ENSEMBLE FUND INVESTOR LETTER – FOURTH QUARTER 2018
Below is the Q4 2018 quarterly letter for the ENSEMBLE FUND (ENSBX). This quarter’s Company Focus is on Charles Schwab Corp (SCHW) and Sensata Technologies Holdings PLC (ST). You can find historical Investor Communications HERE and information on how to invest HERE. Enjoy!
The performance of the Ensemble Fund (“the Fund”) this quarter was quite weak both due to the overall equity market decline and the fund underperforming. The fund was down 15.79% vs the S&P 500 down 13.52%. Due to our strong performance in the first nine months of the year, our full year performance was essentially in line with the overall market with the fund down 4.43% vs the S&P 500 down 4.38%.
As of December 31, 2018
|4Q18||1 Year||Since Inception*|
*Inception Date: November 2, 2015
Performance data represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment in the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than the performance data quoted. Performance data current to the most recent month end are available on our website at www.EnsembleFund.com.
Fund Fees: No loads; 1% gross expense ratio.
The decline during the quarter was driven by 25%+ declines in Trupanion (1.9% weight in portfolio), Netflix (5.9% weight in portfolio) and Ferrari (7.8% weight in portfolio). On the more positive side Starbucks (4.0% weight in portfolio) was up 14% while Oracle (4.4% weight in portfolio), Sensata Technologies (6.4% weight in portfolio), Verisk Analytics (3.2% weight in portfolio), First Republic Bank (7.4% weight in portfolio) and Paychex (4.8% weight in portfolio) declined by about 10%.
With all of our holdings except for Starbucks declining during the quarter, despite these company’s serving a wide variety of customers and geographies, it is clear that a broad-based shift in market expectations has been the primary driver of performance.
The gain in Starbucks was a continuation of outperformance for this stock as the company showed progress towards reaccelerating the business and laid out at their Investor Day what we believe is a very credible long-term business plan. After a period of time earlier in the year when the stock was quite cheap, and we acquired our position, the 40%+ rally from the lows of the summer to the end of year highs brought the stock much closer to our assessment of fair value. We believe the company offers a unique combination of dependable results and solid growth. While many other defensive stocks have been valued at levels we view as too expensive in recent years, the brief growth scare this past summer opened up an opportunity in Starbucks, although that opportunity was relatively short lived with the stock sharply outperforming the broader market and the consumer discretionary sector over a very short time period.
The outperformance of Oracle’s stock that we noted last quarter continued into the end of the year. In last quarter’s update, we noted that despite weak revenue growth, cash flow is growing nicely as they transition their client base to software as a service-based offering. The company’s prodigious cash flow has allowed them to buy back $20 billion worth of their stock in the last two quarters or approximately 11% of the entire company. While many investors see Oracle as a mature tech company that is being left behind by the Amazons and Googles (4.5% weight in portfolio) of the world, we see a cash flow machine that we expect to continue producing buckets of cash for a very long time. We would note that it was only a few years ago that most investors had relegated Microsoft to the dustbin of uninteresting, mature tech companies, only to have the stock double over the last three years and become the most valuable stock in the world surpassing Amazon and Apple (2.0% weight in portfolio). We would also note that we’re not the only investors who are positive on Oracle with Warren Buffett’s Berkshire Hathaway establishing a position in the company during the third quarter.
The selling in both Trupanion and Netflix that we highlighted last quarter continued, with Netflix declining despite reporting very strong third quarter results and Trupanion’s results exceeding analyst expectations. We believe Netflix’s stock declined primarily due to the general “risk off” market environment. While many investors believe that the stock is too expensive, even after the recent decline, in October we wrote on the Intrinsic Investing blog about how the company is intentionally keeping their subscription price well below what customers are willing to pay. If you assume, as we do, that the company could reasonably charge between $15-$20 a month for their service vs the $10 they charge today, earnings would explode higher. Assuming this higher level of pricing and the current subscriber count, the stock ended the year trading at just 12 times earnings even while it continues to grow its subscriber count at 25% a year. Now certainly we don’t think Netflix could reasonably raise their pricing to this higher level over night, but we also think it would be foolish to think that the service, which won more Emmy’s this year for its own original programing than any other media company, is only worth $10 a month.
Ferrari was another stock experiencing significant weakness in the quarter. After attending the company’s analyst day in Italy back in September, our enthusiasm for the company is unabated. We believe the stock’s relative weakness this quarter has been due to first, the fact that it is an Italian company with a primary stock listing in Italy while market concerns that Italy may eventually exit the European Union have increased, and that it is a European car company at a time when the US is threatening to levy additional tariffs on cars imported from Europe. However, despite being headquartered in Italy, Ferrari’s customers are global and while an Italian economic crisis could cause some short-term challenges for the company, we do not think it is a long-term risk to the success of their business. On tariffs, we are certain that the ultra-high net worth customers of Ferrari are not going to suddenly feel like they can’t afford a new one if tariffs are raised. While an increased tariff on a Volkswagen might cause a US customer to buy a Ford instead, there are essentially no substitutes for a Ferrari and we do not think new tariffs are a material risk.
While that covers some of the company’s specific activity and news flow in the fund this quarter, the real story was the significant repricing of the overall market over the last three months that appears to us to now assume a US recession in 2019 is almost a sure thing. This is a sharp reversal from the increasingly optimistic economic outlook the market embraced over the course of the first three quarters of the year. At this point, the S&P 500 is trading at just 15 times current earnings, the cheapest level since 2013. We believe any economic optimism about continued growth, let alone a continued acceleration of growth, has now completely been removed from investors’ expectations. Given persistent investor concerns that the stock market is overvalued, it is worth noting that 15 times earnings is as cheap as the US stock market has ever been during the past 30 years other than very brief periods at the depths of the financial crisis and the very beginning of the massive bull run of the 1990s.
Investors should consider the investment objectives, risks, and charges and expenses of the Fund carefully before investing. The prospectus contains this and other information about the Fund. You may obtain a prospectus at www.EnsembleFund.com or by calling the transfer agent at 1-800-785-8165. The prospectus should be read carefully before investing.
An investment in the Fund is subject to investment risks, including the possible loss of the principal amount invested. There can be no assurance that the Fund will be successful in meeting its objectives. The Fund invests in common stocks which subjects investors to market risk. The Fund invests in small and mid-cap companies, which involve additional risks such as limited liquidity and greater volatility. The Fund invests in undervalued securities. Undervalued securities are, by definition, out of favor with investors, and there is no way to predict when, if ever, the securities may return to favor. The Fund may invest in foreign securities which involve greater volatility and political, economic and currency risks and differences in accounting methods. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. More information about these risks and other risks can be found in the Fund’s prospectus. The Fund is a non-diversified fund and therefore may be subject to greater volatility than a more diversified investment.
Distributed by Rafferty Capital Markets, LLC Garden City, NY 11530.
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The information contained in this post represents Ensemble Capital Management’s general opinions and should not be construed as personalized or individualized investment, financial, tax, legal, or other advice. No advisor/client relationship is created by your access of this site. Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. If a security discussed in this blog entry is owned by clients invested in Ensemble Capital’s core equity strategy you will find a disclosure regarding the security held above. If reviewing this blog entry after its original post date, please refer to our current 13F filing or contact us for a current or past copy of such filing. Each quarter we file a 13F report of holdings, which discloses all of our reportable client holdings. Ensemble Capital is a discretionary investment manager and does not make “recommendations” of securities. Nothing contained within this post (including any content we link to or other 3rd party content) constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instrument. Ensemble Capital employees and related persons may hold positions or other interests in the securities mentioned herein. Employees and related persons trade for their own accounts on the basis of their personal investment goals and financial circumstances.