Investor Essentials Daily

How continued problems in supply chain stand to benefit this company

September 19, 2023

The U.S. has underinvested in supply chain and infrastructure for a long time. This was only realized when supply chains started not functioning during and after the pandemic.

The government and companies are now investing to fix this and make supply chains more reliable, but it’s just starting and is projected to take almost a decade to complete.

This is where Hub Group (HUBG) comes in with its logistics management and supply chain solutions services.

The company enjoyed high demand in the last two years, which increased its profitability exceptionally.

The market doesn’t think these levels of profitability are sustainable. But in current conditions, there is still a long time until we fully solve the supply chain problem. The existence of these problems will continue to benefit Hub Group immensely.

Thus, Hub Group showed up on our screen. The company makes a great FA Alpha 50 name due to its potential for high returns and low expectations from the market.

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The pandemic left global and domestic supply chains in complete disarray.

Supply chains have been exposed in the past through events like the 2011 Japanese Tsunami. But nothing showed the true fragility and inability to respond to changes in the global dynamics of our supply chains like the pandemic.

Lead times got extended, orders got canceled, and transportation got costlier. This caused manufacturers’ capacity to drop as they couldn’t get their hands on the necessary raw materials.

Now, with the pandemic essentially over, the market thinks these supply chain issues will be left behind as well.

This statement couldn’t be more wrong…

Indeed, the pandemic has taught us a lot. We are now on the path to addressing these issues. The government has already taken actions like The Bipartisan Infrastructure Bill to encourage investments in improving supply chains in the country.

However, it’s essential to remember that solutions take time. Just like Rome wasn’t built in a day…

Improving the current state of supply chains will take billions of dollars in various forms of investment. This supply chain evolution, which we call the supply chain supercycle, will take at least a decade to play out.

And with the added issues of inflation, geopolitical crisis, and increased extreme weather events, it doesn’t look like current supply chain issues will subside anytime soon.

There are a few companies that stand to benefit from this long-term trend we are seeing. Hub Group (HUBG) is one of them.

Hub Group is a transportation management company that offers a range of services.

The company helps solve these big supply chain issues through its vast network of rail carriers and end-to-end logistics solutions. They are present from planning and execution to monitoring and reporting.

Because the pandemic hurt supply chains so severely, the demand for Hub Group’s services increased dramatically. This high demand ended up leading to very strong profitability as well.

Hub Group’s return on assets (“ROA”) jumped from 8% in 2020 to 17% in 2021 and then to 27% in 2022.

The chart shows that the company performed incredibly well during a time of supply chain uncertainty.

And yet, the market doesn’t think this high performance will be sustainable.

We can see this through our Embedded Expectations Analysis (“EEA”) framework.

The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections.

In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.

At the current stock price, the market expects the company’s ROA to fall below 10%, assuming the demand will collapse.

Given the likelihood that supply chain issues will continue to persist and the company’s essential position in supply chain logistics, these expectations seem overly pessimistic.

Hub Group is just where it needs to be to continue benefiting from the issues in the global supply chain.

That is why Hub Group showed up on our screen. The company makes a great FA Alpha 50 name due to its potential for high returns and low expectations from the market.

Throughout financial market history, many of the world’s most successful investors have been candid in their belief that Generally Accepted Accounting Principles (“GAAP”) distort economic reality.

Warren Buffett, for example, once said investors should “concentrate on the world of companies, not arcane accounting mathematics.”

Investors who neglect the very real issues with as-reported accounting can find themselves caught up in investing with the crowd, blindly following hot “themes” without a thorough grasp of how to understand the businesses in question.

The only true way to focus on the “world of companies,” as Buffett suggests investors do, is to present a clear picture of how a business operates, something that can only be done by adjusting financial statements to reflect the arbitrary nature of certain accounting rules that leave much to discretion.

The world’s best investors understand the need to make these adjustments, which allows them to focus not on picking out the most popular companies but rather on looking for great names in sleepy areas that the market isn’t paying much attention to. From there, the goal is to then identify quality companies with significant growth potential at reasonable prices.

That’s exactly what we’ve set out to do with the FA Alpha, our monthly list of 50 companies that rank at the top for quality, high growth, and low valuations.

This list has outperformed the market by 300 basis points per year for over 20 years now, effectively doubling the performance of the market by focusing on the real fundamentals and valuations of companies with our proprietary Uniform Accounting framework.

See for yourself below.

To see the other 49 names on the list, click here.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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