Our investment approach is based on a detailed rating system we have developed that allows us to assess a company as an investment proposition and determine its intrinsic value. We consider a range of qualitative and quantitative factors specific to a company that are relevant and applicable regardless of its size, structure or industry. If the company scores well against these measures, we then identify a relevant catalyst we judge will re-rate its share price.
Some important factors we consider when assessing if a company represents a good investment proposition include:
The quality of a company’s CEO and senior management team is critical to assessing the overall value of an enterprise as this factor can significantly influence a company’s future financial performance. Our evaluation of a company’s management is one of the most important factors informing our investment decisions. As past success is often the best predictor of future success, a track record of performance is one of the best ways to judge a management team. For example, we regard the team leading RCG Corporation (ASX: RCG), owner and operator of several footwear businesses, very highly given their considerable industry experience and strong track record.
When evaluating management, we also ask ourselves the following questions: Do they have a clear and consistent vision and strategy for the company? Are their remuneration and incentive structures aligned with the company’s shareholders’? As research shows a correlation between a company’s financial performance and its organisational culture, we also consider if the management team has a successful leadership style, which includes a focus on creating a positive, values-based culture. Our observations during site tours often provide some of the most valuable insights into a business’s corporate culture.
2. Free cash flow
When assessing a company experiencing strong growth, it is particularly important to understand how that growth is being funded. We look for positive cash flow overall and especially positive cash flow from operations. A company’s free cash flow (found in its cash flow statement) can be calculated by taking the operating cash flow and subtracting the dividends and capital expenditure.
3. Forecast earnings per share (EPS) growth
In our view, movements in a company’s earnings per share (EPS) have the greatest correlation to movements in that company’s share price. We look for companies that are experiencing EPS growth and, ideally, have forecast EPS growth of 15 to 20 per cent forecast for the next two years.
A company can be valued on a price to earnings (P/E) basis, or discount to asset basis. On a P/E basis we seek out companies growing at 1.5 to 2.0 times their P/E. On a discount to asset basis, we try to find companies trading at a discount to the value of their assets. However, an understanding of the make-up of those assets and how they are valued is important. A discount to asset ‘play’ can provide a low risk investment for patient investors.
5. Industry position
Analysing a company’s market or industry position is important to our understanding of a business’s operating environment and key in evaluating if a company’s long term strategy is feasible in the context of its current business environment. In making our assessment, we consider whether the company is operating in a new, high-growth sector or a more mature and stable, low-growth market. In the early stages of a new high-growth market, many small companies in start-up phase perform well because there is plenty of growth to ‘go around’. At the other end of the spectrum, it can be very hard for new companies to establish themselves in a mature, low-growth market (like retail). In this environment, there are usually a few large and dominant players with considerable market share and often significant financial clout that they can use to counteract the threat of new entrants. Ideally, we try to identify well-positioned companies in growth industries.
Identifying a catalyst before investing
Before making the decision to invest, we ensure we are able to identify a catalyst we consider will enhance the company’s prospects and drive its share price higher. A catalyst is anything we consider will have a positive impact on the value of the company in the market’s eyes. For example, a catalyst may be when a company announces a better than expected profit result (an earnings surprise), a change in management, a material and structural change in the company’s industry, the expansion of its operations into a new market, a considerable franking account balance, or the sale or acquisition of an asset or division. With a clear understanding of how a company generates revenue and the factors impacting its profitability, a catalyst can be most readily identified.
Entities managed by Wilson Asset Management own shares in RCG as at the date of original publication.
This article or publication does not take into account the investment objectives, financial situation or particular needs of any person and should not be used as the basis for making investment, financial or other decisions. We strongly suggest that investors consult a financial adviser prior to making any investment decision.