Quality Investing Flashcards
What type of investing is most akin to private equity?
Quality investing
What are common characteristics of quality businesses?
Strong, predictable cash generation
Sustainable high returns on capital
Attractive growth opportunities
Each on its own is attractive, but combined, they are particularly powerful, enabling a virtuous circle of cash generation, which can be reinvested at high rates of return, begetting more cash, which can be reinvested again
How does compounding relate to cash flow in quality investing?
Compounding free cash flow generation through high returns on capital and then growing the business, can lead to large returns over a short period
For ROIC, is strong historical growth or strong future returns more important?
No, although past can be related to future, we care about businesses that can sustain these appealing financial outputs
What are the five main ways of allocating capital in investing or financing decisions?
Capex for growth
Advertising and promotion or R&D
Debt paydown
Mergers and acquisitions
Distributions to shareholders through dividends or share buybacks
Difference between maintenance and growth capex?
Maintenance capex is required just to maintain the status quo, and therefore should be relatively predictable if keeping YoY revenues flat
Growth capex is the deployment of capital for the purposes of generating organic growth
What is the definition of growth capex?
The deployment of capital for the purposes of generating organic growth
Examples of growth capex?
Construction of a new plant to increase production capacity, or investment in new stores for a leisure or retail concept
How would a retailer employ growth capex?
How about maintenance?
Purchasing more stores, for example H&M used growth capex to go from 1,200 stores in 2005 to 3,500 stores in 2016
Maintenance would be making sure they keep current units up to a standard that would maintain current footfall and sales.
How can advertising be likened to both maintenance and growth capex?
A certain level of marketing is needed to sustain brand awareness at its current level (i.e. maintenance), whilst additional marketing can grow a businesses brand (i.e. growth)
What is the downside of advertising spend vs capex?
Advertising spend creates no tangible assets, which means that, if it goes poorly, there won’t be any resale value
Should marketing expense be treated as a cost or investment?
More akin to investment, given that they are more flexible than ‘costs’. During challenging economic times, advertising can be scaled back relatively quickly, adding agility to protect and manage cash flows.
The one cautionary note is that paring back too far or for too long can lead to long-term value erosion
Should you spend more money on organic growth or inorganic growth?
M&A is a common source of value destruction, so it is usually better for capital to be deployed on organic growth as opposed to M&A
When is it particularly attractive to employ M&A?
Consolidation of fragmented inudustries is often an appealing rationale for growth through acquisitions. Such roll ups do not invariably succeed, but there are several notable examples of successes.
What is an example of an eyewear company that successfully employed bolt-on acquisitions?
Essilor, a global leader in making lenses for eyewear
Bolt-ons have added more than 3% in annual sales per year for the last decade.
