My three rules of investing

Investing in structural change

Randall Dishmon discusses his investment philosophy and approach.

Everyone that has met me over the past 20 years I’ve been in the financial industry knows what I think of labels when it comes to investing. Labels are your enemy, and I strongly recommend you forget as many of them as possible. Growth, value, core, small, large, balanced…we’re in the business of making money with money. You do that by buying great companies trading at prices less than they are worth. That’s it. Call it anything you want as long as you get the job done.

As many of you know, I recently took over the Invesco Global Focus Equity Fund. It will now follow the same investment philosophy and approach as the global focus strategy I launched in the US 13 years ago. As an introduction to me, my team, and this strategy, I wanted to share a few things that I’ve learned about investing over the years and what I’m trying to accomplish for my clients.

One evolution that has been clear to my most tenured clients in the US is the decrease in holdings – the strategy is more concentrated than when I started. I’ve done hundreds of meetings with clients over the years, and from those it became obvious to me that the average customer is significantly over-diversified. They just own too many things to outperform. I did not want to contribute to that. Couple that with learning over the years how to construct a portfolio to balance risk and reward and additional concentration in the fund is a natural outcome.

I’ve also been increasingly interested in compounding returns vs trading returns. When you hear most people talk about a stock or the “market”, they talk about it having this much upside or that much, the implication being that you buy it, get that upside and sell it. Great businesses, though, are like machines that produce a return by earning more than their cost of capital. When the advantage that they have is durable, they can earn more than their cost of capital over many, many years. That’s the compounding effect that everyone is looking for, and it’s generally far more valuable than the trading returns that most people are focused on. Shouldn’t compounding returns be considered in valuation as well?

Compounders also have a certain profile that you learn to recognise. One thing that they have in common is the importance of cash. Stable cash flow growth and cash orientated valuation metrics play a significant role in both the consideration of business quality and valuation. After 20 years of investing experience, we have found no better representation of business reality than cash – it is the most difficult thing to manipulate and less subject to the influence of human hands. A "compounder" is a business that can compound cash flow at an above average rate over many years. We have a simple set of things we look at that give us insight into the compounding ability of a business.

Is the business exposed to a sustainable growth theme? The world is always changing. Some parts of the economy are greatly favoured and can enjoy decades of opportunity. Others face structural headwinds and may be disadvantaged for decades or outright destroyed by change. We look for investments in those areas that are favoured and avoid those that are swimming upstream. The tailwinds provided by structural, sustainable growth solve a lot of problems for companies.

What is the company's advantage and is it durable? Great investing requires you to understand the nature of advantage. Advantages come in many different shapes and sizes. We spend much of our time identifying advantages and the source of that advantage to evaluate how durable a company’s position will be. Advantages in the hands of the right management team translate into consistent revenue growth over long periods. That’s a key ingredient in compounding. We spend a lot of time as a team and with companies discussing the nature of advantage. Having done this for many years, we know what advantage looks like and what makes it durable.

Do the economics of the business improve with growth? We love companies that get better as they get bigger – where margins go up not down. This quality isn’t required for a business to be good but it can certainly make a great business even more attractive. Balance sheets matter, too. Strong balance sheets allow management to take advantage of opportunities that weak balance sheets cannot. Bear markets and financial crises create opportunities for great businesses.

Part and parcel to the evolution of owning more "compounders" is the willingness to, as Warren Buffet put it best, “pay a fair price for a great business”. It can sometimes look like you’ve paid a premium to the market or a sector, but in our experience it may still be a substantial discount to true value. The discipline around buying something for meaningfully less than what it’s worth remains our north star. It is what investing is all about.

In summary, perhaps the most important attribute of a successful portfolio manager is learning throughout one’s career. The world is very dynamic. Many of the best companies and leading technologies when my career began are long gone – either bankrupt or competed away to irrelevancy. It never stops. If you stop learning, the same will happen to you as a portfolio manager.

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