Our investment philosophy and process is so much part of our DNA that we forget not all clients are familiar with what we actually do and how we make our investment decisions. Wanita Isaacs explains the basics of our approach to investing.
Investing, according to the Oxford dictionary, is simply putting money into shares, property or a commercial venture expecting to make a profit. There are various ways people do this, with varying degrees of success. Some investors try to make quick wins by speculating on trending ideas. Compared to the go-go world of market speculation, our approach can seem relatively boring: we do careful research, find good value investments and buy them only when they are available for a bargain – ‘on sale’.
We use this same approach regardless of market conditions. We remain rational and avoid getting caught up in hype or emotion.
To illustrate the process let’s consider a normal trading business – like a corner shop – over the course of its life. Although a JSE-listed company is larger and more complex, when we decide whether to invest in a business we look at it from the perspective of an owner and the same fundamental business principles apply.
Our research is in-depth, on-site and takes time
While most investors use the news – share prices and media reports – to pick the companies they want to bet on, we work hard to establish the true value of a business as a whole, including its ability to make a sustainable profit over time, and under different conditions.
If you were to value a corner store you would look at various factors to establish what the shop is worth and whether it is likely to make a profit. You may come up with a list of questions that looks something like the following:
- What is the value of the stock owned by the shop, less any money owed to suppliers?
- How much are the equipment, shop fittings and any vehicles owned by the shop worth? Are these things all in a good state?
- How much is the shop owed by its customers and are they all likely to pay their bills?
- Is there any cash in the bank or is there an overdraft or other debts due by the shop, like rental arrears or rates, or taxes not accounted for?
- How good is the manager at buying the right amount of stock and at stocking the kind of things that the shop’s customers want to buy? Is the store’s pricing consistent with what they stand for?
- Is the shop in the right location? Does it have a sensible rental deal and how long does its lease have to run?
- How many employees are there and how good are they at running the shop and serving customers? Are they happy?
- What are all the staff, rent, maintenance and operating costs that the shop incurs over time? What monthly sales does it have to achieve to pay for all these costs?
We value JSE-listed companies in a similar way. The list of questions we try to answer in each case is very different, and some businesses are quite complex to value, but the basic concept is the same: how much would a rational buyer pay for the whole business?
Some important questions appear in almost all of our research reports, for example: how profitable is the business through market cycles and what drives these cycles; how much cash is generated by a business’s operations and how much cash is required for it to grow (for example to pay for increased stock or for new factories); how skilled and transparent are the management team, and how good have they been at deciding where and when to allocate capital?
We don’t buy all good value assets
To go back to our little corner shop, let’s imagine that every year during the school holidays children pile into the store to buy sweets. Sales soar, stock flies off the shelf and as offers to buy the business pick up, the owner increases the asking price to get the best deal. Would you buy this business now?
In many cases the market would answer: yes!
But, if your estimate of the value of the shop looked at how sales change through the seasons (these are this business’s market cycles), you would know that the current price is not a true reflection of what the shop is worth through the market cycle. Of course, there are styles of investing that try to time the upswing by buying the corner shop the day before school holidays start, or perhaps as the price is starting to rise. This approach can be lucrative, and quite exciting, but there are two problems that make it risky.
First, others are also anticipating the upswing, and so by the beginning of the school holidays the impact of this is already priced in – you have to be really early to beat the crowd. And at the end of the school holidays, sellers anticipate the downswing and attempt to time their exit just before everyone else. This often results in a peak and then a sudden decline in value, both with unpredictable timing, leaving many investors nursing a loss from having bought at the peak and sold in the trough. The second problem is that not all business cycles are as predictable as a summer holiday. For investors looking to ride a trend, mistiming is easy and can be very costly.
A great deal of emotion and group-thinking influences share prices but this doesn’t affect the true value of the company. Our philosophy of looking to buy businesses based on what they are worth to a long-term buyer often leads us to businesses that are unfashionable and out of favour, because this is when they are priced at a bargain. This sometimes feels risky because it means going against the crowd, but in fact it is exactly this that has allowed us to create wealth for clients over time, and it has proven less risky than other strategies.
We only buy undervalued assets
We start to see opportunities when, in our example, the school holidays end and the corner shop seems to be worth a lot less and thus goes up for sale at a much lower price, because no-one is really that interested anymore (they’re all looking at the school uniform store). In the real world you usually have to wait a lot longer than a school term to see a fair return, but patience pays off.
Our investment process relies on thorough research that gives us the ability to value a business, and it relies on the discipline to stick to our knitting. It is not an exact science, and it’s not always exciting enough for investors looking for quick wins, but it has proved itself over our 42-year history.