Given the choice you would rather invest in a great company than a poor one, right? However it isn’t always obvious until it’s too late. Companies that you thought were great end up struggling, while companies that weren’t even on your radar rise inexplicably to the top of their industry. After a decade as a fund manager, I’ve learned a few signs you can watch for to indicate you’re on the right track
- A High ROIC
Always check the ROIC. In my opinion this is the single most valuable metric when judging the quality of a company. If you do no other work at all, then do this. If the ROIC is low to mid single digits, then you’ve got a problem on your hands (unless it’s a downturn in a highly cyclical industry) That company either needs a damn good plan to improve ROIC or you should avoid it entirely. If the company isn’t even aware that it’s a problem, that’s even worse.
- A Wide “Moat”
Try to invest in companies that have a durable competitive advantage (or a “moat”). Companies with a moat will also tend have a high ROIC and, what’s more, they are likely to sustain that high ROIC. It can be a brand, a process or a patent – but look for its existence with every company you consider.
- A Culture of Cost Control
Look for companies with an ingrained culture of cost control. Not the ones that embark on a massive cost cutting exercise every three years, but the ones who are constantly keeping cost down. Look for companies with spartan headquarters, not the ones with expensive art in the lobby. Not surprisingly this factor also correlates with ROIC
- A Decentralized Structure
Local decisions are better taken locally. Avoid companies that are excessively autocratic, or where there are too many layers of hierarchy. In particular avoid companies that feel like they are built around a single CEO. Remember Buffett’s quote “try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will”
- A Culture of Transparency
You want to invest in companies that are open in the way they communicate. Find companies that are honest, not the ones constantly feeding you soundbites. The real test is when the company disappoints the market – look for a management team that is honest about its mistakes and doesn’t try to conceal or trivialize issues. Obviously all companies are going to be honest when they’re doing well so look to see how they handle bad news.