A consistent investment process is key to long-term success in investment management. While a process should naturally evolve and improve over time, a simple, yet clear foundation will ensure that it is applied consistently through various market cycles. Our process seeks to identify a select number of good companies, that are well run, and that trade at a reasonable discount to a conservative business valuation. Critical to identifying and taking advantage of such opportunities, is a patient, long-term orientated approach.
Our investment process summarised
The average investor does not have much patience and as a result the movements in share prices can be extreme, depending on the prevailing sentiment. It is difficult to imagine that it was just five years ago that it was an exceptionally difficult task to persuade anyone that quality global equities (for example, Procter and Gamble, Johnson and Johnson etc) were a better long-term investment than domestic counters or other emerging market equities. Those were the days when British American Tobacco was considered a boring, low growth utility that only contrarian investors wanted to own in size.
While we prefer to own high quality names, we have for some time had concerns regarding the market’s willingness to pay up for earnings visibility. Price discipline is the cornerstone of our process, and the key to generating our returns at below average levels of risk. As a result, many of our recent purchases have been seemingly average companies, but when combined with decent management and an exceptionally cheap entry price, we view them as relatively low risk long-term investments.
We have, however, managed to find some opportunities that meet all three of our desired investment criteria and we have been using market setbacks to add to these positions. Qualcomm is a stock we have long admired and is a good example of how our process works. We have always thought it was a very good company, given its unique patent portfolio in 3G and 4G network technology. They collect royalty income on the vast majority of 3G and 4G mobile phones sold globally. Unfortunately, until recently, it has been a popular share amongst growth investors seeking exposure to the growing smartphone market. The resultant valuation has always been an obstacle to us investing in the company. In the past twelve to eighteen months the company has faced a few headwinds that have stalled earnings growth, and the share price has followed. Last year we started using this weakness to start building a position in this high quality business, and we have continued to add to positions in recent weeks. Qualcomm has a cash laden balance sheet, solid management who have returned more than 50% of the current company value to shareholders in the past three years, a starting dividend yield of over 4%, and a single digit (excluding cash) PE multiple on low earnings. Given the quality of the business and the above characteristics, we see little long-term downside when buying at these levels.
Many investors have become nervous that we are entering a bear market for stocks. While our posture remains broadly defensive, we are excited by the fact that we are able to find stocks like Qualcomm that have already had their bear markets. We fully expect that broad economic fundamentals will continue to deteriorate, but we are being careful not to let this hamper our ability to make excellent investments for the next ten years. One does not get to buy companies like Qualcomm on a 7 PE (excluding cash) and 4.5% dividend yield when the news flow is good!