Having been active in the global markets for almost half a century, investment legend Ray Dalio has managed to grow Bridgewater into the world’s largest fund by assets under management. Today’s FA Alpha Daily will investigate if the fund is positioned smartly in the current market environment under the lens of Uniform Accounting.
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Founded in 1975, Bridgewater has been an active player in the global markets for almost a half-century.
With his charm and success, Ray Dalio has managed to grow the fund that started in his apartment to the largest in the world by assets under management.
The fund has always been named among the best hedge funds around the world. Over that long period of investment history, Bridgewater managed to successfully go through many crises and market crashes.
He was able to turn a profit during the 1987 stock market crash, handled the dot-com crisis brilliantly, and forecasted the global financial crisis in 2007.
As a man that got over lots of crises and market crashes, Ray Dalio shared his recent insights on the market and the economy.
He thinks any rally in the market is a sign of naive and inconsistent thinking about how the economic machine works, as the Fed is going to slow the economy.
Throughout 2021, Bridgewater lagged behind the market before recording a stellar December and ending the year in line with benchmarks. Meanwhile, 2022 is where Bridgewater has really started to accelerate.
Even while the market has been down almost 20% through the first half of the year, Bridgewater is currently up a whopping 32%.
Let’s examine if his portfolio is positioned smartly for the market environment he’s done a great job of predicting so far.
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 is 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.
Just as one would expect, there is still merit to investing in companies that combine the power of finance and technology, as the Uniform returns are much stronger than the as-reported metrics dictate.
See for yourself below.
Using as-reported accounting, investors would think investing in the world’s largest hedge fund is not that profitable.
On an as-reported basis, many of these companies are poor performers in terms of profitability and operating with an average as-reported ROA of just 8% which equates to below corporate averages in the United States.
However, once we make Uniform Accounting (UAFRS) adjustments to accurately calculate earning power, we can see that the returns of the companies in Bridgewater are much more robust.
The average company in the portfolio displays an impressive average Uniform ROA of 38%, which is almost four times the corporate average returns.
Once the distortions from as-reported accounting are removed, we can realize that The Coca-Cola Company (KO) doesn’t have a ROA of 8%, but returns of 60%.
Similarly, Abbott Laboratories’ (ABT) ROA is actually 35%, not 8%. Abbott Laboratories is a highly successful company that engages in the discovery, development, manufacture, and sale of a broad and diversified line of health care products.
Alibaba Group (BABA) is another great example of as-reported metrics mis-representing the company’s profitability. With a Uniform ROA of 122%, an as-reported ROA of 5% is wholly misleading and misses the story.
If investors were to look at the fund as powered by as-reported metrics, they would think that Ray Dalio is not a great fund manager as it seems.
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.
When distortions from as-reported metrics are removed, investors can see that Bridgewater is actually doing a great job and they are highly successful. However, investors shouldn’t jump into the fund without considering the upside potential of such an investment.
Once we account for Uniform Accounting adjustments, we can see that many of these companies are strong stocks but have already realized most of their 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 Uniform ROA FY0 represents the company’s current return on assets, which is a crucial benchmark for contextualizing expectations.
- 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 is 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 24x.
Embedded Expectations Analysis of Bridgewater paints a clear picture of the fund. As the stocks it tracks are strong performers historically, the markets are pricing to remain in line with current returns, while analysts see returns dip.
While analysts forecast the fund to see Uniform ROA decline to 31% over the next two years, the market is pricing the fund to see returns decrease to 37%. This means the stocks have downside risk.
The markets are expecting McDonald’s (MCD) Uniform ROA to rise to 28%. Meanwhile, analysts are projecting the company’s returns to remain flat at 17%. This could lead to a potential retraction in equity valuations.
Procter & Gamble (PG) may further disappoint investors as their returns are expected to slightly decrease to 34% Uniform ROA, while the market expects them to increase their returns to 51%.
To sum up, the portfolio is composed of historically strong performers and names that can deliver high profitability as is expected from a legend such as Ray Dalio. However, the market is most likely already pricing in Dalio’s portfolio correctly, leading to a flat performance after such a strong run.
This just goes to show the importance of valuation in the investing process. Finding a company with strong 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 have 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 Bridgwater’s largest holdings.
SUMMARY and The Procter & Gamble Company Tearsheet
As Bridgewater’s largest individual stock holding, we’re highlighting The Procter & Gamble Company (PG:USA) tearsheet today.
As the Uniform Accounting tearsheet for P&G highlights, its Uniform P/E trades at 25.5x, which is above the global corporate average of 19.7x, but around its historical average of 25.2x.
High P/Es require high EPS growth to sustain them. In the case of P&G, the company has recently shown 10% Uniform EPS growth.
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, P&G’s Wall Street analyst-driven forecast is for EPS to grow by 1% in 2022 and by 4% in 2023.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify P&G’s $142 stock price. These are often referred to as market embedded expectations.
The company is currently being valued as if Uniform earnings were to grow by 4% annually over the next three years. What Wall Street analysts expect for P&G’s earnings growth is below what the current stock market valuation requires in 2022, but matches it in 2023.
Meanwhile, the company’s earning power is 6x the long-run corporate averages. Also, cash flows and cash on hand are greater than the total obligations—including debt maturities and capex maintenance. In addition, intrinsic credit risk is 50bps. All in all, these signal low dividend and credit risks.
Lastly, P&G’s Uniform earnings growth is in line with peer averages, and is trading in line with its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research
This portfolio analysis highlights the same insights we use to power our FA Alpha product. To find out more visit our website.