Invest in the Best by Keith Ashworth-Lord

As I was searching to understand how value investing could bring success to different people, I chanced upon this book. I thought it would be a good way to understand more about how value investor invest in UK. Is it any different from USA or Asian investors?

You can check out the book over at Amazon. (Click here)

The author Keith Ashworth-Lord is known as the Warren Buffett of the UK. He introduced a new term called Business Perspective Investing.

Here is my book summary for future references.

Understand the dynamics of business better; the more predictable it is… the better it is. This includes pricing powers, scalabilitity without balance sheet risk, strong dynamics in conversion cycles  (QoE>1), management that acts with the owner’s eye and is focused on delivering shareholder value.

Ideally, go for businesses with great business franchise with high castle walls and piranha-infested moat.

Move away from cheap shares to outstanding companies.  Move away from businesses with poor economics or management.

[WOW Learning] Every 2.5% increase in profitability delivers more than in added value than every 2.5% increase in revenue growth. Often, there will be a trade-off between sales growth and fatter margins, but the very best companies usually seem to able to combine the two. Game Workshop and See’s Candies!

If you have a weak business, focus on increasing its profitability FIRST then grow its volume SECOND.

Earnings are not created equal! If higher earnings are created out of meaningless “money throwing aka maintenance capex”, then the earnings are not very valuable. However,  if higher earnings are generated out of a business that has very little fixed asset needs, it can scale quickly. Its remaining free cash flow can used for acquisitions, shares buy back or dividends.

Likewise, when a company has very long receivable days, it has bad cash conversion dynamics, and it is very hard to scale a business like this. The bigger it gets, the more problems it will have.

It is free cash flow that ultimately determines value. Hence, capital intensity businesses that lack free cash flow are very slow compounders.

[BEST!] Business that absorb very little new capital yet consistently produce superb returns.

Strong businesses are those that rely on intangibles or unique or properietary selling points of their business to be able to charge supernormal profits — propelling them further away from commoditised, undifferentiated products in the market.

In short, they possesses something called economic goodwill. Something that it extremely hard for would-be competitors to repliace.  Intellectual capital (skill of the employees), proprietary technology, or owning a piece of owner’s minds.

In my view, the invsible asset is the only real source of competitive edge that can be sustained over time. In my view, use sales-to-tangible-fixed asset as a ratio to find this moat out.

Who says F&B is not scalable? Domino’s Pizza scaled really well! Capex is spent by franchise partners and the parent company takes sales cut in terms of royalties, franchise fees, sale of ingredients, property leasing and IT systems. Very similar to McDonald’s!

When profits is up but ROE is down… this could spell problems! The improtance of analysing incremental rates of reutrn should now be apparent. They are therefore a powerful lead indicator for both the future upside and downside potential.

A powerful booster to any companies could be “getting rid of underpreforming assets” or closing down business units. Just take a look at FACB Industries, Systemax, and Auric Pacific.

When companies are growing for hyper growth, it may relax its trade receivable days. And that’s a bad sign because it may eventually turn into bad debts. You can check using this ratio of working capital to sales. Working capital tends to the one that caused the divergence between reported profit and cash flow.

Goodwill to Total Asset is another metric to be careful. Often, acqusitions are done via DCF modellings and re-adjusted once being absorbed to the acquirer’s balance sheet. Should the acquiree underperform, the acquirer ought to do write-downs. It is a balance sheet risk indicating inflated balance sheet and future write-down expenses hitting P&L statement. . Preferably, I like it below 20%.

The more certainty you have, the more safe is your investment. Less of market price volatility.

The key driver of any business is first and foremost, sales. I do not want to see low quality growth (profit growth resulting from cost-cutting). I like high quality growth. Revenue growth. The key indicator is sales per share, it has to increase YoY.  The best sales are recurring in nature which provides stability to the revenue base.

His advice:
“My advice would be to select a few companies that are likely to produce above average returns over the long run and then concentrate the majority of your investments in their shares. Next, make sure you have the mental strength to hold steady during any short-term market ructions. This is the antithesis of what most people think that portfolio management is, or should be, about. It is as Warren Buffett is to Gordon Gekko.“

Finally,

“You must only swing when there is an appreciable margin of safety between where you think you are receiving in economic worth against what yo uare being asked to pay in price. When there is, hit the ball hard and commit large amounts of capital to the investment. Having made the investment, allow time and compounding to work their magic. Resist the temptation to sell a holding unless there is a very good specific reason. Avoid the temptation to sell solely to crystallise a profit. Run your profits and cut your losses. By doing so, you will be well on the road to investment enlightenment and success.“

Further thinking:

Companies with low working capital relative to their sales?

Sales-to-equity ratio?