Investment Process

I am a value investor. When I look at a business with a view to owning a part of it, I ask myself four main questions:

1. Is the business in my circle of competence?

In other words, do I know where this industry is going to be in 10 or more year’s time and what the position of the business will be in this industry? Companies which are technology or fashion dependent are firmly outside my circle of competence and so I leave them to someone else. Businesses in slow-changing, some would say “boring” industries are firmly in my circle of competence. This is where I feel most at home.

2. Does the business have a long term sustainable competitive advantage?

I am looking for businesses that can generate high returns on the capital which their owners entrust to them. In competitive and open economies, high returns are the exception rather than the rule as high returns always attract new competitors – this is why entry barriers are essential. Warren Buffett coined the term “moat” to refer to entry barriers. The main entry barriers are: Patents, brands, licences, switching costs, the network effect and cost advantages, for example from scale. I look for entry barriers that will persist for a long time, not just a few years.

3. Does the management possess talent and integrity?

I would never knowingly invest in a company in which I did not have complete confidence in a management’s competence and integrity. After all, what is the point in owning the most wonderful business, if the cash flows are wasted either through incompetence or dishonesty? I always endeavour to conduct myself with the utmost integrity (whether with talent I will let others judge). I feel better that way and tend to find it brings me into contact with the kind of people I want to associate with.

4. Is the price attractive?

When I find a great business run by managers I like and respect, I want to buy it at an attractive price. In public markets, I find that parts of businesses can periodically be bought at enormous discounts to their fair value, especially when there is pessimism about the future. Benjamin Graham, the teacher of Warren Buffett, uses the analogy of “Mr Market” to describe public markets. Mr Market calls out prices every day – you are free to either buy from him, sell to him, or ignore him. Mr Market has very changeable moods. Sometimes, he is enormously optimistic about the future, can only see rising earnings, and will pay a very high price. Sometimes, he is manically depressive, can only see the risks and will sell to you almost at any price. I try to be a buyer when Mr. Market is going through his periodic bouts of depression.  

An investment process which consists of four steps, each of which has a "yes" or "no" answer may sound simple and indeed it is. This is because the best capital allocation decisions are typically made at moments of extreme market distress. To operate effectively in such an environment requires a process which is robust and simple to administer. However, each capital allocation decision is preceded by months of research and often years of waiting for the right price to come along. Before I invest in a business, I want to build an in-depth knowledge of its business model and the people running it. I will typically seek the view of competitors, customers and suppliers as well as the directors and senior managers running the business. I always visit the company before investing and where possible or relevant will visit overseas subsidiaries. A lot of the information gathered may not necessarily be relevant to the investment case, but I find it essential to building the conviction necessary to make a capital allocation decision when the outlook is at its bleakest and prices are at their most attractive.