How I look to invest.
There is no point being an active investor unless you want to beat the market. But to do better than average you can’t just do what everyone else is doing. This means that you generate above average returns when you are right and other people are wrong.
The problem is that investors aren’t wrong that often. Share prices generally reflect huge amounts of information, dissected by lots of intelligent people, and are therefore normally right. There are however, times, when I believe uncertainty creates opportunities to buy good companies, at great prices.
This may be when a fast growing company misses an earnings target, or where a business is affected by an event outside of its control. These periods create uncertainty for investors, which is generally reflected in the share price. This creates opportunities to buy companies where the long-term story of the business remains intact, at prices which suggest the opposite.
The types of companies I invest in.
Someone once told me that ‘a good business is not always a good investment, but that bad company is always a bad one’.
I therefore look to buy shares of quality companies, with long-term structural drivers of growth and clear competitive advantages. Defining quality is tricky, but it generally refers to companies able to earn a return on the capital invested in their business above that of their peers. Excess returns however, attract competition, which seeks to erode these abnormal profits. The companies that win in the long-term are those with the competitive advantages that enable them to resist this effect.
I do not invest in one particular sector, although I do steer clear of banks, but my focus is on UK equities. Whilst this may seem like an unnecessary limitation, and one that I may amend in time, I believe that the number of potential opportunities that currently exist means there is little need to look further away.
My focus is on small companies, generally those with revenue below £100mn. The reason for this is I believe there is less efficiency in this segment of the market, with most professional investors either unwilling or unable to participate. Like a game of poker, I prefer to play at the weakest table.
How I value companies.
I think value investing as a term is often misunderstood, and those still practicing it in the Graham mould of the 1930s are likely to generate subpar returns. For me it is nothing other than buying a company for less than its intrinsic value. For a business, or any other cash generating asset, this is the present value of its future cash flows.
Determining a business’ value therefore involves making numerous assumptions about factors like revenue growth, reinvestment and profitability. To do this, you need to have an understanding of the business, the market it operates in, and its competitors. Even with all of this information, you will still be wrong.
“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know." John Kenneth Galbraith
My goal therefore is not to be exactly right about how much a company is worth, but to find companies that are priced so far below my estimate of intrinsic value that the odds are heavily in my favour.