Marketing material for professional investors or advisers only.

Simon Adler, Fund Manager and Liam Nunn, Analyst

Joint Investment Forum

Global Value

January 2020

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Learning outcomes

Describe the four step process by which you can identify worthwhile value stocks

List the 7 red questions used to avoid value traps

Describe why value investing works over the long term

The Value Team Edges

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In a competitive investment world, you have to have an edge…

Informational

Organisational

Analytical

Behavioural

Focuson value

Informational – the importance of screening

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Always start with the cheapest stocks to avoid style drift

Source: Schroders. For illustrative purposes only and should not be viewed as a recommendation to buy or sell.

Recycle - too expensive Opportunity Set

Analytical – One True Model

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Minimum ten year model

Source: Schroders. For illustrative purposes only and should not be viewed as a recommendation to buy or sell.

Analytical – 7 Red Questions

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Discovering company DNA

The answer to each question contributes an element of risk and/or reward

Source: Schroders.

Risk

Reward

Missingliabilities?

Misleadingprofits?

Structural changes?

Profits into cash?

Financial stress-test?

Business ‘quality’? ESG?

Analytical – 7 Red Questions

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Q1) Is the screen missing any liabilities (or assets)?

Discovering company DNA

Source: Schroders. For illustrative purposes only and should not be viewed as a recommendation to buy or sell.

Missing liabilities?

Misleading profits?

Structural changes?

Profits into cash?

Financial stress-test?

Business ‘quality’? ESG?

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16

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(29)(48)

(23)

190177

144

¥100

¥125

¥150

¥175

¥200

¥225

Market cap MinorityInterest (BS)

(Net Cash) Bloomberg EV Pension andProvisions

Minority Top-up (FinancialAssets)

Capital gainstax

(Associates) Our EnterpriseValue

Liability Asset Total

Analytical – 7 Red Questions

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Q2) Are the screen profits misleading?

Discovering company DNA

Source: Schroders.

Missing liabilities?

Misleading profits? ESG?

– Satisfied historic profits are representative

Structural changes?

Profits into cash?

Financial stress-test?

Business ‘quality’?

Missing liabilities?

Misleading profits?

Structural changes?

Profits into cash?

Financial stress-test?

Business ‘quality’? ESG?

Analytical – 7 Red Questions

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Q3) Is the business likely to suffer from structural change?

Discovering company DNA

Source: Schroders. For illustrative purposes only and should not be viewed as a recommendation to buy or sell.

– Most of the business has limited structural threats

– c.10% of profits come from a division that includes structurally challenged HDDs

Analytical – 7 Red Questions

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Q4) Do the profits turn into cash?

Discovering company DNA

Source: Schroders. For illustrative purposes only and should not be viewed as a recommendation to buy or sell.

– 10 year median free cash flow/net income conversion of 95%

Missing liabilities?

Misleading profits?

Structural changes?

Profits into cash?

Financial stress-test?

Business ‘quality’? ESG?

Analytical – 7 Red Questions

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Q5) How would the business stand up to a financial stress-test?

Discovering company DNA

Source: Schroders. For illustrative purposes only and should not be viewed as a recommendation to buy or sell.

– Very strong balance sheet

– They have net cash of Y28bn which compares to their lowest EBITDA since 2008 of Y37bn– In addition they have Y48bn in financial assets

– 1.9x gross debt/lowest EBITDA since 2008

Missing liabilities?

Misleading profits?

Structural changes?

Profits into cash?

Financial stress-test?

Business ‘quality’? ESG?

Analytical – 7 Red Questions

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Q6) Is it a high quality or low quality business?

Discovering company DNA

Source: Schroders. For illustrative purposes only and should not be viewed as a recommendation to buy or sell.

– 10 year return on lease adjusted capital of 13.5%

– They haven't made a loss in any year for the last 12

– Two (modestly) negative free cash flow years

Missing liabilities?

Misleading profits?

Structural changes?

Profits into cash?

Financial stress-test?

Business ‘quality’? ESG?

Analytical – 7 Red Questions

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Q7) Are there any ESG considerations?

Discovering company DNA

Source: Schroders. For illustrative purposes only and should not be viewed as a recommendation to buy or sell.

– Stakes in related businesses including suppliers and customers– Poor allocation of capital or required for Japanese corporate relationships?

– Daido Steel is their largest shareholder

– Fines for monopolistic behaviour in the hard disk drive business

– Board is old, entirely Japanese and lacks independent experience

– Share count hasn't increased for 12 years

Missing liabilities?

Misleading profits?

Structural changes?

Profits into cash?

Financial stress-test?

Business ‘quality’? ESG?

Behavioural – all about judgement

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Overall levels of risk and reward are evaluated and balanced

Source: Schroders. For illustrative purposes only and should not be viewed as a recommendation to buy or sell.

Reward Risk

EBIT margin 5.7% 4.0%

Upside 101%

Behavioural – all about judgement

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Reward

Source: Schroders, September 2019. For illustrative purposes only and should not be viewed as a recommendation to buy or sell.

Reward

Market cap 381,900

Net debt/cash 28,514

Other EV adjusts 17,731

EV 335,654

EV/NOPAT multiple 14.0

NOPAT 23,883 19,639 23,975

P&L tax rate 28% 61% 28%

EBITA 33,171 27,277 33,299

5.3%

Normalised

625,486

10 year median Last year Normalised

Sales 585,573 681,006

Behavioural – all about judgement

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Risk

Risk score 4/10 (where 10/10 is the highest risk)

Source: Schroders. For illustrative purposes only and should not be viewed as a recommendation to buy or sell.

– Balance sheet risk very low

– Most of the business has limited structural threats

– c.10% of profits come from a division that includes structurally challenged HDDs

– Numerous ESG risks

Risk

Behavioural – all about judgement

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Overall levels of risk and reward are evaluated and balanced

Source: Schroders. For illustrative purposes only and should not be viewed as a recommendation to buy or sell.

101%Reward

4/10Risk

Stock debate

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This is an illustrative example

Risk4/10

Reward

101% vs.Risk

3/10Reward

75% vs.

Risk3/10

Reward

90% vs.Risk

4/10Reward

115% vs.

Simon Adler Andrew Lyddon

Nick Kirrage Liam Nunn

Organisational – the value team archive

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Efficiency, learning, sharing

Source: Schroders.

Company

Archive of all companies

Portfolio construction

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Largest positions are ideally in stocks with lowest risk

Source: Schroders.The risk score is driven by the company’s finances and all other potential risks, including, but not limited to, the regulatory environment, geographic region, industry and management. A lower risk score equates to lower risk. For illustrative purposes only and should not be viewed as a recommendation to buy or sell.

Stock Position held Risk

Company A 4.1%

Company B 3.8%

Company C 3.3%

Company D 3.0%

Company E 2.7%

Company F 2.5%

Company G 1.7%

Company H 1.6%

Company I 1.6%

Company J 1.5%

Company K 1.2%

Company L 1.2%

– Risk to capital is the most important factor in determining positions sizes, however this is balanced with several other factors

– Reward i.e. upside to fair value, is the key other determinant

– Overall portfolio characteristics e.g. sector position sizes, play a role too

Higher risk

Lower risk

Process

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Focus on getting better

The Value archive allows us to embed systematic reflection and learning into our process

Source: Schroders.

2014

Regular Team Learning Days

Proposed Hypothesis

Large sample sizeAll stocks

Systematic process

Development

The Value Team Edges

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In a competitive investment world, you have to have an edge…

Informational

Organisational

Analytical

Behavioural

Focuson value

Value archive for stockpicking, portfolio construction and getting better over time

Valuation screens are the sole source of investment ideas

One True Model and 7 Red Questions to avoid traps

Quantifying risk and reward

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Learning outcomes

Describe the four step process by which you can identify worthwhile value stocks

List the 7 red questions used to avoid value traps

Describe why value investing works over the long term

Important information

Marketing material for professional investors or advisers only. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall.Schroders has expressed its own views and opinions in this document and these may change. This information is not an offer, solicitation or recommendation to buy or sell any financial instrument or to adopt any investment strategy. Nothing in this material should be construed as advice or a recommendation to buy or sell. Information herein is believed to be reliable but we do not warrant its completeness or accuracy.Any data has been sourced by us and is provided without any warranties of any kind. It should be independently verified before further publication or use. Third party data is owned or licenced by the data provider and may not be reproduced, extracted or used for any other purpose without the data provider’s consent. Neither we, nor the data provider, will have any liability in connection with the third party data.The material is not intended to provide, and should not be relied on for accounting, legal or tax advice. Reliance should not be placed on any views or information in the material when taking individual investment and/or strategic decisions. No responsibility can be accepted for error of fact or opinion.The forecasts included in this presentation should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts. Forecasts and assumptions may be affected by external economic or other factors. Any references to securities, sectors, regions and/or countries are for illustrative purposes only. Schroders will be a data controller in respect of your personal data. For information on how Schroders might process your personal data, please view our Privacy Policy available at www.schroders.com/en/privacy-policy or on request should you not have access to this webpage. For your security, communications may be recorded or monitored. Issued in January 2020 by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU. Registered in England, No. 1893220. Authorised and regulated by the Financial Conduct Authority.

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