It's a beautiful summer melt-up as we enter August. Strong companies like Martin Marietta Materials (MLM) , Texas Instruments (TXN) , Acuity Brands (AYI) and A.O. Smith (AOS) are hanging out on a perch here, among many others. All the companies mentioned reported decent results in the most recent quarter, definitely thesis-confirming. But are they supportive of the ever-increasing valuation multiples attached to the stocks recently?
We've seen this before. This summer melt-up is a party, in a way. The market is generously awarding high multiples to the market's leaders. For those who are long companies of the best quality, there is a giant Catch-22.
What do you do if you want to shave the froth off your best-performing positions? Especially if the mandate is to be more or less fully invested? A portfolio constructed for long-term compounding of cash flow, after significant multiple expansion, is almost like being put into a really tough box.
It is a difficult spot that many professional money managers find themselves in when the market does this. Many of these companies are not "new money" buys. It is probably time to review what the original investment thesis plan was.
Do catalysts remain? Capital allocation capabilities? M&A aspirations? What was the exit plan?
When multiples expand in anticipation of future growth, imagination needs to kick in. Yet, in this choppy economic backdrop, it is generally difficult to find such certainty that future earnings can, in fact, fill into the expanded multiple.
I'm still a believer that even if rates rise, there is still more ammunition for companies to grow. But I'm not sure, if rates rise, that these premium multiples will remain without at least decent, if not accelerating, earnings growth from here.
Brush up on specific drivers. Remind yourself of customer concentration, seasonality and how some of these companies actually sell their wares. Look at inventories at distributors and customers, to see if there may be a gap in the smooth flow of the supply chain.
Those wrinkles, in periods of time such as these, can justify trimming a position in a strong company after a period of multiple expansion. It is so tough to get rid of your quality sometimes, though.