As part of our investment philosophy we say that we invest in quality companies. We develop this further by saying we invest in companies with sound financials, strong franchises and responsible stewardship. What do we actually mean by this?
There is no such thing as a perfect company.
All companies change over time and quality is about a journey; a direction of travel.
The diagram above tries to explain our approach to quality, suggesting that quality is made up of objective factors (e.g. working capital numbers or a company’s historical record), as well as subjective ones (e.g. owners/management integrity or attitude to risk).
The attributes listed within each circle are not necessarily the most important elements of quality, but simply indicate that there are many different aspects to quality.
The size of each circle, however, is significant and reflects the relative importance of each category to us. We have always emphasised that quality of stewardship is the most important ingredient of quality. Assessing stewardship quality is not always easy; it is subjective and exhibited in a number of ways, as indicated in the diagram above and related appendices. We rarely find responsible stewards directing companies with overstretched balance sheets or with deteriorating franchises for other than a short time period.
Quality should be regarded as fluid and multi-faceted
Our approach to quality is not driven by lists or box-ticking. We believe that quality is not set in stone but is a fluid concept. As an investment team, we are always seeking ways of reappraising what quality is, as part of the ongoing debate within the team about which companies we should invest in for clients.
The definition of quality is not the same for all members of the investment team. Individuals on the team emphasise different aspects or characteristics of quality, but all recognise its crucial role in the investment process. Consequently, all of us would consider a very significant proportion of our investment universe as totally uninvestible.
Why do we invest in quality?
We believe that by investing in quality companies we can control risk in businesses which we are not running ourselves and so preserve capital for clients. This is evidenced most clearly by the historic outperformance of our portfolios in extended down markets.
We believe our emphasis on quality is far from universal, although it does seem a more favoured approach now than it was 20 years ago. Many investors focus much more, sometimes exclusively, on quantitative data, often extrapolating recent trends as if they will continue forever. However, it is only common sense that those companies, which are able and willing to eschew short-term profit performance to build solid foundations for sustainable growth, and which look after the interests of all stakeholders, are likely to be long-term investment winners.
In the three appendices that follow, we provide some of the elements of quality we seek in our three ‘pillars’ of Stewardship, Franchises and Financials. When appraising quality, these indicators are by no means exhaustive and we are always looking for new ways of defining and measuring quality.
As an aside, insofar as we can, we try to manage the Stewart Investors business in accordance with the above principles. We also know that we have a very long way to go before becoming that mythical perfect company!
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