Comprehensible Companies

Businesses that we can understand and value that fall within our "circle of competence". These will tend to be high quality companies in growth sectors that are profitable and expected to be around for a long time.

Competitive Advantage

Added-value businesses with sustainable gross margins and expanding operating margins. We look for companies with strong products and services; technological leadership or innovation; resilient brands with high barriers to entry. Such businesses will tend to have a broad customer base (companies with a lumpy order book and concentrated client base are best avoided) and the power to raise prices and margins. We look closely at the competition to determine market trends and potential risks.

Competent Management

We place great store on management and spend a lot of time trying to understand what makes them tick. We want to gain a vision of where a company will be in five years time or more. People who have succeeded before tend to do so again - serious overachievers are worth backing. Focused management teams who are not overly deal driven are more reliable than those who are. Since all key decisions are made at Board level, we pay a great deal of attention to Board structures and the quality of executive and non-executive directors. We check out individuals carefully through a wide network of contacts.

Caring Management

It is not enough to be a good manager; we look for individuals who care about both their employees and their shareholders. If they are unwilling or indifferent about communicating with investors it is unlikely that a long-term relationship can develop. Commitment by management to the company should be evident through high insider ownership paid for with real money.

Consistency

We dislike surprises – particularly negative ones. We would rather pay more for a company that shows consistency in earnings growth and cash flow as a result of clarity of management strategy. Predictable companies can be valued more accurately and make better long-term investments.

Compound Earnings

We see little point in investing in companies that are not growing or are in sectors that are ex-growth.

Cash

Of all the criteria we consider, cash is the most important. Cash does not lie. If a company does not generate its profits as cash, we want to know why. Cash management is one of the clearest signs of the competence of the Executive. It is not enough just to generate cash – it should be evident how the cash can be reinvested successfully. Core holdings should have replicable strategies that can be achieved by self-financed growth, typically enjoying high recurring revenues with little need for capital investment.

We focus on return on capital employed, which should be high and sustainable. Balance sheets should be robust with low gearing and/or high interest and dividend cover. Through a thorough knowledge of a business we try to understand future capex and working capital requirements.

Adding Value

Due to the large number of small companies within our investment universe (many of which are poorly researched) we are spoiled for choice. Ideally we would like each of our investments to meet all our criteria. In practice, few companies pass on every criterion. However, this is only the first stage in identifying a possible investment. We complete a detailed financial model, meet the management and spend time out of the office to learn about the business in situ. This is how we can add value.

Our valuation models include a comprehensive discounted cash flow analysis to determine the intrinsic value of a company. As part of this exercise, we examine Economic Value Added ("EVA"). We seek to invest in companies that generate returns in excess of the cost of capital - in other words, management that add value.

Our investment approach aims to identify a focused portfolio of well-managed companies at an attractive discount to their intrinsic value that can be held over the long-term. We are doubtful about the merits of trading and view market corrections as an opportunity to add to our core holdings. By establishing the "intrinsic value" of a company, we can form a view about whether it is undervalued. If it is not, but meets the criteria that we look for, we will simply wait for a better time to invest