In the April issue of our monthly newsletter, we wrote that the market is ripe for long-term investors. That was not investment advice but we like to share our thoughts and write about how the Sifter Fund responded to situations. We decided to take advantage of the opportunities presented by the crisis.
During the spring, the atmosphere at Sifter was calm but determined. While we knew that our portfolio consists of carefully selected high-quality companies, we had concerns about the effect of the coronavirus crisis on companies’ cash flows.
We initiated a three-stage process that we wrote about in our blog earlier in the spring.
In the three months since then, we have added four new companies to our portfolio. Over the same time period, share prices have returned roughly to the levels seen at the start of the year.
Sifter’s portfolio was strengthened by the coronavirus pandemic
We believe that the dip in share prices caused by the coronavirus pandemic allowed us to add even more high-quality companies to our portfolio. We keep track of many different indicators, but the table below shows the ones we consider to be the most important for us.
We compare the median values of the performance indicators of Sifter’s companies with the companies that make up the S&P 500 index. These figures support the view that Sifter’s companies are in excellent shape.
| KPIs | Sifter Current | S&P 500 Current |
| ROIC | 15 % | 7 % |
| Operating margin | 24 % | 15 % |
| Sales growth | 4 % | 1% |
| Net debt / EBITDA | 0.1x | 2.5x |
| EV / EBITDA | 12.6x | 12.4x |
Sifter’s investment strategy is clear
Times of crisis are when strategies are put to the test. It’s good to get the occasional reminder for ourselves and our investors about how we invest their wealth.
We want to hold shares in a small number (approximately 30) of high-quality companies that have a sharp competitive advantage along with a clear revenue model and which we believe will increase their ability to generate profits in the future.
There are not many companies out there that fit this description, and they are rarely available to buy at attractive prices. When we identify such companies and manage to buy their shares, we want to keep them in our portfolio for a long time. The key elements of our strategy are quality and a long-term approach.
Four reasons to sell our holdings
In a normal year, we add only 3–5 new companies to our portfolio. This keeps the portfolio’s turnover very moderate. Over the past five years, the annual turnover of our portfolio has been about 10 percent. This means that Sifter’s investors do not have to bear the cost of unnecessary trading expenses.
We have defined four scenarios in which we are prepared to sell our holdings in a company. We sell when
- the company’s earnings model or competitive advantage is permanently damaged,
- there are significant changes in the senior management of the company,
- the company is sold and we don’t see the merger will benefit the company,
- we identify a better business to replace the company.
During the tumultuous spring caused by the coronavirus pandemic, we made decisions based on item 4 above when plummeting share prices meant that companies coveted by us suddenly had attractive valuations.
The fact that we maintain a ranking of all of the companies in our portfolio made it relatively easy to decide to sell those of our holdings that were at the bottom of the list.
We added four new companies to our portfolio during the spring. We’ll provide more information on the new additions at a later time.
The ability to generate profits is more important than the share price
We are not interested in short-term fluctuations in share prices or increases in target prices. Instead, we focus on whether the key business performance measures of Sifter’s companies develop favorably.
This way, we know that the Sifter portfolio consists of high-quality companies and share price often follows growth in the ability to generate profits.
Return on invested capital (ROIC) is an important indicator for us
We believe that high-quality companies improve their ability to generate profits when they are able to invest their capital in the profitable development of their operations. If a company has favorable growth prospects, we are willing to pay a little more for it. The buying price of the share is not as significant when the investment horizon is long.
The median ROIC of the companies in Sifter’s portfolio is 15%. Respectively, the median ROIC of the S&P 500 index is 7%.
This means that Sifter’s companies earn twice as high a return on the capital they invest. This is good for their shareholders.
We avoid companies that are in debt
The indebtedness of companies (net debt/EBITDA) is another important indicator for us. Sifter’s companies are practically debt-free (the median value for this key indicator is 0.1), whereas the median net debt/EBITDA ratio of the S&P 500 is 2.5. This means that their net debt is 2.5 times their annual EBITDA.
We know that most companies have had to take on more debt due to their profit performance declining during the difficult spring. Nevertheless, we believe that Sifter’s companies are in a good position thanks to their low debt and we are confident that they can improve their position in the current circumstances.
Trying to guess which way the stock markets will move is an exercise in futility. Long-term ownership of high-quality companies is a better option. It provides peace of mind and it has often also generated good returns.
Santeri Korpinen
CEO, Sifter Capital Oy
