IN today’s investing world, every number reported by a company, industry body or statistical agency is quickly sucked up by a computer, analysed by an algorithm and traded.
In this environment most of the quantitative information tends to be efficiently priced by the market.
As Einstein once wrote, “Not everything that counts can be counted, and not everything that can be counted counts.”
At Cooper Investors, our process is qualitative led. In our experience, the market persistently fails to fully appreciate and value the importance of management – the people running the business, and the culture they foster within an organisation.
We believe that behind every number is a human decision or behaviour.
Analysing management is not easy.However in conjunction with our assessment of operating and industry trends and value latency, we think it’s the secret sauce to our investing success.
So what does the assessment of management entail?
It is the all-encompassing information gathering on a company’s people and culture condensed into a short summary and snapshot.
For example one needs to understand the capabilities of the entire management team, beyond just the chief executive officer (CEO).
It is crucial to appreciate their strategic mandate and why this will create value for shareholders.
We should also know how they are incentivised to achieve this mandate – all too often we see earnings per share as the key financial metric in remuneration plans.
Earnings per share is a short term metric. We much prefer to see management compensated on cash flow and return on capital metrics as these are what determines business value over the long term.
Another important part of a CEO’s job is capital allocation – how, and how much profit they re-invest back into the business versus return back to shareholders.
The only way companies can compound value for us as shareholders over the long term is by reinvesting capital at attractive rates of return.
In our experience the track records of most listed companies in deploying capital for growth are very underwhelming. This is probably a big reason why shareholders demand such a large portion of profits be returned as dividends and buybacks.
In Australia the dividend payout ratio (dividends as a per cent of profits) is above 70 per cent.
This dynamic has crept into overseas markets where S&P 500 companies typically return a similar portion to shareholders, albeit it is more evenly split between dividends and buybacks.
This raises the question – how does a company grow when it is not investing in the business and growth opportunities?
Further, if a company is not growing its earnings this will ultimately crimp growth in dividends. One has only to look as far as the domestic banks to see a live example.
This is why it is important to find companies that are willing and capable of investing for the long term as there are great benefits to shareholders.
However we need to find management with the credibility and capability to make these long term investments.
In a world where the average CEO tenure is roughly five years, the time horizons between long term shareholders and management teams often does not match. This is why we like “family and founder” led companies.
These are companies led by management and boards that understand sustainable long term investment and how this drives shareholder returns.
We see this day to day in our own organisation as Cooper Investors is an employee owned organisation.
Like anything in investing, not all family or founder led businesses guarantee a successful investment or experience. Business and markets are more complicated than that.
We have also heard all the war stories that come with founder or family linked companies.
However, when the people running a business have their own skin in the game and importantly the emotion or “soul in the game” it can do wonderful things for long term shareholder returns.
It’s a rare and unique company that meets this criteria among all the other things we look for in an investment.
Over our nearly two decades of investing we have been searching the globe for these companies.
These companies form the basis of our new specialised portfolio called the Family and Founder Fund.
We think the combination of the unique family and founder attributes in combination with attractive industry and strategic dynamics will make for compelling long term returns.
Allan Goldstein leads the new Cooper Investors Family & Founder Fund at Cooper Investors. The information provided is the opinion of the author. The AJN recommends that readers seek independent financial advice.