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.
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.