With the start of a new year (let’s hope it’s an improvement on the last) we’re resuming our Investment Insight series and taking a look at the corporate characteristics Sarasin & Partners use to classify companies under consideration for investment.
The characteristics have their own quality, growth and valuation dimensions and help Sarasin identify the most important risk and return factors to consider in each investment decision. As the economy and stock market move through their regular cycles, certain categories/characteristics are likely to be more fruitful sources of ideas than others. Using this categorisation approach can therefore help Sarasin to ensure they are looking for opportunities in the right places at the right time.
We’ll run through an overview of the different corporate characteristics and then in the coming weeks we’ll explore each one in more detail, using a specific business from the Sarasin portfolio as an example.
- These businesses are typically market leaders in their industries, with demonstrable barriers to entry.
- They consistently earn high returns on invested capital with limited variability across the economic cycle.
- Free cash flow generation is usually high and predictable.
- The companies generally have pricing power and a sustainable competitive advantage.
The compounding effect of these factors can be very powerful.
Givaudin is an example of a defensive franchise.
- These are companies with the ability to attack large entrenched profit pools with a superior product or service.
These businesses may not generate high returns on capital when investing to drive growth, but can be enormous creators of shareholder value.
ASML Holdings NV is an example of a disruptive growth business.
- These businesses are also generally market leaders with high barriers to entry, like the defensive franchises.
- They create value over a full economic cycle, but a degree of cyclicality means they may not achieve this every year.
End market demand is variable and usually highly dependent on levels of economic activity.
Schneider Electric SE is an example of a cyclical franchise.
- These are usually mature businesses with limited internal need for the excess cash that they generate.
- As a result, they are likely to return this excess cash to shareholders via dividends or share buybacks.
The market can underestimate the duration over which these companies are able to maintain superior and growing cash returns to shareholders.
Equinix Inc is an example of a cash harvest business.
This covers a broad category of investments with specific and unusual investment case drivers, such as:
- corporate restructuring
- spin off businesses
- companies which own real estate and other financial assets
- family-controlled businesses
These are all examples of where a conservative approach can be a source of superior returns.
The next post in this series will look at defensive franchises in more detail, with a specific focus on Givaudin, a leading manufacturer of flavours and fragrances for a variety of consumer-oriented end markets.