Many macroeconomic forces impact our portfolios. Unfortunately, these are factors we cannot control, and they come in different shapes and sizes, as discussed in our last video. However, we can control the criteria we impose on our investment selection to achieve successful long-term performance.
Our Investment Committee focuses on five fundamental strengths the businesses we invest in must have for long-term success and compounding growth over time.
1. A Strong Balance Sheet.
Here we evaluate:
- Can the company deal with an increased cost of borrowing?
- Can the company weather an economic storm?
- Can it continue to invest in research and development and capital expenditures?
We’re looking for companies with cash on hand and low debt levels to make strategic investments and weather through difficult times.
2. Pricing Power.
- Does the company have a competitive advantage that will give it the ability to maintain or even raise prices?
- If the company has to raise their prices, will it lose customers, or is it delivering enough value to remain dominant in the industry?
- It’s important to know how replaceable the service is.
- How sustainable is this competitive advantage?
- Essentially, for how long can the advantage be maintained?
Think of Microsoft as an example. Would companies stop using their Office 365 apps if Microsoft raised prices? Probably not.
3. Earnings Resilience.
- How resilient are the company’s earnings?
- Is it in a growing industry with tailwinds?
- We evaluate the resilience of growth acceleration, as well as the resilience of the actual growth.
- If the earnings slow, is it temporary or structural?
- Is the company subject to supply chain issues or risks outside its control?
We tend to favour companies with industry tailwinds and can scale effectively despite the economic environment.
4. Competent Management.
- How has the management team dealt with company-specific issues?
- How has the management team dealt with changing macroeconomic environments?
- Do they have successful capital allocation strategies, or have they diluted shareholders in the past?
- Have they maintained their profit margins, and have they increased cash flow and free cash flow over time?
Most importantly, we look for companies with experienced management teams. Companies with comprehensive strategies for generating organic growth, as well as clear acquisition plans. Also, companies with enough liquidity to take advantage of market opportunities in turbulent times.
- How is a company priced?
This goes beyond simple ratios analysis but also considers many other qualitative factors.
Despite the in-depth research, it’s important to understand that it’s not because you own good companies that their value will not go down when pessimism is high or when there’s an economic contraction.
The Key Takeaway?
During tough times we double our efforts ensuring the companies we invest in have a record of stability and growth based on fundamental strength.
History has taught us that these are the kind of businesses that tend to strive over time, and with a capable management team, they can continue to perform throughout challenging economic conditions.
We’ll leave you with a quote from Warren Buffett:
“The stock market is a device to transfer money from the inpatient to the patient.”
On behalf of TWM Group, thank you for watching and see you next time.