On more than one occasion, Warren Buffett has stated that his preferred time horizon when investing in a business is “forever”. The idea is not to sell but to participate in a business that invariably has reasonable expectations of growth and profitability. Though not always easy, finding one of these gems and keeping it in your portfolio for many years is among the most effective ways to obtain extraordinary results. In his book 100 Baggers, financial proponent and investor Christopher Mayer pinpoints the elements common to those companies that have multiplied their value 100x over long periods of time.
One of the initial fundamental elements is to find top-quality businesses that operate in very large and growing markets. The quality of a given business is not always easy to determine, since many qualitative factors come into play. From a strictly accounting point of view, these are companies with elevated return on invested capital (ROIC) and profitability that is stable or increasing over time. We seek companies that are capable of growth, while simultaneously maintaining or improving profitability. In this respect, there are two crucial elements. First, any reinvestments the business may require (capex); those without major reinvestment needs will always be preferable. We want to invest in growth, not in businesses that absorb our capex needs. Second, retained profit, meaning companies that can reinvest the surplus cash they generate while maintaining high rates of return.
With regard to the foregoing, one factor common among all companies capable of generating very high returns for their shareholders is an excellent management team. Once again, this is a qualitative component that is difficult to measure. Mayer stresses the importance of management teams that think like owners or business proprietors, rather than executives, which often requires perfect alignment and translates into CEOs who are also the founders and main shareholders of the company. What’s more, their remuneration comes mainly from the appreciation of shares over prolonged periods rather than in the form of wages or payment with shares. Logic dictates that generating extraordinary returns in the long term requires a management team (and shareholders) wholeheartedly committed to the long term, which may seem normal but is neither evident nor frequent.
Among other things, this requires a management team that excels in the allocation of funds generated by the business. With the cash it generates, the company can (1) reinvest in the business and help it grow, (2) acquire other businesses (inorganic growth financing), (3) repay its debt, (4) reward its shareholders, either through (4) dividend payments or (5) share buybacks (in the case of listed companies whose intrinsic value is clearly higher than the share price). Any company whose results surpass those of the market stands out in this respect.
Mayer’s book contains many other valuable observations for long-term investors and between the lines lies a message that reflects EDM’s philosophy: to focus more on the quality and prospects of the businesses in which you invest and less on market timing. Money is not made on the stock market by buying and selling, but by holding shares in good businesses for long periods of time.
Luis Torras,
Wealth Management director
