted picture of homebuilders in a rapidly rising or falling housing market.  The financial crisis wiped out IFRS earnings and made book value different from cost or market  value. No earnings and an unfathomable book value left the market without its usual heuristics of P/  E and P/BV which in turn led to the stock becoming cheap.


Long Idea: Glaxosmithkline (LON: GSK)  

Channon noted that the orthodox view of big pharma is that pricing power is being lost due to  patents expiring and therefore companies deserve to trade on a lower multiple than they did in  years gone by. Channon argued that this was a faulty heuristic.

Phoenix’s research on the pharmaceutical industry indicates that the pharma industry is not  prone to creative destruction with open competition leading to lower prices, rationalisations and  bankruptcy. Instead Channon painted a picture of pharma as being a cosseted sector, with high  profitability, little cut throat competition and little change. The time horizons in pharmaceuticals  are very long. All the big companies are at least 90 years old. It is hard for new companies to break  into the large pharma sector. New products take 10-12 years to develop. Companies tend to keep a  stable market share over time.

Glaxo has kept a steady market share at 5% for 30 years. You get stability and high returns due to  industrial scale, not new drug development. Channon argued that patents are irrelevant to the long-  term investor. National health care spending is much more predictive of profitability than the drug  pipeline. Health care spending tends to go up over time as a proportion of GDP.

Channon likes the Glaxo management particularly the CEO Andrew Witty. He believes that Witty  has successfully changed the culture with the company becoming genuinely socially responsible. For  example, Glaxo is working with the Bill and Melinda Gates foundation, they are open with their drug  test data and they are making some drugs available for free in poorer countries.


Book Recommendation

Alfred Chandler’s Shaping the Industrial Century – Channon said the book  is a great introduction to the chemical and pharmaceutical industries.


Be sure to check out other investor presentations: notes from the 2013 London Value Investor Conference.