Francisco Garcia Parames (Trades, Portfolio) runs Spain's Cobas Asset Management after delivering 16% annualized returns over 25 years at his former fund, making him one of the country's best portfolio managers. Ahead of his appearance at the GuruFocus Value Investing Conference, he took some questions from GuruFocus readers. The answers to those questions are below.
Question: What is your favorite indicator when you are checking the financial situation of a company? Do you think that the future of a good investment is more bounded to the ability of the company to keep growing (which probably will implicate a higher price-earnings ratio than the average), or it is better in your opinion to acquire more stable companies?
Francisco Garcia Parames (Trades, Portfolio): As value investors, we tend not to pay for growth, as we think that usually growth will already be reflected in the stock prices. Instead we focus our efforts towards companies with a stable business and competitive advantages which allow us to build a picture of how the business will be looking like within the next few years.
Talking about specific indicators, we usually consider the following ratios: ROCE, Unleveraged FCF Yield, P/E and Net Debt/EBITDA.
Question: What is your opinion of what is going on with the automotive sector in the last month? Do you think that the drop in share prices presents a good opportunity?
Parames: In general terms, we consider that the market is overreacting to the possible disruptive risks that threaten the sector. Additionally, the trade war between China and the U.S. plus fears of a possible global economic slowdown are affecting negatively expectations around the sector. Thus, in our opinion, those risks are already reflected in the stock prices and current valuations seem attractive to us.
Question: How do you calculate position weighting in a portfolio?
Parames: Any candidate company to enter the portfolio is compared in terms of business quality and potential upside against what we already own. If the candidate business has higher quality or is much cheaper, we can include it in the weighting according to which companies it “beats.”
Question: You have a few U.K. stocks in your portfolios (e.g., Babcock (BW, Financial), Dixons (LSE:DC., Financial)). Are you cautious of further investments in the U.K. because of the unknowns around Brexit, or do you see this as a buying opportunity? There would appear to be quite a few undervalued stocks in the FTSE.
Parames: We definitely see these kinds of situations as opportunities. Usually in cases like Brexit, there is fear about investing in the U.K., thus demand for U.K. stocks is scarce and we definitively like that issue to hunt for bargains.
Question: How do you value stocks, and what criteria do you use to find if your stocks are undervalued?
Parames: Our first point is try to understand the business, how it generates free cash flow (FCF) and how stable it is. Afterwards we try conservatively to think about a normalized FCF within the next few years.
Then, by applying a simple method of valuation focused on that FCF, we try to determine an Intrinsic Value of the business. Compare this value with Mr. Market´s mood and you have a picture if the company is under- or overvalued. We also look at normalized P/E ratios.
Question: I would like to ask for your opinion about dividends. Some people think that dividends are the only and genuine source of value. That is, a company has value because it can pay dividends currently or because it will be able to do it in the future. What is your focus on dividends? Are they important for you?
Parames: For us the main point is the value creation of a business, once the value in form of FCF is created, it can be reinvested into the business itself or passed onto shareholders via dividends or preferably via stock buybacks (if the price is right). Resuming, we don’t think dividends themselves are too relevant, it is more a byproduct than anything else.
Question: Why do you not show a target price and upside to mark to market at Cobas as you did at Bestinver starting in 2008?
Parames: We actually do show our target prices and upside in our monthly and quarterly newsletters / comments to our clients. Currently (beginning of March 2019) the target price of the international portfolio is €173 per share which implies an upside of 120%. Our Iberian portfolio has a target price of €176 implying a 68% upside.
Question: A question about your investment process: With so many different ways to screen for suitable investment opportunities from quantitative screens to general news reading and checking what other investors have invested in, how do you go about shortlisting your ideas? How do you decide which names to discard and which names to spend some initial reading time on, and then from there how do you decide whether to spend even more time or stop reading and move to the next idea?
Parames: We always start to explain ourselves in simple words what the researched company does, who their competitors are, how (and why) their market share has evolved in the last decade and lastly if it has any competitive advantage.
Then we compare that company against our owned ones in the portfolio in terms of valuation (cheapness) and quality of the business (ROCE). A stock to enter has to be better than what we already own, if not we discard it for time being.
If we still haven´t discarded the candidate, we look deeper at management, capital allocation and debt between other factors.
Question: In what order do you tend to research an idea – start with annual report, investor presentations and earnings call transcripts or some other way?
Parames: We always start first reading a candidate investments Annual Reports followed by investor presentations and earnings call transcripts.
See Francisco Garcia Parames' (Trades, Portfolio) portfolio here.
