Isaac Newton's Groupthink Folly

Whenever large stock price swings occur, there is a temptation to ignore the fundamentals and let groupthink override your judgement. Even Sir Isaac Newton – the renowned physicist, mathematician and Master of the Royal Mint – fell victim to a period of such exuberance just over 300 years ago.

Sir Isaac acquired shares in the South Sea Company shortly after its launch in 1711. The British firm had been created to sell enslaved Africans to the Spanish Empire to mine gold and silver in its Central and Southern American colonies. The trade is distasteful but was legal at the time. However, it failed to deliver the level of expected profits. In 1720, the company switched focus to deal in the UK national debt, using the cash generated by additional share sales to meet interest payments. In doing so, it created a stock market bubble. Its shares and others’ soared in value thanks to a mixture of hype and greed. Sir Isaac had the sense to sell his South Sea Company shares for a significant profit in the first half of 1720. Historians believe he had become fearful of market froth.

But then the 77-year-old saw the stock continue to climb, and he bought back in at about double the price. That was close to the stock’s peak when the firm’s value totalled twice that of all land in England. Soon after, the stock collapsed, crashing the wider market.

After his death, it was reported that Sir Isaac had lost £20,000 in the market panic. That’s more than £3m in today’s money. He was quoted, perhaps inaccurately, as having said on the matter: “I can calculate the motion of heavenly bodies, but not the madness of people.”

The affair reminds us of the difference between being an ‘investor’ and a ‘speculator’. Investors view their share certificates as giving them part-ownership of a business in which they are effectively a silent partner. Speculators, by contrast, see stock ownership as a way to second guess the market. The distinction between the two is clearest in times of market flux. Speculators take direction from share price swings, giving little care to underlying businesses and their fundamentals.

We fit into the investors’ camp. Our managers’ focus is on acquiring and holding shares at suitable prices rather than market timing. They endeavour to buy and hold only if they believe a company’s future growth will deliver a significant return via dividend payments and a higher share price over the long term. And they sell back to the market when that is no longer true. So a share price move might trigger a review, but in isolation it typically provides little insight into the underlying opportunity.

Edgepoint, co-managers of the St. James’s Place Global Growth fund, concur. Tye Bousada stated, “We don’t get too fussed by noisy headlines. Instead, we focus on the performance of the businesses that make up our Portfolios. The reality is nobody knows if the markets will experience a pullback, how sharp it could be or how long it might last – although the media would like you to believe otherwise. We don’t waste our time trying to forecast such things. We aren’t good at “timing” the market and don’t believe anyone can consistently do it well. Rather, we consider the facts surrounding the underlying businesses we own and make judgments based on those facts. History has shown that we have been good at determining if we’re getting enough for your money during periods of volatility like the one we’re going through today. Historical volatility has helped us build those pleasing long-term track records. The downside volatility made it easier for us to buy growth and not pay for it.” And here is an example of their investments.

Anthem, Inc.  is one of the largest health insurers in the U.S. Healthcare is largely economically resilient and growing long term due to aging demographics and Anthem is the largest player in most of their markets which gives them greater scale and cost advantage versus competitors. It reinvests those savings back in terms of lower premiums to attract more customers. Think of this as a virtuous circle. Half of Anthem’s earnings come from their government business, meaning the U.S. government pays the bill. Given budget pressures, more U.S. states are outsourcing coverage to managed-care companies like Anthem who can provide coverage at lower costs. Like other insurance companies, Anthem gets premiums up front and invests this float before it needs to pay claims. As interest rates increase, Anthem makes higher returns on its investment portfolio.  The business generates significant excess free cash flow; over the last fifteen years the company has repurchased 60% of shares outstanding and the dividend has increased over five-fold in the last decade. Anthem has grown their earnings per share by more than 16% compounded over 22 years and management forecasts 12% to 15% compounded growth over next five years. The stock currently trades at 13.5x free cash flow next year (2023).

Insight and narrative taken from a report published by Baillie Gifford, one of the managers available through the Irongate bespoke portfolio range.

The value of an investment can go down as well as up.

You may get back less than you invested.

Past performance is not a reliable guide to future performance.

The opinions expressed are those of Irongate, this material is not a recommendation, or intended to be relied upon as a forecast.‍