STAGE ONE: RAPID FILTER OF A LARGE UNIVERSE

In an investment pool of over 100,000 opportunities, we filter out a shortlist using a combination of our internally developed software and manual processes. We believe our approach is quite different from industry norms. At a high level, this stage involves attention to:

1. Economies and governance issues revenues are derived in.
2. Return on invested capital and growth rates of distributable income.
3. High-level business model analysis with identification of how value is created, and suitability to our ESG screening. This is a manual task that can take a number of weeks in itself.
4. Income statement, balance sheet, and cash flow statements. Analysis of these statements and interactions between them.

STAGE TWO: DETAILED ANALYSIS OF THE BUSINESS MODEL DRIVERS

The application of analysis is only relevant when the drivers of price and volume are clearly understood.

In deciphering business models we ask ourselves five important questions:

1. How does this business add value?
2. What mechanism/s does this business use to create revenue?
3. Is this business one we can confidently apply our fundamental analysis and growth projection to?
4. Is the business model good for people and good for the environment?
5. Are there any obvious ESG issues that would impact our confidence in the business?

Our analysis has limitations – there’s much we don’t know. To that end we avoid the following businesses for the following reasons:

Commodity-derived revenues – For example, we do not have the analytical ability to predict future prices of oil, wheat, or copper. Predictions surrounding international supply and demand, rainfall, and geopolitical tensions lie outside of our capacity and so we have little insight to the value of commodities.

Contract winner – This company must continually tender for, and win, contracts to carry out and increase its business. Typically in the construction industry, the company comes unstuck in two ways: inability to accurately cost new projects, and the willingness of new competitors to under quote. Examples generally include:

• Commercial and residential construction.
• Infrastructure builder of government initiatives – e.g roads, bridges, tunnels, ports.
• General government procurement such as marketing, engineering, logistics, defence equipment, building construction and consulting.

We don’t believe we have the analytical ability to predict future chances of this contract winner to:

1. Continue to win larger values of contracts.
2. Continue to quote these contracts accurately and maintain margins.
3. Avoid material liquidated damages.

Manufacturer – This company is engaged in manufacturing products for various brands. It takes raw materials and brings them together to produce given outputs. The classic example is the textile manufacturer who produces clothing for different retail brands. Ones we avoid are low in the value chain.

Logistics provider – This is a capital-intensive operation that uses physical warehouses and transport vehicles to move goods around. Examples include third-party logistics providers and traditional transit solutions over land and water. We also include airlines in this category.

We avoid the logistics provider because:

• Logistics solutions are a commodity with vast numbers of competitors mainly competing on price.
• Material changes to profit subject to the price of oil, a commodity we can’t predict the future price of.
• High labour costs consistently increasing.
• Large investment in depleting assets in constant need of replacement.
• High depreciation expense.
• High lease expense.

Real estate developer – This entity raises funds to develop land, usually into apartments. They purchase land, engage a construction company to build residential or commercial assets and then sell those assets. Here the developer is subject to movements in interest rates, broader economic performance, and market sentiment subject to change over the project lifecycle.

We avoid real estate developers because of:

1. Inherent requirements for large debt loads.
2. Inability to scale at speed.
3. Reliance on domestic economy with frequent inability to grow internationally.
4. Reliance on very specific local economies and positions.

Researcher – This company is generally in the business of biological innovation. They will create, manufacture, and innovate drugs or other health promoting agents. They compete on having the most effective treatments and so constantly research and innovate to stay ahead of the competition or to develop treatments of untreated ailments. These are often pharmaceutical companies.

We do not invest in researcher-based business models because we do not have the analytical ability to:

• Confidently understand the revenue streams well enough to be able to identify the competition.
• Understand the intricacies of the treatment in how easily it might be replicated or superseded.
• Be aware of current research and progress of current trials that may compete with or supersede the treatment under our analysis.

STAGE THREE: DETAILED FINANCIAL STATEMENT AND NOTES ANALYSIS

This analysis covers multiple data points across the income statement, balance sheet, equity statement, and cash flow statement. It also draws on insight gained from specific interrelations between these data points. At a high level we believe that:

• Companies must have robust growth in revenue. The product or service should be good enough to propel its own popularity in the market without the need for exuberant marketing spend.
• Balance sheets must have sustainable levels of debt and adequate cash reserves.
• The cash flow statement must fit with all other analysis in uncovering distributable earnings or at least a clear pathway to positive and growing distributable earnings. Distributable earnings being cash-flow generated from business operations available to equity holders as opposed to accounting profit or net income as displayed on the income statement.

We then turn our attention to detailed analysis of the notes to the financial statements with attention to reserve accounts, off balance sheet commitments, revenue recognition policy, and other matters as they present in relevance to the individual company in question. Checks and balances of all relevant concerns are covered more thoroughly in stage six below.

STAGE FOUR: CALCULATION OF INTRINSIC VALUE AND COMPETITOR ANALYSIS

Market capitalisation matches value by chance, not design.

The market will often make prices that have no basis in a company’s current or possible future earnings. This regularly presents as greatly overestimating earnings ability, creating a price too expensive to participate in that earnings growth, or simply overlooking a sound company with good prospects leaving its share price undervalued. Therefore we must make our own independent valuation of a company’s worth or intrinsic value. In calculating intrinsic value we consider, amongst many other factors and as a broad summary, the following quantitative and qualitative elements:

Quantitative

1. Strength of financials.
2. Reproduction cost.
3. Distributable earnings as opposed to accounting earnings.
4. Value of the company as it is now.
5. Value of growth.
6. Present value of future cash flows.
7. Risks to future cash flows.

Qualitative

1. Identification of underlying business model drivers and the robustness of these drivers.
2. Relative position of the individual company in the industry.
3. The company’s physical, geographical, and operational characteristics.
4. The capability and character of management.
5. The outlook for the company, the industry and business in general.

Competitor analysis

We identify relevant competitor business models and perform detailed analysis on strategy and financials. We then consider how each strategy is likely to compete with that of the company in question, the performance of their financials, and the stability of their capitalisation. We analyse and record their progress over time alongside our investment.

STAGE FIVE: DETAILED ESG ANALYSIS AND CONSIDERATION

We integrate Environmental, Social and Governance (ESG) factors into the core of our analysis, with a process that has been adapted and expanded from the United Nations Principles for Responsible Investment (PRI) guidelines.
We assess companies from all angles. We go beyond financial factors to assess the ESG factors that are relevant to specific companies. This gives us a 360 degree view of the risk and opportunities of a business.
For evolution to occur change must be beneficial to the organism. For it to be sustainable over the long term, it must coexist with, and be beneficial to, its surrounding organisms and the ecosystem at large. Evolution in business models is no different. That’s why we believe in the importance of ESG factors and have become signatories to the PRI.
Read more in our Sustainability Policy HERE.

STAGE SIX: ACCOUNTING MANIPULATION CHECKS AND BALANCES

In this section we cover a series of checks and balances that uncovers signs of accounting manipulation.

This process accounts for some 143 data points, 46 calculations, and interrelations between those data points and calculations. Information is found within management discussion, financial statements, and notes to those financial statements. Past annual reports must also be analysed to gain insight into how these metrics are changing and to highlight any abnormalities that may be indicative of suspicious behaviour by management or other concerns. This is quite a detailed process but very broadly it involves analysis of:

• Earning quality calculations in the reported financial statements.
• Statements from management, their highlighted performance metrics, and how these change over time.
• Governance structure and governance risks.
• Revenue recognition policy.
• Off balance sheet commitments.
• All reserve accounts – the need for their existence, balances, and changes over time.