Quality Investing by Torkell T. Eide
https://www.goodreads.com/book/show/28453139-quality-investing
- Quality is the combination of (1) strong and predictable cash generation (2) sustainably high ROIC and (3) attractive growth opportunities.
- Technology: Only a handful of companies have maintained tech advantages over the long term. It is only sustainable if it delivers sustained benefits over long periods of time. Look for consistent R&D. When pace is measured it is typically complex improvements. Also takes competitors longer to catch up if investments were made over a long time.
- Recurring revenue: Industries with recurring revenue generated from up front sales tend to be attractive. If service is mandated by regulation this increases attractiveness (jet engines, elevators). Look for products with long useful lives as shorter ones will be replaced rather than repaired. Service networks become more valuable as density increases. Upfront payments can be an added benefit given negative working capital.
Risks
- Cyclicality: The longer the cycle the harder to analyze because it becomes easier to mistake cyclical growth for structural growth. Supply led cycles are less attractive than demand led ones as it becomes virtually impossible to predict prices. Look for businesses linked to customers operating rather capex budgets. There are “flow products” and have less cyclicality and less scrutiny due to their small and recurring nature.
- Innovation/Disruption: Key question is “will this company’s products still be relevant in 10yrs”
Avoiding Mistakes
- 80% of 1yr returns are determined by changes in multiples but nearly all of long terms returns are determined by earnings power. This disconnect is a sustainable source of alpha.
- It is hard to overpay for a quality company with truly sustainable earning growth. Well researched qualitative judgments trump quantitive ones in the long term as the latter has just as many subjective inputs.
- Rethink a thesis after a profit warning. It is usually a sign of a serious internal problem and often can signal deteriorating quality.
- Quality investing is especially susceptible to the endowment effect given the large due diligence effort up front. Be wary.
- Checklists are helping to focus on what matters.