Value investing. Growth investing.
In theory, these approaches represent the full spectrum of investing.
As is usually the case in practice, the most sensible approach is somewhere between two academic extremes.
Pure value investors are obsessed with buying companies at low multiples, but there is often a reason why something is so cheap. Growth investors are obsessed with buying companies that are growing quickly, with little regard for the multiple paid. This can become an expensive mistake if there is disruption in the sector or if anything causes the growth rate to slow.
In the middle, we find a concept called quality investing.
The name is a good start and it only gets better from there. We can think of these investment strategies as a spectrum rather than unique approaches. For example, investors may have a growth bias while following quality principles.
This is the approach taken in the Unicorn Fund, which we have been touting for several years now.
Ironically, quality investing has its roots in the writings of Benjamin Graham, the father of value investing. His argument was that investors should spend time looking for quality value stocks. This is a perfect example of the spectrum noted above.
While Graham would spend his time today looking for undervalued stocks in traditional industries, in the same way that Berkshire Hathaway does (Warren Buffett and Charlie Munger), the team in the Unicorn Fund seek growth stocks that exhibit certain characteristics.
When assessing investment opportunities, they always start by looking at the management team. A business is only as good as its people and that is especially true regarding the strategic heads. By looking for stable management teams with solid ratings among staff, customers and other stakeholders, half the battle is won.
Technology stocks operate in dynamic competitive ecosystems, often in a winner-takes-all race of disruption. Management teams need to be focused yet adaptable, incentivised in the business but also willing to allow other views at the table.
The assessment of management is ultimately a subjective test but is well worth the time spent in preparing this analysis.
The best management teams in the world can’t operate without sufficient funding. A strong balance sheet is the fertile soil for a business to grow in. This is especially true in uncertain times. Although the pandemic is (hopefully) a once in a lifetime event, economic downturns are part of the game and often flush out companies with risky or weak balance sheets.
There’s an adage in the market that companies should raise money when they don’t need it. Why? Because desperate capital raises lead to desperate results. It’s the same as selling a house slowly vs. a rushed sale due to emigration. The outcome is likely to be very different.
Moat’s, Market’s & Tickets
Companies with strong management teams and powerful balance sheets still aren’t guaranteed success. A market in terminal decline won’t be an attractive 10-year investment. A business model without strong competitive advantages and barriers to entry (often called a “moat”) is open to disruption and potential failure.
The right management team with a supportive balance sheet is just the ticket to the game. The moat helps them be in the game for longer. Other important assessments include total addressable market (whether they are playing a large enough game) and operating margin expansion (whether the game is profitable).
These are the key focus areas for quality investors with a growth bias. Fast-growing companies with quality characteristics don’t come cheap and can trade at very high multiples, but the overall thesis is that the multiple will be less of an issue over time and the share price will increase substantially as the company grows.
A value bias would place emphasis on dividends and earnings stability accompanied by a modest valuation multiple, hoping to earn more stable returns that are ahead of the market on a risk-adjusted basis.
A growth strategy executed well, which we certainly believe is the case in the Unicorn Fund, combines features of value investing with the desire for growth. This means investing in companies with great management teams, strong balance sheets, large addressable markets, key competitive advantages and attractive long-term margins.
The recent sell-off in many such stocks is an opportunity rather than a cause for concern especially if you are investing from ZAR. Our long-term view remains that the road to wealth creation is paved with high quality growth stocks.