Whatever the broader economic backdrop, we believe there are always opportunities and superior companies that can take advantage of them – but they can be few and far between. The challenge for us, therefore, is to achieve a deep understanding of prospective holdings, identifying risks to business models and growth expectations, as well as the industries in which they operate, to enable us to assess whether their long-term potential is appropriately valued.
On the one hand, our approach implies there are indeed market inefficiencies that we can exploit; and our experience tells us this is certainly the case in European equities, as it is elsewhere. On the other, it implies the need for almost forensic analysis to give us the confidence that we have found a mispriced business exhibiting the sort of quality and growth potential that is worthy of a long-term investment.
Our investment approach has the following characteristics:
- We seek to identify long-term excess returns that are underappreciated by a market driven by short-termism.
- We typically favour quality franchises with high barriers to entry, and growth companies supported by secular, rather than cyclical growth drivers.
- Our business model analysis is thorough, and we utilise Porter’s Five Forces to assess industries and competitors.
- We have a long-term investment horizon; turnover is low, and we expect company growth to compound shareholder value.
- Our approach is high conviction and benchmark agnostic; we only buy companies we like and have no obligation to hold index giants.
- We keep the strategy fully invested and do not make tactical allocations to cash.
- Our understanding of valuations is informed by cash flow and returns metrics, not short-term earnings.
Long-term excess returns underappreciated by market driven by short-termism
In our experience, short-termism in the market can create opportunities for long-term investors committed to conducting thorough analysis. It is common knowledge that mean reversion is a feature of real-world economics. Thus, businesses that earn high returns on capital tend to attract competitors who then compete away those returns on capital back down towards the cost of capital. We see this feature underpinning market behaviour. We have observed that the equity of the best businesses is often mispriced and believe diligent analysis can identify ways to exploit this anomaly. But why is there a mispricing? The rise of short-termism in equity market behaviour in recent decades is wholly at odds with the investment horizon of business management teams and their broad base of stakeholders. This mismatch in time horizons creates an inefficiency that we seek to exploit.
We have seen that there are businesses that stand out, companies which deliver higher returns, higher growth rates and sustain them for much longer than the majority of professional stock market investors are prepared to ascribe value to. This is because they have protective moats around their business. Market myopia means it can take a long-time for the stock market to re