Key insights
- In our view, markets have greatly underestimated the earnings and cash flow recovery potential from many companies hard hit by the pandemic—to us, that represents the opportunity for future performance.
- We remain focused on not paying a price for a stock that reaches beyond its future earnings recovery and growth.
- Beyond the immediate recovery, we anticipate more defensive positioning and investors' renewed focus on valuation.
In the early weeks of January, after morning commutes to corners of bedrooms and repurposed dining room tables, we conducted our first client portfolio reviews of 2021. The approval of highly efficacious Covid-19 vaccines in the fourth quarter 2020 had, as we expected, halted the long-running outperformance of quality/momentum/growth stocks. The cyclical value exposure Causeway had increased throughout the pandemic ignited an enormous rebound in November. Our clients asked, how much further can these cyclical stocks run? We believe there is still meaningful upside in client portfolios, particularly in operationally geared companies on the verge of revenue increases. These companies, poised to regain the market's attention, are our highest conviction examples of what should be a broader recovery ahead for cyclical and value stocks.
We recognize that undervaluation without any prospects for growth is insufficient for outperformance. That is why, in our clients' fundamental portfolios, we have emphasized companies with substantial operational gearing that allows them to deliver outsized profits as a percentage of revenues. We have identified, and continue to vet, portfolio companies run by talented management teams who are using the Covid crisis to make their firms more profitable as business improves and revenue growth resumes. In our view, markets have greatly underestimated the earnings and cash flow recovery potential from many companies hard hit by the pandemic—to us, that represents the opportunity for future performance.
For several portfolio companies in economically cyclical industries, 2020 was supposed to be the end of a multi-year investment cycle, with ensuing years of capital return to shareholders. Covid replaced those plans with a scramble for liquidity. Portfolio companies with revenues most affected by lockdowns, in aerospace, aviation, and travel/leisure, have used this crisis to dramatically reduce their costs. Most have implemented efficiency programs, accelerated implementation of advanced information technology, and migrated computing to the cloud. We spent much of last year gaining exposure to many companies undergoing what we estimate will generally be the most effective operational restructurings.
From our valuation models, we share examples of these companies to highlight this recovery potential.
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