- Equity Portfolio Manager
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When we look for companies that fit our definition of quality value, there is one key characteristic we keep in mind: resilience.
Firstly, while quality and resilience often go hand in hand, resilience is measuring future quality. Something can be high quality without necessarily being resilient. I used to be an engineer designing car engines, so one of the first examples that comes to mind relates to cars. While all cars lose their value over time, high-end luxury cars tend to be known for depreciating the fastest. But quality that endures and improves over time – or resilience, as I think of it – is special.
Resilience is also revealed in the face of adversity. There's a reason you’re often asked in an interview to share an example of a time you’ve faced adversity — a person who has successfully navigated difficulties is likely to have learned coping skills that make future stresses easier to manage.
These two beliefs combine to shape my personal philosophy as a portfolio manager. I believe resilience is an underappreciated facet of quality — and that companies that successfully navigate periods of difficulty may have an edge when it comes to adapting to changing competitive, regulatory, social and climate forces. Crucially, these periods of difficulty can offer value to long-term investors, allowing them to buy high-quality companies at attractive entry points.
How to find quality value
I‘m a huge believer in process – no surprise for an engineer by trade. Engineers are highly process-oriented – which makes sense if you’re constructing bridges, planning transportation systems or designing car engines, as I was. As a portfolio manager, I try and apply the same robust approach.
One of the main challenges our process is designed to address is the fact that large cap investing is an efficient market. How can you extract market inefficiencies to find undervalued growth potential? My team and I look at companies through three key lenses: value, dividends and resilience. We make use of a scorecard to evaluate companies across the investment universe, employing a quantitative framework to help us screen new ideas, highlight ideas for future analysis and inform position sizing. ESG is another key input during the investment process and is particularly relevant for our analysis on resilience1 . Specifically, ESG controversy, governance and management culture are important considerations for us; they help to understand downside risk, and often come hand in hand with valuation improvement, proving a natural fit for our philosophy.
So how does this transition into a repeatable process?
First of all, we buy at a discount. Unless a company is trading at a discount, we won’t take it any further.
A common transitory reason a company might be discounted is complexity or controversy. The market is quick to price in negative information but slower when it comes to taking a long-term perspective. When the market dismisses a company, that’s often our signal to take a closer look – is the negativity justified or are short-term roadblocks distracting from a more positive long-term runway for growth? If we want to avoid value traps and focus on long-term success, we need to have a clear view on the answer to that question.
Where we find most of our ideas is within large multi-line enterprises and cyclical industries. There is often a great deal of complexity surrounding these companies, which can give rise to inefficiencies, as investors are more comfortable with clarity. Johnson & Johnson is a great example – they are a conglomerate consisting of three separate business lines: pharmaceuticals, medical devices, and consumer staples. We like to look at cyclical companies in areas like industrials, financials, and utilities when they are out of favour. Our time horizon is long, so we’re not afraid to wait for the business cycle to turn around.
The second thing we look for is dividends. Sustainable dividends can be a potential source of downside protection and compound returns that investors focused on capital growth may not fully appreciate. Furthermore, a company’s ability to invest in the business and willingness to balance that with paying out dividends — as evidenced by strong balance sheets and a history of paying out consistently in good times and in bad — can be a powerful way to distinguish between quality value companies and deep value companies, which may have intractable balance sheet or business risks.
Finally, we assess the potential resilience of a company. Resilience analysis can be more of an art than a science but in our experience, resilient companies tend to demonstrate deep expertise in their fields, creating enduring value for clients. They also tend to benefit from scale, providing operating leverage and natural barriers to entry for competitors. Strong balance sheets make it more likely that a company will be able to continue paying dividends, but balance sheet flexibility is particularly important when assessing for resilience, pointing towards the potential to invest and sustain dividends, which may dampen volatility for investors over time.
Additionally, we believe companies with leading diversity and inclusion metrics deliver better long-term results for shareholders, as well as for the communities they serve. We also believe that an active commitment to participate in the mitigation of climate change can both enhance returns and reduce business risk. We are particularly concerned with management culture; in fact we find that diverse boards and management teams tend to go hand in hand with a better risk management and capital allocation decisions2.
The controversies that we mentioned earlier – which can provide attractive entry points – can often be ESG-related. Again, this is often our cue to dig deeper. We want to understand what the downside risks are, and whether ESG problems are deep-rooted or whether the company is on a path to improvement. If a company is willing to take steps to improve, our time frame can provide us with the ability to engage meaningfully with a company over the long term, guiding them towards making positive decisions and ultimately, in our view, helping to improve their valuations.
The benefits of looking for resilience
Above all, we believe that resilient, dividend-paying companies purchased at a discount can present compelling long-term investments. We think of these companies as ‘battle-tested’ – able to evolve over time and work through market turmoil, as well as having the potential to provide downside mitigation in a variety of market environments.
1The portfolio does not have a sustainable investment objective. While the evaluation of Sustainability Risks through the analysis of ESG factors is part of the investment process, it may not necessarily result in the exclusion of a security. | 2The Strategy commits to invest at least 60% of its net assets in companies with more than three women on their board.
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Andrew Heiskell
Nicolas Wylenzek