Disclaimer: I have a material personal interest in Macfarlane shares. A portfolio I help to manage has a large weight in Macfarlane shares. Hence, I cannot help but be biased. Please do your own research – my projections are mine alone.
How I Invest
As I described in my year-end post, to the extent I have a framework in investing, it is this:
- Buy companies which are cheap in absolute terms, and in any case cheaper than the market
- … which are more predictable than the market
- … which are higher quality than the market (as judged by prospective return on invested capital)
- … and have better growth prospects than the market
My order of priority is roughly as I’ve laid it out above.
To me, this is a common-sense way of investing. Look for cheap stuff which should be more highly valued.
So what determines whether a company should be highly valued? Why do some companies trade at 25x, and some at 5x?
Well, highly valued should come from a combination of:
- Bonds trade at lower expected returns than mature stocks, which have lower expected returns than start-ups
- The riskier an asset, the higher the necessary returns investors will demand , and the lower the ‘multiple’ the asset will trade on
- The higher the returns on invested capital, the more a business is worth. A growing business is worth nothing if that growth requires a huge amount of uneconomic capital
- Subject to the quality hurdle, more growth is better than less. Everyone knows fast growing business trade at better valuations
You can nuance this further. Some people would tell you that brilliant management or an aligned board should be prized. I agree. But these only matter to the extent they show through in one or more of the numbers above. Excellence at the top of a business should translate into excellence through the business and in the income statement.
Excellence in Action
Sticking with this theme, let me take a cherry-picked sample of some UK industrial/distribution businesses: Bunzl, Halma, Spirax-Sarco, Oxford Instruments, RS Group, Renishaw and Diploma.
These are all high-quality mid-cap industrials. Each of them has a decade of good growth behind them, strong returns on invested capital, and a highly predictable P&L. None of them has lost money in the last decade. Look at the EPS progression in the chart below:Continue reading“Macfarlane – Consistently Underrated”