Now you can buy cash flows of quality companies at a good discount

Last week, I got a call from our French investor. He contacted me and initially, I assumed he was scared about his investment. I was thoroughly surprised when he stated that he had a very calm mind. However, he had two questions.

First, he wanted to know how our investments are doing in these exceptionally tough circumstances. Second, he asked the stock investor’s classic question:

“Is it a good time to invest more?”

The first question was easier to answer because Sifter’s investment strategy favors quality companies that can be expected to do better than their peers in difficult times.

I raised three points.

1. Low debt and healthy balance sheet

In a low interest rate environment, money has been leveraged, but we at Sifter have always been reluctant to use leverage. One of the criteria of our screening method is low debt.

We like low-debt, even cash-rich companies. Especially in times of unexpected crises; it gives peace of mind.

When a company has a lot of money relative to debt, its risk of bankruptcy is low, even if the economy is in a big shock, as it is now.

A strong company also gets money from the market on reasonable terms, which opens it up to opportunities if weaker competitors are in trouble.

Credit rating agencies also value Sifter’s portfolio companies. The most common credit rating of our portfolio at S&P is A.

See an example of a cash-rich Japanese investment with more than € 2 billion in cash.

2. High return on capital

A high return on capital is a classic feature of quality business. That is why in Sifter stock selection we pay great attention to the return on invested capital (ROIC) of companies.

Return on invested capital is the ability of a company to create value for money invested by an investor.

When the company’s ROIC is, for example, at an excellent level of 15%, the euro invested in the company’s business returns EUR 1.15 to the company.

The best companies do not distribute all their profits to their owners but reinvest part of the profits in their operations at a high rate of return. It adds value to the owner.

When a company consistently makes a return on invested capital of more than 15% and is expected to do so in the future, we are happy to buy a part of that future cash flow.

That is why we consider quality companies’ shares to be very attractive and, in the long run, safe investments.

The median ROIC for the companies in Sifter’s portfolio is 15%. This can be contrasted to the median ROIC of the S&P 500, which is 9%.

This is a simple, but arguably the most meaningful metric which suggests that the Sifter 30 are of superior quality.

See an example of S&P Global in Sifter’s portfolio, which has a ROIC of 37 percent.

3. Predictability of results and competitive position

In uncertain times, predictability falters.

For years, we have been looking for 30 companies with a clear and predictable earnings model in Sifter’s portfolio. The products and services of such companies are often important to the customers and the nature of the turnover is continuous.

An example is US-based Verisign, which maintains corporate Internet domains (such as .com and .net). The domain name is important to the company but its cost to the company is negligible.

Even if the coronavirus persists, companies such as Verisign remain relatively predictable in revenue and earnings.

Is now a good time to invest?

I had to tell our investor that I was not allowed to give direct investment advice. And even with the permission, I wouldn’t give advice.

The question includes another question: “Can I buy from the market bottom?”. I can easily answer that: “I very much doubt it.”

It would be tempting to sell shares at the start of the downturn with the idea of buying them back at the beginning of the uptrend. While good in theory, In practice it is very difficult, if not impossible.

This is because the strongest rallies often come very quickly and suddenly. 

However, I said:

“If you believe in long-term investment, you can keep your extra money invested for more than five years and, most importantly, believe in growth, capitalism and the adaptability of companies in the post-corona world.”

So far, Sifter’s investment strategy has kept it ticking. Since the beginning of the year, prices for almost all shareholders have fallen sharply, but companies in the Sifter portfolio have fallen slightly less.

So we are + 3.8 % ahead of the Index (MSCI ACWI). Sifter Fund -15.7 % vs -19.5 % (3/31/2020).

What are the attributes that protect high-quality companies from the effects of the coronavirus crisis? Read more.

Santeri Korpinen
CEO, Sifter Capital Oy

This article was first published in Finnish on 6 April 2020 on the website of Arvopaperi, Finland’s premier financial publication.

Disclaimer. The contents of this page do not constitute investment advice or purchase recommendations for stocks. This page describes our opinions on the companies we have invested in or whose shares we have sold. The past performance of the fund is not a guarantee of future results.
Long-Term Quality Investing - Download the Guide
Long-Term Quality Investing – Download the Guide
Subcsribe sifter newsletter

Ideas for Quality Investors

In our newsletters, we share our thoughts how we invest in quality companies globally. Subscribe to the Sifter newsletter and receive: