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Why Equity?Why A-List?

Why Equity?

For us, equity holds great fascination. Our research is predicated on the belief that equity – or shareholders’ funds – is the single most important part of the balance sheet. All of our research effort therefore distills into understanding what might happen to a company’s equity:

  • Is it being compounded and, if so, at what rate of growth and at what risk?
  • Is the equity backed by surplus cash which could ultimately be distributed to shareholders, or does the business require ever more investment just to stay in the game?
  • Is the financial structure optimal for delivering returns to shareholders?
  • Does the achieved return on equity stem principally from the operating profits of the business, or from the gearing effect of debt finance?

Equity markets, however, hold almost no fascination for us at all. In recent years they have developed a volatile persona of their own that can be completely removed from the underlying businesses. (This was perhaps epitomized by the ‘flash crash’ of 6 May 2010 when several large US stocks more than halved in price before recovering completely, all within the space of less than fifteen minutes). Indeed, high frequency, short-term trading is now thought to account for the majority of US equity market turnover. For these punters, it is sentiment, news flow and trading momentum that count. But for real investors, time spent trying to interpret the gyrations of equity markets, rather than researching companies, is likely to be detrimental to investment performance.

Similarly, the rise in popularity of ‘private equity’ financing has distorted true equity investing via the stock market. Certainly, some companies are better suited to single party ‘private equity’ ownership outside of the quoted arena. However, where the new owner extracts equity and overloads the business with debt, the resulting exceptional returns should be viewed in the context of their exceptional levels of risk. Many a good company has left the stock market, only to be brought low by the burden of a ‘private equity’ capital structure. And yet perversely, several of our A-list companies would be ideal candidates for ‘private equity’ ownership because of the high predictability of their business, their strong cash generation and sensible levels of existing debt. Of course we’d prefer them to remain in public hands where all of our subscribers can participate in the realization of the businesses’ long-term potential.

We approach investment as if we were buying the whole company with the intention of owning it forever. Of course there are rare times when we accept that equities as a class are best avoided. But beyond that, our only interest in markets is their ability to let business owners realize their investments and new owners to be found without disturbing the capital of the company. It is an approach that has delivered investment performance again and again.