For over 48 years, Ray Dalio established himself as one of the most successful hedge fund managers as he founded Bridgewater Associates, one of the most distinguished hedge funds in the investment world. As he exited the firm, he pushed the firm for a sizeable exit package despite the fund’s mediocre performance of 7% last January. In today’s FA Alpha, we will look into Bridgewater Associates’ top holdings to see if the firm can maintain its track record under a new management.
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Bridgewater Associates, founded in 1975 by Ray Dalio, started as a small investment firm in a two-bedroom apartment in New York and became one of the largest hedge funds in the world.
Recently, the firm has been shaken up due to the change of leadership as Dalio announced his retirement from the firm in October last year.
Dalio has served as the chief executive, chief investment officer, and chairman of the firm. Sometimes he took these roles all to himself and rode solo but sometimes he had help from his partners and executive team.
With this huge responsibility, now he describes the fund as his property rights and demands a massive exit package.
However, things have been pretty messy for Ray Dalio in the last few years.
In 2018, the firm announced that it will become a partnership to be transformed into an entity that is owned or controlled by the top executives rather than one man, but this plan has never come into sight.
Also, Dalio had some controversial views on China’s human rights and drew an analogy of the government as a “strict parent” while the firm has been managing billions of dollars for Chinese entities that are partly owned by the government.
Additionally, there were criticisms about his performance as the firm has lost around $45 billion in assets under management last year.
With all these concerns, Bridgewater’s top executives took on a mission to say goodbye to Dalio for good, even for a hefty price.
When he retired in October last year, the co-chief executive Bar Dea started to make some changes in the firm, such as making Dalio’s radical transparency principle optional.
As he has been trying to be pushed away from his company by his successors, Dalio demanded a huge compensation package in order to come to an agreement about his exit.
The agreement between these two parties granted him to remain as a board member and to get paid by a special class of stock that will be called “Ray’s Shares” and that will pay a gigantic dividend to Dalio before anyone else in the firm gets paid.
In that context, let’s take a look at Bridgewater’s top holdings using the Uniform Accounting framework and see if the fund is well-positioned for the upcoming year amid the leadership change.
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 Bridgewater Associates 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 15 holdings of the fund is 9%, which is below the U.S. corporate average of 12%.
However, once we make Uniform Accounting adjustments to accurately calculate the earning power, we can see that the average return in Bridgewater Associates’ top 15 holdings is actually 28%.
As the distortions from as-reported accounting are removed, we can see that The Coca-Cola Company (KO) isn’t an 8% return business. Its Uniform ROA is 60%.
Meanwhile, Visa (V) looks like a 15% return business, but this massive payments technology company actually powers a 66% 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 Bridgewater Associates’ top 15 holdings is actually 28% which is much better than 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 Bridgewater Associates paints a clear picture. Over the next few years, Wall Street analysts expect the companies in the fund to stay flat in terms of profitability but the market does not agree with analysts and thinks returns will improve significantly.
Analysts forecast the portfolio holdings on average to see Uniform ROA remain at 28% over the next two years. At current valuations, the market thinks differently from the analysts and expects a 43% Uniform ROA for the companies in the portfolio.
For instance, The Procter & Gamble Company (PG) returned 33% this year. Analysts think its returns will stay flat around 33%. And at a 25.9x Uniform P/E, the market expects an improvement in profitability and is pricing Uniform ROA to be around 48%.
Similarly, Colgate-Palmolive Company’s (CL) Uniform ROA is 32%. Analysts expect its returns remain at these levels around 32% but the market is pricing its returns to rise to 43%.
Overall, Bridgewater’s portfolio is composed of compelling names in which their quality is masked by the distortions in as-reported accounting. However, the market’s expectations for these quality names are really high and that limits the upside potential at current valuations. Considering the recent recessionary concerns and coupling it with high expectations and a leadership change in the firm might lead to some significant downside risk for investors in Bridgewater. Yet, investors should carefully analyze the risks and valuation before making any investment decisions.
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 Bridgewater Associates’ largest holdings.
SUMMARY and The Procter & Gamble Company Tearsheet
As one of Bridgewater Associates’ largest individual stock holdings, we’re highlighting The Procter & Gamble Company (PG:USA) tearsheet today.
As the Uniform Accounting tearsheet for The Procter & Gamble Company highlights, its Uniform P/E trades at 25.9x, which is above the global corporate average of 18.4x, but around its historical average of 25.8x.
High P/Es require high EPS growth to sustain them. In the case of The Procter & Gamble Company, the company has recently shown 5% 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, The Procter & Gamble Company’s Wall Street analyst-driven forecast is for EPS to grow by 0% and 5% in 2023 and 2024, respectively.
Furthermore, the company’s return on assets was 33% in 2022, 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, its intrinsic credit risk is 40bps above the risk-free rate. Together, these signal low operating risks and low credit risks.
Lastly, The Procter & Gamble Company’s Uniform earnings growth is below peer averages, and has above peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research
This portfolio analysis highlights the same insights we share with our FA Alpha Members. To find out more, visit our website.