Our Investment Philosophy

‘Investing in quality, undervalued companies entering an earnings upgrade cycle.’

Alphinity’s investment philosophy seeks to identify and invest in attractively valued, quality companies in, or about to enter, an earnings upgrade cycle.  Simply put, we look for stocks that can deliver ‘earnings surprises’ to drive outperformance.  If a company is in an earnings upgrade cycle and attractively valued, there is a strong likelihood it will outperform.

A company’s earnings ultimately will drive its share price performance over time.  The share price will, at any given point, reflect the market’s future earnings expectations.  However, the market is typically inefficient at accurately pricing future consequences of new information that will affect company earnings.  Clearly identifiable characteristics exist for companies whose earnings ability is likely to be under (or over) estimated by the market, allowing an investor to exploit this inefficiency to create outperformance.

A typical earnings revision path is shown below. We will enter a position when earnings per share for a company are underestimated by the market. We then sell the position when the share price runs too far ahead of our earnings estimates.

25256_Figure1-Typical-company-earnings-cycle

Our approach has solid backing in academic research and statistical analysis, as well as in practice over a long period of time.  For more detailed background please refer to our research paper “Finding alpha in an earnings upgrade cycle“. In summary:

  • a positive earnings announcement by a company is more likely than not to be followed by a period of sustained positive earnings revisions/surprises driving share price out performance (and vice versa for negative announcements);
  • earnings revision cycles can be explained by the gradual nature of business cycles as well as human behavioural biases; and
  • the investment performance from investing in companies in an earnings upgrade cycle (called Momentum) is enhanced when combined with Quality and Valuation factors.

Using a ‘relative earnings surprise’ approach is unique in the Australian market. We do not wait in hope for a turn in company fortunes or expect sustained earnings growth into perpetuity and as such see our investment philosophy as very much a “Core” approach, rather than being strongly style-based.  The diagram below depicts a company’s earnings life cycle and demonstrates our preferred time to invest. We believe these types of investments can be found at any point in the broader market or economic cycle.

25256_Figure 3- Investment clock_Wide_V2

Buying and selling are equally important.  The greatest risk with using an earnings revision-base investment approach is the risk of missing the end of the upgrade cycle. By combining earnings revision factors with quality and valuation factors, growth and value traps can typically be avoided.