One of the best ways to outperform is to identify “great companies.” In this spirit, our research team set time aside this quarter to describe and debate what factors make a great company. We focused on how a company becomes and stays great, which helps us in our search for new companies, and allows us to consistently frame our analysis and adjust to changing environments. Although everyone at First Wilshire believes deeply in buying stocks at value prices, this exercise was less about financial statements or stock market valuations, but more about tangible and intangible attributes of companies that allow them to grow profitably over a long period of time and presumably lead to stock outperformance.
Great companies experiencing temporary problems can be great investments, and we factor these into our analysis. Exercises like this help us learn from each other and keep it at the forefront of our minds.
Although some of the points seem obvious, they are hugely important. The subtlety is in the research, where the analyst must decipher these attributes to find companies trading below their intrinsic value. Following are a few themes that emerged from the discussion:
- Honest, Entrepreneurial, and Competent Management – management is very important. We spend a lot of time interviewing management and evaluating their track record through good and especially bad times. Why they made various decisions in the past and how those decisions turned out is key.
- Good Culture – their team works cohesively in all economic environments. They encourage curiosity and work hard. They have the ability to recruit, train and retain the best workers.
- Competitive Advantage – a sustainable ability to generate outsized margins in different economic cycles. We look for monopolistic characteristics, pricing power, recurring revenues, cost advantages, first mover advantages and the ability to defend margins.
- Efficient Use of Capital – great returns on capital employed, focus on cash flow and cash return to shareholders. Demonstrated ability to make good decisions with their capital.
- Favorable Macro Drivers – timing is important at the industry level. Our founder used to say that if you could identify the best industries each year you will generate great returns. Some of this is luck but more important much of it is research and constant learning.