Tim Carleton

Investors shouldn’t mistake market volatility as representing material changes in the value of listed companies, according to Tim Carleton, Auscap Asset Management’s CIO, who says the reality is that the underlying value of certain businesses is far more stable than their share price movements might suggest.

“Developments in artificial intelligence, the outbreak of hostilities in the Middle East, and the perceived impact of the budget on residential property prices and disposable income, have dominated short term share price movements,” he says.

“Such factors affect consumer confidence and the perception around the near-term economic outlook. From a markets perspective, this creates volatility and dislocations as participants respond to the news flow.

“However on the ground, we are seeing that there is often far more that is in the control of management in terms of the business’ future economic performance and earnings growth than there is outside their control.

“When everyone is fixated on the present, we believe it pays to focus on the future and what the business will look like in a few years from today.”

Carleton says two Australian businesses that are great examples of this are Nick Scali and Lovisa, both of which are consumer-facing business and therefore, at face value, vulnerable to softening consumer confidence.

“We recently spent time in the UK visiting these businesses and the story was much more positive than the headlines might suggest,” he says.

Australian furniture retailer Nick Scali (ASX: NCK) expanded its operations into the UK in 2024, buying a network of existing UK stores, Fabb Furniture, and converting them to Nick Scali stores. The most recent half year results reflected that the Nick Scali range was starting to resonate with British consumers, with like for like sales growth at 32 per cent in January 2026 for stores that had been branded as Nick Scali for more than 12 months.

“While the proof will be in the company’s results in years to come, increasing referral customers and conversion appears to be improving, all while still operating in a tough macroeconomic environment.

“The long-term investment thesis in Nick Scali is positive, and we continue to see opportunities for the company to grow its revenue and earnings in Australia and the UK, and to also take its operations beyond these two markets.

“Similarly, Lovisa’s expansion in the UK is putting it in a very strong position. Despite the remarkably low price point, the jewellery is extremely high margin. In the first half of FY26, Lovisa recorded gross margins of 82.9%, leading to very profitable store metrics. With a key global competitor, Claire’s, falling into bankruptcy in 2025, closing 290 stores in the United States and nearly 300 in the UK across 2025 and the first half of 2026, Lovisa should be in a position to increase its market share in these and many other underrepresented international geographies.”

Carleton says taking a view on what the business will look like in the future allows investors to benefit from “time horizon arbitrage” which involves taking a longer term perspective to buy into high quality, growing businesses when they are priced attractively on a through the cycle basis due to short term, transient concerns.

“Consumer discretionary businesses like Nick Scali and Lovisa remain in our portfolios. These two businesses offer good value for investors, and have solid future management growth plans that will positively impact earnings growth over the long term.

“We are excited by the quality of the current portfolios, positive on the earnings growth we expect over time and enthused about the value on offer,” says Carleton.

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Tim Carleton

Much is being made of the fact that the vast majority of active fund managers are underweight Commonwealth Bank of Australia (CBA). Its strong performance in recent years has led to widespread active management underperformance because it represents over 10% of the All Ordinaries Index. Should this positioning be criticised or encouraged? Is it sensible for investors to have over 10% of their domestic equities portfolios invested in a large domestic retail bank, or are fund managers acting rationally in being less exposed to this one company than the broader market?

If there is one certainty, it is that the future will not look like the past. No two sets of circumstances are the same. The companies that exist at various points are different. The reactions of governments and societies to events can vary. This makes investing challenging enough. But added to this, investment markets, if they were presented with the exact same scenario as one recently experienced, would react differently to the way they did initially, precisely because everyone would have the knowledge of how markets reacted to that event or set of circumstances previously. Some initial reactions to the COVID-19 pandemic were similar to those witnessed during the Spanish flu pandemic of the early 20th century, including the quarantine periods imposed, but because of that experience, changes in society and medical and technological developments, there were far more differences than similarities between the two periods. This is what makes investing an intellectually interesting exercise.

Markets are unpredictable. And so they do unpredictable things. Pro Medicus, a global leader in healthcare imaging software, is currently trading on more than 100x forecast FY26 revenue and more than 200x forecast FY26 earnings with a market cap that is bigger than Brambles, the global leader in pallet supply, Sigma Healthcare, the owner of the dominant pharmacy chain Chemist Warehouse or REA Group, Australia’s leading property portal. It has a great product, a market leading position and lots of opportunities for growth, but so do these much larger companies that all earn more than five times as much as Pro Medicus. Why didn’t the share price stop at 100x forecast earnings, or 75x, or 50x? Was it predictable that this would happen, and so as long as one was convinced of the progress of the product then one should have bought in?

Since 2015, Pro Medicus’ forecast earnings per share (EPS) is up by an excellent 16 times, and the company has paid modest dividends. But an investment in Pro Medicus is up 132 times, meaning that multiple expansion, or paying more for each dollar of earnings, has been the difference between a $100,000 Pro Medicus investment in 2015 today being worth $1.6m and $13.2m. There can be valid reasons for multiple expansion over time, such as an increase in the durability of a business moat or the demonstration of wider applicability of a product, but this level of contribution is extreme.

Will buying a business with great growth prospects on an extremely elevated price to earnings ratio always lead to an attractive shareholder return? It could, but if the ratio falls significantly in the near term, for whatever reason, it may take many years of sustained earnings growth just to breakeven. History is littered with examples where periods of extreme valuation are followed by periods of mean reversion. After the dotcom crash it took Microsoft 17 years to make a new stock high, despite remaining as the dominant global computer software company throughout this period and growing its EPS by over 285%.

Cisco, the multinational digital communications technology conglomerate based and listed in the USA, is today still not back to its peak share price that it made in 2000, some 25 years ago, despite EPS having grown over 600% during this period.

These companies were expected to experience strong EPS growth which led to investors rationalising elevated multiples at the time. Despite this being correct, investors who purchased near the peak were underwater on their investment for many years.

At the other end of the spectrum, who would have predicted a decade ago that the hottest stock on the ASX in FY25 would have been a domestic bank offering a low dividend yield and anaemic earnings growth, both historical and anticipated, in a competitive and largely commoditised domestic environment, while trading on the most expensive multiple of earnings that an Australian bank has traded on in the last 30 years? And yet, the same could have been said about CBA two years ago, and it has continued to perform strongly, rallying another 80%. We also suspect an objective outsider would recoil at the suggestion that more than 10% of a domestic equities portfolio should be invested in such a stock. That it has delivered such strong returns does not change the sense in having a lower exposure to the company. There are many possible paths markets can take, and sensible investing involves making decisions that are likely to deliver satisfactory returns irrespective of the path that eventuates.

Our core belief is that successful long-term investing is about having a sound process that will lead to solid results over time. A fixation on short term relative performance against an index risk damaging a sound investment process. The reality is that over the short-term noise is highest, and the performance of stocks can be driven by many factors, including those that have no relationship to company performance, such as the flow of capital. A focus on relative performance against an index also drives consideration of the constituents of the index, even though its composition is a function of what has happened historically and not what is sensible going forward. This all has the effect of taking the focus off the process and placing most emphasis on the outcome. To use a sporting analogy, this is akin to a golfer focusing on what score he or she is going to shoot, rather than playing each shot on its merits and focusing on the process of executing these individual shots. In our experience focusing on the outcome rarely works and is often counterproductive.

In our view the underweight in CBA by domestic fund managers appears sensible, assuming that in aggregate active managers are invested in businesses with better medium-term prospects than CBA. To criticise the decision to be underweight such a stock is to focus on the result, rather than the process. And such conclusions can often lead to future decision-making mistakes. Short term market outcomes are often random, a function of market forces that at times have little to do with fundamentals. A focus on short term results will have the tail wagging the proverbial dog and, we are confident, lead to poorer long-term outcomes.

To deal with uncertainty we continue to focus on our investment process. We aim to own a selection of market dominant, high quality businesses with good long term growth prospects, with discipline around the price we are willing to pay for and hold onto these investments. Our core belief is that the total return delivered by equities over time will be a function of the earnings they generate today plus the growth in earnings they deliver, assuming we have not materially overpaid in acquiring the asset in the first place. So our focus is on identifying these businesses and paying a fair price or better for them. This will certainly lead to different results from the index, with the objective of more attractive longer-term returns.

By Tim Carleton, CIO

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