In general, companies catch our attention if they display the following characteristics:
The potential to generate double-digit organic revenue growth for several years
40%+ gross margin (demonstrating high value-added)
30%+ market share within a monopolistic/oligopolistic market structure (demonstrating robust barriers to entry)
All growth financed from internally-generated cash flow
Debt-free balance sheet
An attractive (typically low P/E) valuation.
We restrict ourselves to what we believe are the 3-5 most interesting Emerging Growth themes of the time. Each theme must be broad enough to encompass an array of sub-themes, providing a multi-year investing opportunity. An example of such a theme would be ‘the rise of e-Commerce’, where possible sub-themes may include: Online Retailing, Online Gaming, Online Advertising, Cloud Computing, Internet Traffic Congestion and others. Once a theme is established it typically remains in the portfolio for several years until another theme, with greater returns available from that point, replaces it. We take great care to thoroughly research the whole eco-system of companies within a theme, searching for bottlenecks wherever they may exist.
Competitors or peers displaying the opposite characteristics may be considered as possible ‘fakes’ or ‘dinosaurs’ and shorted to enhance returns, but never to hedge risk for its own sake. The majority of our risk management comes from the detailed checking and research we conduct in-house. In making our decisions we place a heavy emphasis on our contact with company managements, their competitors, their customers and our proprietary supply chain connections. We also build in-depth financial models around each company’s key inputs.
Typically, our stock investments end up being concentrated into a small handful of companies within each theme – bottlenecks are not easy to find! Our time horizon for generating the expected return is at least 18-24 months but the holding period may prove shorter if the return is captured more quickly. For exceptionally strong long-term growth companies we may hold a position for several years, reviewing it periodically. Under most circumstances the portfolio should not contain more than 30 stocks (long and short combined), split across different themes, with good geographical diversity and usually with a fairly heavy long-bias.