Quality investing is one of the best investment methods in the world.
Since 2010, this investment strategy returned more than 18% (!) per year to shareholders.
Learn how to find quality stocks here:
Since 2010, this investment strategy returned more than 18% (!) per year to shareholders.
Learn how to find quality stocks here:
What is a quality company?
For legendary quality investor Terry Smith, quality investing is based on 3 metrics:
1. Buy good companies
2. Donβt overpay
3. Do nothing
Here you can find a thread we recently wrote about Terryβs investment strategy:
For legendary quality investor Terry Smith, quality investing is based on 3 metrics:
1. Buy good companies
2. Donβt overpay
3. Do nothing
Here you can find a thread we recently wrote about Terryβs investment strategy:
Some great examples of quality companies can be found in Terry Smithβs portfolio (Fundsmith):
Chuck Akreβs three-legged stool also offers a great framework for quality investors:
1. Buy good, very profitable businesses with a wide moat
2. With capable and integer management
3. Which can reinvest a lot of free cash flow in organic growth
1. Buy good, very profitable businesses with a wide moat
2. With capable and integer management
3. Which can reinvest a lot of free cash flow in organic growth
Chuck Akre is currently invested in beautiful companies like Mastercard, American Tower and OβReilly Automotive.
The million-dollar question is how to find these quality companies.
Quality companies have the following characteristics:
- A wide moat
- Integer management
- Low capital intensity
- Good capital allocation
- High profitability
- Attractive historical growth
- A secular trend
Quality companies have the following characteristics:
- A wide moat
- Integer management
- Low capital intensity
- Good capital allocation
- High profitability
- Attractive historical growth
- A secular trend
Wide moat
Over the past decade, wide moat stocks outperformed no-moat stocks with more than 8% (!) per year.
You want to invest in clear market leaders with strong pricing power and a great product/service which customers love.
Over the past decade, wide moat stocks outperformed no-moat stocks with more than 8% (!) per year.
You want to invest in clear market leaders with strong pricing power and a great product/service which customers love.
Management integrity
Companies with skin in the game outperform companies who donβt with 3.6% per year on average.
You want to invest in businesses where the interests of management are aligned with yours as a shareholder. Think about companies like LVMH and Copart.
Companies with skin in the game outperform companies who donβt with 3.6% per year on average.
You want to invest in businesses where the interests of management are aligned with yours as a shareholder. Think about companies like LVMH and Copart.
Learn more about skin in the game here:
Low capital intensity
The best companies require very little capital to operate.
Almost all compounding machines have a low capital intensity. Seek for companies with a CAPEX/Sales < 5% and CAPEX/Operational Cash Flow < 15%.
The best companies require very little capital to operate.
Almost all compounding machines have a low capital intensity. Seek for companies with a CAPEX/Sales < 5% and CAPEX/Operational Cash Flow < 15%.
Some low CAPEX quality businesses: Automatic Data Processing (CAPEX/Sales: 1.2%), Dominoβs Pizza (CAPEX/Sales: 2.2%) and Blackrock (CAPEX/Sales: 1.8%).
Good capital allocation
When a company earns cash they can do three things with the FCF they generate:
- Reinvest for organic growth
- Acquisitions (M&A)
- Share buybacks and dividends
When a company earns cash they can do three things with the FCF they generate:
- Reinvest for organic growth
- Acquisitions (M&A)
- Share buybacks and dividends
Seek for companies who reinvest most free cash flow in organic growth.
In general, the greater the capital allocation of a company, the better.
Looking at ROIC and ROCE is a good start. We prefer companies with a ROIC greater than 20%.
Looking at ROIC and ROCE is a good start. We prefer companies with a ROIC greater than 20%.
This visual from @safalniveshak sums it up quite well.
@safalniveshak High profitability
The free cash flow margin shows the percentage of sales that is translated into cash. When a company has a FCF margin of 30%, for every $100 the company sells, $30 of cash is generated.
The free cash flow margin shows the percentage of sales that is translated into cash. When a company has a FCF margin of 30%, for every $100 the company sells, $30 of cash is generated.
@safalniveshak The FCF margin of a company should be at least 15% (and preferably more than 20%). Furthermore, a high percentage (> 90%) of the companiesβ earnings should be converted into free cash flow.
@safalniveshak Performance since IPO
As a quality investor, you donβt want to invest in the next big thing. You want to invest in companies that have already won.
Only invest in companies that managed to generate a return of 15% per year for shareholders (CAGR) since their IPO.
As a quality investor, you donβt want to invest in the next big thing. You want to invest in companies that have already won.
Only invest in companies that managed to generate a return of 15% per year for shareholders (CAGR) since their IPO.
@safalniveshak Secular trend
The trend is your friend. A lot of quality companies are active in a strongly growing market.
Think about themes like urbanization (Otis), cybersecurity (Fortinet), datacenters (Arista Networks), hearing aids (Sonova), and obesity (Novo Nordisk).
The trend is your friend. A lot of quality companies are active in a strongly growing market.
Think about themes like urbanization (Otis), cybersecurity (Fortinet), datacenters (Arista Networks), hearing aids (Sonova), and obesity (Novo Nordisk).
@safalniveshak Aim for companies which can grow their organic revenue with at least 7% per year in the foreseeable future.
@safalniveshak Valuation
For quality investors, the quality of the business is more important than the valuation.
In the long run, your return as an investor is equal to:
Return = FCF growth per share + shareholder yield +/- multiple expansion (contraction)
For quality investors, the quality of the business is more important than the valuation.
In the long run, your return as an investor is equal to:
Return = FCF growth per share + shareholder yield +/- multiple expansion (contraction)
@safalniveshak The longer you invest in a company, the more important the FCF per share growth will become.
When you can buy a great business at a fair price, great things will happen.
When you can buy a great business at a fair price, great things will happen.
@safalniveshak Does this strategy work?
Since 2010, the return of our investable universe with quality companies only was equal to 18.2% (!) per year. This is almost twice as good as the MSCI World.
This means a $10.000 investment would have become $87.300.
Since 2010, the return of our investable universe with quality companies only was equal to 18.2% (!) per year. This is almost twice as good as the MSCI World.
This means a $10.000 investment would have become $87.300.
@safalniveshak To summarize:
As a quality investor, you want to invest in the best companies in the world. Quality companies have the following characteristics:
- A wide moat
- Integer management
- Low capital intensity
- Good capital allocation
- High profitability
- Attractive growth
As a quality investor, you want to invest in the best companies in the world. Quality companies have the following characteristics:
- A wide moat
- Integer management
- Low capital intensity
- Good capital allocation
- High profitability
- Attractive growth
@safalniveshak That's it for today.
If you liked this, you'll love this summary I made of all public writings of Warren Buffett.
It's a 60-page document full of wisdom. Grab it here: compounding-quality.ck.page
If you liked this, you'll love this summary I made of all public writings of Warren Buffett.
It's a 60-page document full of wisdom. Grab it here: compounding-quality.ck.page
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