Lex Hall: As the name suggests, Forager Funds Management seeks to unearth unloved gems. They have two funds, one Australian and one international, and both have beaten the index in the past 10 years. So, I thought today I would check in with Forager in-chief, Steve Johnson, to see where they're seeking value and what he thinks of the outlook in general.

Steve, welcome to Morningstar. Thanks for joining us.

Steve Johnson: It's great to be here.

Hall: Now, the first thing I wanted to ask you was that you made a comment recently in one of your updates. You said the "COVID spending economy" will continue through the year. What makes you think that that will be the case?

Johnson: Well, I don't think that this is true globally, but particularly here in Australia, consumers are in rude health. The savings rate here in Australia is as high as it's ever been at about 20 per cent of disposable income. That surprised a lot of people, but it is a fact, and we are still in an environment where there are lots of things that you can't spend money on and international travel is off the cards probably for the most of this year as well. So, I think you are still going to see people in that frame of mind where they're feeling more confident about life out there. They've got money to spend, and there's only a limited number of things to spend it on. So, I'm pretty confident about that.

I'm also confident that post COVID the retail environment in Australia is probably going to be better than it was leading up to it, and I think that's something that a lot of people have forgotten here that the three or four years leading into 2019 was a really horrible period for retail spending in Australia.

Hall: OK. We're going to do a second video in which we'll talk about a lot of stocks. But there's so many interesting stock picks in both of your funds. So, I thought I'd sort of – we could dwell on that a bit. Forager Australian Shares Fund has outperformed the All Ords since its inception about 10 years ago by 3 per cent. What are you seeing out there in particular that's of value today, Steve?

Johnson: It's a very bifurcated market here in Australia. You've got a small collection of very, very expensive tech stocks, and I think outside of that a very sensibly priced market. I mean, we're quite resources and banking heavy here. So, we're exposed to a value factor in general, but we're still finding plenty of opportunities, and we've got a very full portfolio of businesses that are outside that very rapidly growing tech space. So, I think looking outside that area it's still a pretty perspective market in general.

We're adding a lot of software businesses by business-to-business, so enterprise software companies to our portfolio over the past few months in particular. It's a sector that we're pretty optimistic about long term that's been hit very hard by COVID, and it's taken the market a while to realize that. So, share prices have sold off a lot recently, but there's some good opportunities in that space in particular.

Hall: Let's switch to the International Shares Fund. It's outperformed the MSCI AC World Net Index since its inception by 3 points—or 3 per cent, I should say. It's up 48 per cent from June 2020. There are some interesting picks in it. But before we get into them, Steve, you recently said that some fund managers have drawn the conclusion that buying rapidly growing companies is the only thing that's going to work in the future, but you're a bit sceptical about that. Why do you think that?

Johnson: I think it's the wrong lesson to draw that there are some very important lessons to take out of the past ten years. These businesses are—or lots of these businesses that have grown a lot are wonderful businesses and I think we got the valuations wrong 10 years ago by forecasting growth for too short a period or not forecasting enough growth or not understanding how profitable some of these businesses were going to be at scale. So, those valuations were wrong, and I think we need to update the way we think about the world and it being a global economy and the economics of some of these technology businesses and be open minded to them being worth a lot more than a traditional investor might have valued them at 10 years ago.

That doesn't mean that argument works at any price, and I think we've seen the success of the sector feed on itself. The fact that things have gone up has convinced everyone that they're going to keep going up. I think it's a very dangerous lesson to draw because at really high prices you can be paying for an enormous amount of growth for a very long period of time, and you're taking a lot of risk that that doesn't happen. And my favorite example is probably Microsoft. Out of the dotcom bubble there was actually nothing wrong with that business at all. It grew its earnings for 15 per cent per annum for the subsequent 15 years, but the share price went absolutely nowhere over that period. It started at 60 times earnings and finished that period at 12 times earnings. That was a wonderful time to be investing in the business at the end of that period, but it wasn't at the start and I think it shows you that you can pay too higher price for almost any business.

Hall: OK. You've sold out of a few stocks recently. Celsius Energy Drinks, Ulta Beauty, Farfetch, and Uber in particular. What do you see about Uber that made you want to sell? Was it just doing so well that you had to get out of it or…?

Johnson: Yeah, it's just price related on every single one of those stocks. We're really happy with how the businesses are performing, and we'd like to own them again at some point in time. We bought Uber at $23 thinking it was worth $50. We've probably updated that valuation a little bit. The food delivery part of the business there is going much better than we had anticipated. There's maybe a case for a fair value of $60 or $65 there now, but it was trading up into the $70s at one point in time.

So, for us, again, we need to make sure that we're not just stuck and anchoring ourselves to an old price. So, we're updating our models and I'm saying to the team every day, are you sure that we're not just reacting to a share price going up here? Are you confident in your valuations? Have you updated it enough for what we've seen over the past 12 months from these companies? But when we answer that and we say, yes, and I'm being super bullish here, and even if I make a more bullish case, I don't think we're going to make great returns from today's stock price. It's time for us to cut the stock. And we're still finding plenty of interesting new things to add to the portfolio. About a third of the portfolio in our International Fund has been added in the past six months alone. So, while ever there are plenty of new things to buy, the hurdle for something staying in the portfolio needs to be fairly high as well.

Hall: Good lesson for retail investors, too. And while you're on that, you've bought into Whole Earth Brands which specializes in zero and low-cal sweeteners, I think, Twitter and Boohoo. Twitter and Boohoo, why in particular? What do you see there? Boohoo is an online retail or fast fashion player, I think.

Johnson: I think they're both good examples, those companies, of a willingness on our part to buy businesses that we think can grow over a long period of time, but where we still think we have some edge around why we're buying it. And that's the category that I would put us into, deep fundamental research, and try and understand something about a business that's not anticipated in the price at the moment. And this whole value growth debate, I think, it's been hijacked over the past few years. I think for decades, good value investors have been buying good quality growing businesses where they've got some insight into it and where they think they can buy it at an attractive price.

Boohoo is a pretty easy one. There are ESG concerns over that stock that we think are being completely overblown. In fact, we think that company has taken steps over the past 12 months that are going to make it one of the more ESG-friendly businesses in its sector. It is in the business of selling clothes and it's not easy there to do things that tick all of the boxes. But I think relative to the competition, they've made some huge strides. And it's been a wonderful investment and a great business for a long period of time, and we can see that continuing for some time yet. So, as those ESG concerns fade away, we think you'll see the true value of the business turn up in the share price.

And then, with Twitter, I mean, it's been a disappointing stock for the best part of a decade. It was still trading under its IPO price 12 months ago. And our view there is, you had two activist investors come onto the register. You had to board appointments from those activist investors. And the message from all of that was things are going to change at Twitter and we've seen an enormous amount of change over the past 12 months. Money is being spent in the right places; the tech stacks being updated. Anyone that works in the advertising industry will tell you that finally they are able to actually find the people they want to market to on Twitter and that's because a lot of these changes that have taken place. So, it's always been—the number of users and the time on the side, it's always been a wonderful asset that's been growing over the past decade, but their execution around turning that into revenue and profits for shareholders has been horrible. That's changed in the past 12 months and we think it's got a lot of prospects ahead of it. It's really the early stages of turning those very active participants on the Twitter platform into revenue over time.

Hall: OK. Some really compelling arguments there and some interesting stock ideas, too. Stick around to another video with Steve in which we'll drill down into a few more Australian names and one international one as well. But for the time being, Steve Johnson from Forager, thanks very much for your time and your insights today.

Johnson: Thanks a lot.

Hall: I'm Lex Hall for Morningstar. Thanks for watching.