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March witnessed the third month of the fear-based swing to stocks perceived as short-term winners from the Ukraine invasion and Covid related supply chain issues. Think: materials and economically sensitive stocks. These same events also precipitated a knee-jerk move away from stocks viewed as 'growth' related at the same time. The ensuing impact on inflation from both of the above events added to fear-based motivations.

Consider this: Most stocks receiving current price lifts (commodities, energy & banking) tend to possess various combinations of low PEs, a history of business underperformance, low returns on invested capital, high Credit Default Swap prices, low sales growth, and lesser margin control. Few successful fund managers have enriched investors built around these factors. In the last few months these stocks outperformed by a large margin those that are; highly profitable, with strong margins and price control, long run earnings growth, lower debt, and not as reliant on macro factors (like inflation). It's interesting to note that many leading "value-managers', have also posted negative returns. Banking, industrial cyclicals, and housing related stocks generally trade on low P/E ratios, yet they too had their prices weaken recently. This is principally due to the 'supply side' commodity price shock at a time when macro-economic growth is weakening. This is not the environment for a rising tide to lifting all value stocks.

In our minds, this swing represents the same but opposing side of the unjustifiable prices that many tech/disruption stocks enjoyed until recently. Neither group are worthy of serious, risk aware and longer-term investment. It's why we invest in companies that can sustainably deliver strong above average Earnings Growth. Their stock prices tend to always follow (Barr the odd event-based, short-lived exception like the one we are experiencing now).

Are the businesses enjoying stock price rises today also the winners of tomorrow?

Lately we are all experiencing one tectonic event after the next. Foundations of the political and economic framework that have dominated much of the world since the 1980s are now being challenged; the impacts on globalisation, the questioning of the USD central role, and previously deeply embedded structural relationships in the energy markets to name a few.

Regular readers of our newsletter know that our approach is far less dependent than our peers are on these issues, including inflation and interest rates. The jury is still out on whether inflation will be a temporary or a longer-term phenomenon.

Covid and the tragic invasion of Ukraine have created significant commodity, energy, and labour mobility pressures. Companies that:

• can raise prices are clearly better placed than those that do not.
• enjoy high margins and operating leverage are better protected than low margin businesses with high marginal costs and no pricing power.
• possess high incremental return on capital may be able to not just defend their profitability but actually see it expand!

These are the required factors for a business to continue delivering healthy returns in real terms and are thus the same attributes Insync seeks.

Most companies are not able to do this. Those companies possessing the most levers to pull going into an inflationary period are also the most likely to protect and even thrive for their investors. There will likely be tougher times ahead, quality growth investors should find themselves better positioned than most to weather the storm and come out substantially ahead.

Why earnings power is crucial

A shy, humble investor living on a suburban street in a small mid-western US city is often cited for his quips.

"In the short-term markets are a voting machine. In the long-term it's a weighing machine"

Over shorter periods sentiment in markets can shift wildly depending on the narrative of the day. This is driven by perceptions of investors trying to gauge where we are in the economic cycle, the path of inflation and interest rates, the impact of a geopolitical crisis, and what style of investing will be best equipped for the future. These are impossible to predict with any degree of certainty or to do so consistently.

The one thing that is more certain over time is that in the long-term, share prices follow the consistent growth in the earnings of a business.

We know that the most profitable companies remain profitable even ten years later fuelled by the enduring, large megatrends.

Megatrends are so predictable you can set your watch by them. This is whether it is the rising importance of the Gen Z'ers, the acceleration in the number of people aged 70+, GDP+ growth in spending on skin and beauty, or the insatiable desire to spend on experiences. A portfolio of the most profitable companies tied to megatrends provides consistency in earnings leading to strong stock price returns. They are also mostly impervious to interest rate settings, the state of the economy or current commodity prices.

3 portfolio examples of why Earnings Growth is good for investors

The evidence shows it all. Here are 3 companies in our portfolio. The coloured line in each graph is the path of earnings over the past 10 years. The white line is the share price performance.

Observe the strong correlation between the earnings growth and share price performance. From time to time the two lines deviate based on an 'event', as is the case now. Obviously, present prices present an outstanding opportunity to invest.

These highly profitable businesses benefitting from Insync's identified megatrends have become even more attractive due to recent price falls. This is because their ongoing and established earnings power remains intact. Such excellent buying opportunities do not often present themselves.

The 'coiled Spring' phenomenon continues to gain energy.