Transcendent Companies

My first passion is investing, but away from work, I truly enjoy going out for dinner – whether it's burger bars or Michelin stars, sharing meals with friends and family is my favourite thing to do outside of the office. Living in London I am spoilt for choice, so choosing the right restaurant is of utmost importance. To help me choose, I like to understand the ethos of the restaurant. Things such as having a chef patron (chef and owner), using quality produce, and buying their food locally, tend to be strong indicators that I will enjoy my meal. In my opinion, a restaurant’s philosophy when it comes to food is a better indicator of your future meal than any review or past visit can determine - no matter how good or bad a restaurant once was, it is always the meal that lies ahead of you that you will be eating. I think the same is true for investment.

It is safe to say that with more than six years under our belt and having delivered in excess of 130% (I class Acc as at 29/02/24) since the inception of the WS Blue Whale Growth Fund, our long-term performance has been good. However, it must be pointed out that past performance is something a new investor cannot benefit from. It is also no guarantee of how we will perform in the future. Therefore, it is important that new investors in the Fund, or people who wish to put more money into the Fund, understand our investment philosophy and how we intend to drive performance in the future. Like going to a restaurant, it is only the food in front of you that you will see the benefit of – any previous meal, and past performance, is unobtainable.

Our investment philosophy is to buy high-quality businesses at attractive valuations. But what does this mean? The concept of a “quality” business is hard to explain. Most investors want to buy into high-quality businesses, but the metrics to determine those businesses vary drastically. Looking at commonly used valuation metrics in isolation can often lead to a false conclusion, so we think it best to get a deep understanding of a business to derive its “quality”. To distil “quality” into a single sentence I would say – “a quality business is one that can transcend the macro-economic environment to deliver share price growth based on its strong fundamentals.”

Finding transcendent businesses

Finding these businesses is relatively simple in theory. Once we have established a company has strong fundamentals through our proprietary research, we look to see if that business can leverage a global trend. Often described as mega-trends, they tend to use technology to drive a fundamental change in the global economy. Examples in the past have been the industrial revolution and the rise of the internet. Digitalisation continues to be a global mega-trend, and many think the next mega-trend is automation and artificial intelligence.

To drive outsized returns regardless of the economic environment and to find these “transcendent companies”, we look for those businesses that can leverage these mega-trends and invest in them at an early-enough stage so that we are benefitting from their upside potential.

Here, Nvidia is a great example. We initiated our position in Nvidia in 2021 having established the business as having strong fundamentals and noticing that it was a key beneficiary of the “AI revolution” due to its production of the world’s best high-powered processing chips. In early 2022, as valuations were reset on high interest rate expectations, the stock fell back considerably. As the share price fell, we continued to invest more into the business as its valuation became even more attractive. But whilst macro-economic indicators continued to deteriorate in the second half of 2022 (interest rates continued to rise predicting a tougher environment for equities), Nvidia bounced back strongly. Since we initiated our position, when the company stood at around $500 billion, the company’s market capitalisation has gone up more than 4x to make it the world’s third largest business and worth around $2 trillion (as at 29/02/24).

Thanks to its strong fundamentals and its importance in providing key hi-tech components for artificial intelligence, Nvidia was able to transcend the macro-economic indicators that could have weighed on its share price. Even when considering the initial fall in 2022, the share price was able to triple from its 2021 peak whilst economic indicators worsened.

Opportunity from uncertainty

Whilst we do not base our investments on the state of the global economy, we do consider the macro environment to make sure that any potential risk factors are considered when investing in a particular company. In some cases, we can not only determine what the macro environment would preclude us from investing in, but we can derive opportunity from uncertainty as well.

A good example here is looking at the geo-political uncertainty in the Asia-Pacific region. For some time now the West has been wary of China, particularly with regards to its perceived ambitions in the South China Sea. Presently the World relies on a single company in Taiwan to produce the global supply of high-end semi-conductors. The West has noticed the potential for this to have huge repercussions should tensions escalate between China and the West. As the West looks to diversify production of this key electronic component away from Taiwan (with $300-$400 billion committed investment), we believe there are a handful of clear winners in companies such as Lam Research and Applied Materials who make the equipment new foundries will require to develop these components. Both companies feature in the portfolio.

With the global economy at an uncertain juncture, and geo-political tensions on a knife edge, it is our job as an investment manager to filter out the noise and find those pockets of opportunity in those businesses that can transcend the bad news. We feel confident our portfolio of high-quality businesses, benefitting from global trends and strong fundamentals, should deliver outperformance for our investors going forward.

And if you are looking for an investment as we approach the end of the tax year, I would like to remind you that I am Chef Patron at Blue Whale, my investment team and I only use the highest-quality ingredients (although I must admit to not sourcing locally, preferring the best produce from around the world), and best of all, I only eat my own cooking!

This communication is issued by Blue Whale Capital LLP which is authorised and regulated by the Financial Conduct Authority. Your capital is at risk. If you cannot afford the potential risk of a substantial loss, you should not invest. Equity investment should be viewed as a long-term investment. Past performance is not a guide to future performance. The value of investments may fall as well as rise and you may not get back the amount of your original investment. Prospective investors should study the Fund’s Prospectus, KIID and application form which together provide a complete list of risk factors. Blue Whale does not give investment advice. If you are unsure if the Fund is suitable for you, you should contact a financial adviser. Views we express on companies do not constitute Investment Recommendations and must not be viewed as such.