In Part I I explained that we let the strong management of our great companies generate value for us over time, and in Part II that our returns are generated by avoiding big losers – the companies we don’t own. The final reason that we are navigating the storm in Europe is that we boost returns by making decisive purchases at opportune times.
The image above shows our European portfolio turnover in the last 12 years – how often we traded by selling existing positions and buying new positions. What you see is that we usually don’t trade much; we usually hold our companies for the long term. But we do trade in the times of greatest opportunity, when some high-quality stocks on our Dream Team list are offered to us at very attractive prices.
For Burgundy’s annual Client Day this past May, I looked at the specific companies that we added to our European portfolio since the beginning of the Euro Crisis (August 2011). As of April 30, 2012, the top-three additions (in terms of returns) had already made an average return of 39%. Equally as interesting, the bottom-three performing companies were still up about 7%. Prior to our purchases, the share prices of these companies had fallen, on average, by almost 30% from their previous highs. These large price declines enabled us to purchase Dream Team companies at attractive price/earning ratios of about 11 times earnings, on average.
The sell-off in the Great Recession, after Lehman went bankrupt in late 2008 and early 2009, was another rare opportunity to buy Dream Team companies that are not usually inexpensive enough for us to buy, with prices that had dropped an average of 40%. Because we purchased them at such bargain prices, we were able to make some attractive returns on these Dream Team companies that ranged from 29-122%, as at April 30, 2012.
I’d also like to point out the price/earning ratios at which we purchased these companies – the average multiple was about 12 times earnings. Using a free-cash-flow valuation model, a company is worth about 12 times earnings if it maintains its current earnings – i.e., its earnings will neither grow nor decline, ever. This is a cheap price that’s rarely available for such high-quality Dream Team companies, but it’s not the statistically cheapest prices that were available during the recession. We chose to use the recession to buy the best companies we could at inexpensive absolute prices, and this is why we were able to build a portfolio that could achieve such profits in difficult times, and therefore weather the storm effectively.
Over the next number of years there are many clouds in the skies over Europe, and some storms continue to brew. But I also know that over the last 12 years the skies were often cloudy and Burgundy successfully navigated through some huge storms. So, overall, I suspect that our approach will work in a similar way going forward, and I encourage our readers not to let the macroeconomic news headlines drive their investment decisions. When there are some inevitable bumps along the way we will continue to do our best to capitalize on the big opportunities that those bumps provide.
Rest assured that Burgundy’s portfolios consist of companies that can navigate some rough storms. There may be temporary delays, but we’ll continue working hard to get our clients to their destination.