Acacia Capital produced a return of 5.03% net for investors for the second quarter of 2017 bringing returns since inception (February 2003) to 462.4% or 12.7% per annum, outperforming the S&P 500 which returned 9.7% over the same period.

In the firm’s second quarter letter to investors dated July 11th, a copy of which has been reviewed by ValueWalk, general partner Peter Kinney provides investors with some interesting thoughts on “investing in the age of disruption” a topic that has received plenty of attention over the past 12 months as the FAANG group’s takeover of the world continues.

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Acacia Capital on deep value in age of disruption

Disruption has sent valuations in disrupted sectors falling to all-time lows, which has attracted the attention of bargain hunters and value investors but as Peter writes, “today’s earnings matter not” instead “it is the future earnings that investors should care about.” With many of the disrupted companies’ future earnings are being undermined by “liabilities that are largely ignored” such as lease obligations, restructuring costs and pension obligations. With these obligations growing and revenue shrinking “apparently cheap multiples quickly dissipate on closer inspection.”

Acacia Capital On How To Invest To Avoid Disruption

The problem is, value investing is all about going against the herd and these industries that are being disrupted are already heavily discounted by the market. If you take the plunge you have a   "chance of being right about intrinsic value and earning supernormal returns if you can figure out which businesses will continue to exist under a slightly adapted business model in five or ten years in the case where entire industries are painted with the same brush. "

Trying to find value among the rubble requires a lot of additional work. There are plenty of beaten down stocks out there, but the question is, which ones will survive. Acacia Capital writes that the best way to try and filter out the best ideas is to ask the most important question, “do we want to buy more stock in this company if it declines from here?”

“So, the question remains of what to do when disruption is everywhere? Do we just capitulate and buy Amazon? Do we run from the secular issues and end up owning just cement companies and airlines? The answer is that we must be uncompromising in our application of the fundamentals. We must analyze businesses without prejudice, avoid those we can’t understand, and act decisively when a disconnect between price and value appear.”

In this environment, we are even more paranoid about avoiding business model disruption risks where the potential issues are being mentioned with insufficient emphasis among analysts or industry participants, and the potential consequences are clearly not discounted in stock prices. We see this disconnect with electric vehicle related disruption to the automotive supply, 3D printing’s impact on manufacturing and distribution, the trend toward “everything as a service,” the quickly changing face of IT environments, robotics and machine learning, and (of course) the dreaded Amazon effect. These disruptions will likely benefit the consumer and increase productivity for the economy, but they create a difficult world in which to make long-term equity investments.”

One idea Peter gives is to raise the bar of investing, rather than think, ‘would I want to own this if the market closed for five years?’ Instead ask, ‘would I want to own this if the market closed for ten years?’ There’s no definitive answer to the disruption question but a clear understanding of a company’s fundamentals and buying at an attractive valuation will mitigate some of the risk.

While Acacia Capital does not offer any specific names, the hedge fund notes that it has 23 percent of its portfolio in 5 names, which span the globe.

  • ALS:  Australia
  • Howden Joinery UK
  • TOTVS Brazil
  • Ryanair Ireland
  • SAP Germany