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DOSSIER : Three Investment Methods

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12/27/2017 | 12:53pm CET

Although there obviously is more than one road that leads to Rome, we can still classify investment strategies according to three general methods: growth, yield, and low valuations.

And it’s precisely through those filters that our quantitative selections (“Top Lists”) are being updated in real-time in the Premium section of the website, in order to offer investors a wide range of opportunities customized for their style and their temperament.

Growth

The goal here is of course to identify those listed companies that are going through a period of rapid growth. Several nuances in terms of analysis come into play though.

First of all, it’s important to keep an eye on the top line (the turnover) and the bottom line (the net profit) and to make sure they evolve in comparable proportions, because growth comes at a cost, and the additional operating expenses can quickly make the profit vanish into thin air.

Along the same lines, we need to be sure that the financial position of the company remains solid. That means an adequate capitalization and a debt that’s under control. It also means a reduced leverage and interest payments that are very easily covered by the operating profit.

Our filters automatically disqualify companies that have too much debt in order to keep only those companies that are most carefully financed. At some of these businesses, the cash alone covers all the liabilities.

The financial dynamics of growing companies are typically the most difficult ones to understand because, on top of the recurring changes in scope, it’s difficult to measure the profitability of the investments (organic or external) in production capacity, something that’s preferably evaluated over a long cycle.

This profitability is sometimes more immediate. SuperGroup PLC, for example, auto-finances its growth and amortizes the openings of its wholly-owned stores in less than two years (in other words an ROI of 50%). In a different register, Thor Industries doesn’t grow through acquisitions, but the impact of those on the profit and the generation of cash is measurable.

Finally, our filters select opportunities among growing companies by keeping only those of which the valuation remains affordable, because the market is unpredictable, and the falling of prices is frequent when the published results are below the expectations of the analysts.

Yield

This strategy is popular among investors that manage their stock portfolio from an income-oriented perspective and aims to identify those listed companies that pay generous dividends and that may even increase (or at least continue) this distribution over time.

Here, the first step of an analytical approach consists of making sure the dividend payments are sustainable. Therefore, the two conditions are to understand the activity of the company and its developments (the dividend of a company in trouble is of course postponed), and to check the distribution coverage by the cash profit (“free cash-flow”).

This is how we clear out those companies that are in structural decline, those that have put themselves into debt or issue new shares to remunerate their shareholders (frequently, in particular in the energy sector), and those of which the compatibility turns out to be difficult to interpret, for example when the net profit is not reconcilable with the cash-flow.

Indeed, it’s more careful for whoever adopts this strategy to base themselves on the cash profit – which retires the investments in the assets (“capex”) and the adjustments of the working capital needs, both consumers of cash – rather than the accounting profit published on the income statement, often distorted by non-cash charges, depreciation and amortizations.

As companies that announce an increase of their dividend are immediately revalued at the rise of the market, our filters privilege those of which the profitability, capitalization and competitive position lend themselves better for this configuration.

Low valuations

This third investment method consists of identifying the companies that are being traded at weak (and unjustified) profit multiples, or at a price inferior to the net value of their assets (revalued equity).

Of course, these kind of low valuations are never innocent and often result in an unfavorable topicality or a perilous conjuncture, like in the oil industry since 2014.

So, two different management styles offer themselves to the entrepreneurial investor here: a diversified approach, systematically and purely quantitative; or a more selective approach, that requires an additional analytical effort.

In the Stock Picks section in the Premium part of our website, we’ve featured a number of companies that were heavily discounted on their assets, certain of which were valued on the stock exchange for less than half of the value of their cash minus all of their debts (which comes down to buying a pile of cash for less than its face value!).

We’ve also featured situations that were a tad more complex, like Renault, a large capitalization with a low valuation on the sum of its parts (“revalued net assets”).

Last week, when we bend ourselves over the same situation, we pointed out that the Finnish group Nokia isn’t eligible for this kind of investment method yet (since a sufficient security margin is failing).

These low valued companies can also trade at weak profit multiples, in which case the analysis focuses more on their historical profitability and their future perspectives than on the value of their assets.



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