The value process as told by professional investors.
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Value Process – Quotes
You mentioned you’re finding plenty of opportunities outside the US in international markets. Are there any particular reasons you find attractive here?
We’re bottom-up investors and very opportunistic. We find opportunities in all kinds of places. I do think there are a lot of things are quantitatively cheap in Australia, but there are actually a lot of risks relating to the economy there such as the real estate bubble and the exposure to China. Other than Australia, I don’t see any regions with an unusually high number of good opportunities right now. We have traditionally, and still do, have a lot of exposure to developed Europe and mostly the UK. But I don’t see an unusually large number of opportunities in those places right now.
Do you think managements are as shareholder friendly in these regions, especially the UK, as they can be in the US?
In my experience yes. I’m not sure there’s any difference in the small-cap universe. Maybe one difference, especially if you include micro-caps, in the UK these companies have a much higher institutional ownership than those micro caps in the US, so they tend to have better shareholder communication policies. I think the US and the UK have the most shareholder-friendly managements around.
So would you say your style is based on a ‘top down approach’?
In terms of selecting the best countries – yes, there’s a big macro element. A lot of value investors, who invest in the US say macro factors, such as politics and economics don’t matter, which is true to a certain extent, accurately predicting US economic growth isn’t going to give you any particular edge in that market. But in international markets, it’s really important to pay attention to economics and politics. Even if you have a great company, if the country’s falling apart you’re not going to make any money. There is a top-down approach to filtering the countries. But then there’s a bottom-up approach to finding the companies in each country.
Is there a list of the countries you’re avoiding right now?
I try to follow global geopolitics quite closely, and keep an eye on what’s going on in different countries around the world. With this information, I’ve devised a list in my mind of the most and least attractive investment destinations.
Emerging markets, in general, have had a pretty rough time recently, are there any specific markets that are looking attractive to you right now?
When I came out of Deutsche Bank in 2006/2007, there was a big thing with the BRICs, Brazil, Russia, India and China and this never really made sense to me. Why limit your international investments to these countries? What’s happened since has validated this view. So, rather than looking at ‘emerging markets’ as a group, I tend to look at specific markets in particular. I classify Israel and South Korea as emerging markets. I think they’re both very attractive. You have to be careful which countries you choose.
So when you finally find a market to invest in, how do you go about searching for prospective investments?
After determining the countries that I’m interested in, I just go back to basic value investing. I look at the company, the balance sheet, and the assets, at the moat, management team and cash flow analysis. This type of analysis is half science, half art. You need to look at the company and say, “what would this company be worth in five years’ time, under different economic scenarios”? And then I look to buy with an attractive margin of safety, we’re traditional value investors. We’re looking for companies that are cheap based on assets, earnings or cash flows.
How do you go about assessing a business’s underlying value? Is your process qualitative or quantitative?
We assess the value of a business the way a businessman would assess a company he is looking to acquire.
We start with what one can be most certain of; the assets. Does the company have an asset, like real estate, that is either unrecognized or is not being used to its full potential? The value will only be reflected in the share price if management changes its use.
Second, we focus on the cash earnings power (the cash the business should generate in a normal environment), the capital needed to invest back in the company to maintain its competitive position, the opportunities to invest to expand the business at returns above the cost of capital, and the companies target debt structure. Those are the quantitative measures we use to assess value.
On the qualitative side, we look for a competitive advantage because it gives the business the ability to earn supra-normal returns on capital. Does the company do something that its customers value and will pay for and that its rivals cannot easily replicate? Will it last? A competitive advantage only has substantial value if it is durable.
How do you go about looking for ideas, what’s your value process?
We avoid the typical screening/filtering. Instead, we have a mental database of companies we’ve deeply looked at in the last 20 years. Then ideas come naturally through many ways: profit warnings in places we know, or a competitor’s praise of a business model for example, or just chatting with like-minded value investors
In your first letter to investors, you highlight the fact that you’re looking for ‘cheap companies,’ how does the fund define cheap in this case and how do you go about calculating your estimate of intrinsic value?
We first try to answer an apparently simple question: will the business be around in ten years? Then, we try to answer a little harder one: will it make more money than today, and why. If the answer is YES in both cases, we then look at the FCF yield to the firm. We are not comfortable with anything below 8-9%…Sometimes we’ve made exceptions if the ROCE is really good and the barrier to entry very solid, in which cases we can settle at 7-7.5%. Below that we do not dare to venture…
Do you think Spain is a market that international investors should consider? Why is this the case?
We do not have opinions about markets “in general”, but rather tend to ask for a particular market: “are there enough cheap good businesses.” In Spain, we have roughly 100 investable companies. Most of them are global, and I would not link them thematically.