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QTD Income Equity – 3Q2024 vs R1000V

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QTD Income Equity – 3Q2024 vs R1000

Market Observations & Portfolio Commentary

Income Equity – 3Q2024 vs Russell 1000 Value

 

Market Update

U.S. equities traded higher during Q3 with most of the major indices posting mid-single digit gains. The quarter was marked by significant market shifts, including inflation cooling, employment weakening, volatility spiking, and a larger-than-expected Federal Reserve rate cut, yet the stock market ended on a high note. The broader market, measured by the Russell 3000 Index, rose 6.2%. There was a notable rotation to small cap and value styles away from large cap growth. This fostered broader market participation, with a wider range of sectors participating, especially the rate sensitive areas. Looking at market factors, Yield and most Value factors posted the strongest returns while most of the Growth, Volatility, and Momentum factors presented headwinds. Quality factors had a mixed impact.

 

Key Performance Takeaways

  • The London Company Income Equity portfolio gained 10.5% (10.4% net) during the quarter vs. a 9.4% increase in the Russell 1000 Value Index. Sector exposure was a modest headwind more than offset by positive stock selection.

  • After struggling in the first half of the year, the Income Equity portfolio solidly outperformed the Russell 1000 Value index and our expectations 85-90% upside capture expectations in a robust return environment. Factors like increased volatility and surging market breadth favored our portfolios. Greater exposure to Yield factors as well as less exposure to Volatility and Momentum factors aided relative performance. We were encouraged to see the Income Equity portfolio protected on the downside amidst the volatility and market drawdown while staying ahead of its benchmark during the market’s sharp recovery.

 

Top 3 Contributors to Relative Performance 

  • Progressive Corporation (PGR) – PGR was a top performer year to date due to its success in growing the business and improving margins. PGR has gained market share from competitors and improved its margins by effectively segmenting underwriting risks and implementing strategic pricing. PGR has achieved its profitability target by lowering advertising costs and focusing on acquiring preferred customers. We remain confident in PGR’s ability to execute in all environments, competitive advantages, and capital allocation strategy.

  • Lowe’s Companies, Inc. (LOW) – LOW was a top performer due to the execution of its ongoing productivity initiatives, share gains, and margin improvement. The Pro business continues to post better than expected results due to LOW’s multiyear investments. LOW is in a good position to continue to gain share despite some moderation following the pandemic boom. LOW has a very strong balance sheet and returns cash to shareholders through dividends and share buybacks.

  • Starbucks Corporation (SBUX) – Despite the business’s current struggles, SBUX shares responded positively this quarter to the news of a CEO change. Formerly the CEO of Chipotle, Brian Niccol was named Chairman and CEO. In addition to Niccol’s impressive background, we believe that someone with deep QSR (quick-service restaurant) experience, which Laxman lacked, is an immediate improvement for the company. SBUX still needs to navigate through a pressured food service environment and self-inflicted operational issues, but we feel incrementally positive with Niccol at the helm.

 

Top 3 Detractors from Relative Performance 

  • Charles Schwab Corporation (SCHW) – SCHW were weak during 3Q, which led to underperformance vs. the broad market YTD. In its latest quarter, SCHW reported weaker results, though with little implications on company fundamentals. Cash sorting from consumers continued in the latest quarter and has persisted longer than we anticipated. We believe that an end to SCHW’s headwinds are near, especially as the Federal Reserve shifts to lower rates, and consequently, we expect a strong rebound in earnings power within the next 18 months. Longer term, we believe the company is well positioned to continue capturing market share and driving sustainable earnings growth.

  • Merck & Co., Inc. (MRK) – MRK continues to experience solid growth in key therapeutic areas, driven by its blockbuster immunotherapy treatment, Keytruda. However, MRK recently lowered its outlook for its HPV vaccine due to challenges in China, which has weighed on investor sentiment. Management attributes the demand decline to the delayed effects of China’s anti-corruption campaign and elevated inventory at its distribution partner. Despite these headwinds, they are confident in the vaccine’s long-term potential especially outside China. We remain attracted to MRK’s strong bullpen of drugs and vaccines and believe MRK’s leadership team can accelerate its drug pipeline and supplement growth with business development opportunities.

  • Microsoft Corporation (MSFT) – Shares of MSFT posted a modest decline during 3Q. MSFT continues to post strong results (15% revenue growth in the latest quarter) driven by cloud and AI purchases by customers. However, valuation based on near term estimates is high at 24x EV/EBITDA, which may have contributed to the relative weakness. In addition, the recent Activision acquisition added some noise to the reported numbers.

 

Sector Influence

We are bottom-up stock pickers, but sector exposures influenced relative performance as follows:

  • What Helped: Underweight Energy (a weaker performing sector) & overweight Cons. Staples (a better performing sector)

  • What Hurt: Overweight Info. Technology (a weaker performing sector) & underweight Utilities (a better performing sector)

 

Trades During the Quarter

  • Increased: TE Connectivity (TEL) – Late in Q3, we added 1% to the existing position in TEL. We initiated our position during Q2, and this recent addition brought the position size close to the 3% weighting that we often target for new positions. We reduced cash in the portfolio to make the addition.

 

Looking Ahead

Stocks enter 4Q in good form, but challenges remain. The market appears priced for near perfection, with expectations of a soft landing and healthy earnings growth driving the S&P 500 to a lofty valuation that leaves little room for error. The Fed’s recent rate cut may sow the seeds for a cyclical recovery, but whether the economic impact arrives in time to avoid a downturn is uncertain. Lower rates tend to support market sentiment and multiples in the short term, but it can take up to two years for policy changes to impact economic and earnings data. Meanwhile, rates remain in restrictive territory. Therefore, the impact of restrictive policy may continue to affect the economy in the months ahead. While we believe that the odds of a near term recession are low, we note the difficulty in navigating a soft landing. 

In terms of the equity market, valuations based on near term earnings are elevated in the context of moderate GDP growth. We believe that equity returns in the near term may be modest, with shareholder yield (dividends, share repurchase, debt reduction) comprising a significant percentage of the total return from equities. Moreover, as a large corporate debt maturity wall approaches, balance sheet strength will likely become a differentiator and an advantage for investors focused on fundamentals. We believe our focus on quality, diversification, and valuation will continue to reinforce our margin of safety, positioning our portfolios for success in this uncertain climate.

 

We believe our focus on quality, diversification, and valuation will continue to reinforce our margin of safety, positioning our portfolios for success in this uncertain climate.

 

Annualized Returns 

As of 9/30/2024

Income Equity - 3Q2024 vs R1000V Annualized Returns

Inception date: 12/31/1999. Past performance should not be taken as a guarantee of future results. Performance is preliminary. Subject to change.

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Disclosure Notes

 

The London Company’s performances are size weighted and annualized based on calculations for the period ending September 30, 2024. The characteristics discussed herein relate to a representative account, and not every client’s account will have these exact characteristics. As London manages its client portfolios according to each client’s specific investment needs and circumstances, London cannot affirm that the characteristics of the account shown are similar to all accounts participating in the strategy. This is due in part to the timing of trades by the Advisor, market conditions, cash availability, and the timing of client deposits and withdrawals. Therefore, prospective clients should not assume that similar performance results to those shown would have been achieved for their accounts had they been invested in the strategy during the period. None of the information contained herein should be construed as an offer to buy or sell securities, or as investment recommendations.

 

Definition of Firm: The London Company of Virginia is a registered investment advisor. Registration does not imply a certain level of skill or training. More information about the advisor, including full descriptions of its investment strategies, fees and objectives, can be found in the firm’s Form ADV Part 2, which is available upon request by calling 804.775.0317 or visiting www.TLCadvisory.com. The London Company claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. Please visit www.TLCadvisory.com or contact us at 804.775.0317 to request a complete list and description of The London Company’s composites and/or a GIPS® Report that adheres to the (GIPS®) standards.

 

Composite Creation/Inception Date: December 31, 1999

 

Composite Definition: The Income Equity strategy invests mainly in common equities with a focus on higher overall dividend yield orientation, which may be supplemented with primarily investment grade, preferred equities. This strategy has a more conservative orientation, with a focus on capital preservation, income and growth, in order to provide greater yield and downside protection relative to our Large and Mid Cap strategies. Our Income Equity strategy is designed to generate above-average, absolute returns over full market cycles. Accounts in this product composite are fully discretionary taxable and tax-exempt portfolios with no minimum dollar amount of assets. The product is measured against the Russell 1000 Value Index and has a creation and inception date of December 31, 1999. There is no use of leverage, derivatives or short positions. All actual fee-paying discretionary portfolios are included in one or more composites that have been managed for a full calendar quarter with limited restrictions and similar objectives. As of July 1, 2022 The London Company redefined the composites to exclude all dual contract relationships and any potentially bundled fee scenarios. This policy is not retroactive, but will continue to apply going forward.

 

Benchmark Description: The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 Index companies with lower price-to-book ratios and lower expected growth values. Benchmark returns are not covered by the report of independent verifiers.

 

Performance and Fees: Gross of fee returns are calculated gross of management and custodian fees and net of transaction costs. Net of fee returns are calculated net of actual London Company management fees and transaction costs and gross of custodian and other fees. Returns may be net of miscellaneous fund expenses. The gross figures do not reflect the deduction of investment advisory fees. Returns are calculated and stated in U.S. dollars. Prior to April 1, 2024 returns are calculated gross of withholding taxes on foreign dividends and interest. Starting April 1, 2024, performance is calculated net or gross of foreign withholding taxes on dividends and interest income dependent on custodian data. Dividends are reinvested. The accounts represented in the composite reflect actual London Company fees paid on the particular account which may be different from the fee normally offered to other clients. Policies for valuing investments, calculating performance, and preparing GIPS Reports are available upon request.

 

Past performance should not be taken as a guarantee of future results. The report is for informational purposes only. Data, while obtained from sources we believe to be reliable, cannot be guaranteed and all statistics are subject to change. The statements contained herein are solely based upon the opinions of The London Company and the data available at the time of publication of this report, and there is no assurance that any predicted results will actually occur. Information was obtained from third-party sources, which we believe to be reliable but are not guaranteed as to their accuracy or completeness. This report contains no recommendations to buy or sell any specific securities and should not be considered investment advice of any kind. An investment in a London Company strategy is subject to risks, including the loss of principal. Referenced strategies may not be suitable for all investors. The appropriateness of a particular strategy will depend on individual circumstances and objectives. In making an investment decision, individuals should utilize other information sources and the advice of their investment advisor.

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