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Stock Picks

The Second Investment, Part II

Having recently re-examined my investment thesis for GEA following the release of Q3 results for FY14, I added to my position today, doubling my holding from 10% to approx. 20% of my overall portfolio.

In building such a highly concentrated position in GEA, I clearly have a high degree of conviction about the Company’s position and prospects. For the reasons already articulated in my earlier notes here and here, I believe GEA is an excellent business, and that the recent share price decline is a short-term reaction to a temporary lull in the business cycle. Furthermore, I feel the magnitude of the decline is also in part attributable to the small free float and relative illiquidity in the stock – a factor that does not have a bearing on the underlying economics and operations of the business.

With regard to the level of concentration in this position, the paucity of attractive investments in public equity markets at present indicates to me that it makes sense now more than ever to focus on only the very best investment ideas to achieve satisfactory returns on capital. Common stock prices remain not just expensive, but artificially supported by ongoing abnormal, interventionist monetary policy. At the general level, this has created an overpriced relative value world, with the expectation for future returns predicated on over-optimistic assumptions regarding business fundamentals (and specifically profit margins) and the continued back-stop of low interest rates. I maintain that mean reversion on margins and normalisation of interest rates will eventually occur, leading to a re-pricing of risk assets generally.

In such an environment, highly selective investment in high quality securities or situations, justified by rigorous fundamental analysis and a sufficient appreciation of risk, is required to identify opportunities that will at the least protect capital, but also generate an adequate return over a reasonable time frame. I continue to view GEA as one of the most compelling investment opportunities in public equity markets, one which meets all the key investment criteria on my investing checklist. On this basis I believe that increasing my position in the Company to 20% of my portfolio is an intelligent allocation of capital.

In summary, the recent decline has afforded me the opportunity to increase my fractional ownership in GEA at a very attractive price, well below a conservative estimate of intrinsic value. In addition, the increased position at a price today of €69.45 per share has allowed me to reduce my weighted average cost by approx. 10%, and thus further increase my margin of safety.  Finally, I believe the risk/return profile remains asymmetric, with limited downside risk versus potential upside being a multiple of this downside, as outlined here. Over the medium term I expect my investment in GEA to produce a very satisfactory return.

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