Investor Essentials Daily

The infamous activist short-seller made a living from a massive COVID trade

March 17, 2023

Bill Ackman is one of the most famous figures in the investment industry these days.

He is known for his focus on investor activism and short-selling of companies that do not comply with or follow his recommendations. Additionally, he is also known for placing bold and huge bets in the financial markets.

He made the news recently with the success of his massive bet on credit default swaps (CDS) just before the pandemic hit the world.

Let’s have a look at his fund’s top holdings from the Uniform Accounting lens and see if he’s prepared for another big bet for the year ahead.

In addition to examining the portfolio, we’re including a deeper look into the fund’s largest current holding, providing you with the current Uniform Accounting Performance and Valuation Tearsheet for that company.

Also below, a detailed Uniform Accounting tearsheet of the fund’s largest holding.

Investor Essentials Daily:
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Ackman has made a living getting big bets right, or owning them when he gets them wrong.

In 2010, he placed a huge bet on the mall owner General Growth Properties, which at the time was subject to one of the largest real estate bankruptcy in American history.

He made a whopping $3 billion from this trade and saved the company.

On the other hand, he had lost around $1 billion in a 5-year fight with Herbalife (HLF), protein shakes and vitamin supplements provider, claiming that it was a fraud.

But his recent bet during the pandemic is the one that will go down famous forever.

In February 2020, when the pandemic wasn’t recognized by the World Health Organization (WHO), he correctly foresaw the potential disaster of the pandemic on financial markets.

Seeing this, he wanted to get out of some part of his portfolio including his big investments in Hilton (HLT).

As he wanted to stay away from his reputation as a corporate raider, instead of dumping the stock, he bought CDS to hedge out his position.

His massive bet started to play out as soon as the next month. In March 2020, WHO recognized COVID-19 as the pandemic, and the stock market crashed. Consequently, hospitality companies were among the most affected ones due to the lockdowns. With this trade, he made a 100-fold return. His initial investment in CDS was only about $27 million which later turned into a whopping $2.6 billion.

He’s been too vocal since on other calls, including recently about bailing out the banks with liquidity issues.

In light of this, let’s take a look at his positions and see what he’s betting big on now using Uniform Accounting.

Economic productivity is massively misunderstood on Wall Street. This is reflected by the 130+ distortions in the Generally Accepted Accounting Principles (GAAP) that make as-reported results poor representations of real economic productivity.

These distortions include the poor capitalization of R&D, the use of goodwill and intangibles to inflate a company’s asset base, a poor understanding of one-off expense line items, as well as flawed acquisition accounting.

It’s no surprise that once many of these distortions are accounted for, it becomes apparent which companies are in real robust profitability and which may not be as strong of an investment.

See for yourself below.

Looking at as-reported accounting numbers, investors would think that investing in Ackman’s fund Pershing Square is not really rewarding.

On an as-reported basis, many of the companies in the fund are poor performers. The average as-reported ROA for the top holdings of the fund is 9%, which is lower than the U.S. corporate average.

However, once we make Uniform Accounting adjustments to accurately calculate the earning power, we can see that the average return in Pershing Square’s top holdings is actually 21%.

As the distortions from as-reported accounting are removed, we can see that Universal Music Group (ENXTAM:UMG) isn’t a 7% return business. Its Uniform ROA is 30%.

Meanwhile, the massive railroad company Canadian Pacific Railway (TSX:CP) looks like a below-cost-of-capital return business with only 3% ROA, but it actually powers a 10% Uniform ROA.

To find companies that can deliver alpha beyond the market, just finding companies where as-reported metrics misrepresent a company’s real profitability is insufficient.

To really generate alpha, any investor also needs to identify where the market is significantly undervaluing the company’s potential.

These dislocations demonstrate that most of these firms are in a different financial position than GAAP may make their books appear. But there is another crucial step in the search for alpha. Investors need to also find companies that are performing better than their valuations imply.

Valens has built a systematic process called Embedded Expectations Analysis to help investors get a sense of the future performance already baked into a company’s current stock price. Take a look:

This chart shows four interesting data points:

  • The average Uniform ROA among Pershing Square’s top holdings is actually 21% which is above the corporate average in the United States.
  • The analyst-expected Uniform ROA represents what ROA is forecasted to do over the next two years. To get the ROA value, we take consensus Wall Street estimates and convert them to the Uniform Accounting framework.
  • The market-implied Uniform ROA is what the market thinks Uniform ROA is going to be in the three years following the analyst expectations, which for most companies here are 2023, 2024, and 2025. Here, we show the sort of economic productivity a company needs to achieve to justify its current stock price.
  • The Uniform P/E is our measure of how expensive a company is relative to its Uniform earnings. For reference, the average Uniform P/E across the investing universe is roughly 20x.

Embedded Expectations Analysis of Pershing Square paints a clear picture. Over the next few years, Wall Street analysts expect the companies in the fund to improve in profitability. The market agrees with analysts’ expectations but it’s more optimistic.

Analysts forecast the portfolio holdings on average to see Uniform ROA rise to 32% over the next two years. At current valuations, the market agrees with the analysts and expects a 43% Uniform ROA for the companies in the portfolio.

For instance, Chipotle Mexican Grill (CMG) returned 16% this year. Analysts think its returns will increase to 19%. And at a 40.3x Uniform P/E, the market expects a further improvement in profitability and is pricing Uniform ROA to be around 34%.

Similarly, the real estate company Howard Hughes Corporation (HHC) has a Uniform ROA of 2%. Analysts expect its returns will increase to 3% and the market is pricing its returns to rise to 8%.

Overall, we can see that Bill Ackman’s strategy has a reflection in his fund’s portfolio as he chooses not to diversify too much and focus on a few companies that have high quality and high return potential.

However, the very high expectations of the market from the names in his portfolio may lead to some downside risk for investors. That is why investors should analyze the current valuations and carefully consider the market’s expectations of these companies before making any major decision on whether to invest or not.

This just goes to show the importance of valuation in the investing process. Finding a company with strong profitability and growth is only half of the process. The other, just as important part, is attaching reasonable valuations to the companies and understanding which have upside which has not been fully priced into their current prices.

To see a list of companies that have great performance and stability also at attractive valuations, the Valens Conviction Long Idea List is the place to look. The conviction list is powered by the Valens database, which offers access to full Uniform Accounting metrics for thousands of companies.

Click here to get access.

Read on to see a detailed tearsheet of one of Pershing Square’s largest holdings.

SUMMARY and Universal Music Group N.V. Tearsheet

As one of Pershing Square’s largest individual stock holdings, we’re highlighting Universal Music Group N.V.’s (UMG:NLD) tearsheet today.

As the Uniform Accounting tearsheet for Universal Music Group N.V. highlights, its Uniform P/E trades at 25.9x, which is around the global corporate average of 24.0x, but above its historical average of 19.4x.

Moderate P/Es require moderate EPS growth to sustain them. That said, in the case of Universal Music Group N.V., the company has recently shown 32% Uniform EPS shrinkage.

Wall Street analysts provide stock and valuation recommendations that, in general, provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Universal Music Group N.V.’s Wall Street analyst-driven forecast is for EPS to grow by 44% and 13% in 2022 and 2023, respectively.

Furthermore, the company’s return on assets was 30% in 2021, which is 5x the long-run corporate averages. Also, cash flows and cash on hand consistently exceed its total obligations—including debt maturities and CAPEX maintenance. Moreover, these signal low dividend risks.

Lastly, Universal Music Group N.V.’s Uniform earnings growth is above peer averages, and above peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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