The four pillars of future quality
Companies that will attain, and then sustain, very high returns on capital, have the ‘future quality’ that Will Low, Head of Global equities at Nikko Asset Management looks for. Here he discusses two highly successful Australian growth stocks, and a global stock that is a household name, through this lens.
He describes the four key pillars of future quality as: “Have they got a franchise; management you can trust to govern; a balance sheet appropriate to fund their own growth; and is the valuation of all that growth and returns over five years not reflected in the share price?” Watch this short video now to see how this translates to his fund’s investments in ResMed, Treasury Wines and Dolby.
When assessing future quality, we are looking for one type of company, which specifically are those companies that will attain and sustain very high returns on capital in the future. In essence, there are four pillars that really support that thesis:
- Have they got a franchise?
- Have they got a management we trust to govern and reinvest capital wisely?
- Have they got a balance sheet that's appropriate to fund their own growth?
- Is the valuation of all that growth and returns over a minimum of five years not sreflected in the share price?
Sometimes these are businesses that the market doesn't fully appreciate. One example that we own in our portfolio is Dolby Laboratories, a business that spent a huge amount of R&D over the last decade to develop new technologies which are only now beginning to come to fruition and resulting in an acceleration in growth, double-digit growth, in a business which is highly profitable. It's got no debt on the balance sheet, so we expect it to grow and improve its returns with really, to be honest, very limited impact from GDP or other things that may be at the top of other investors minds. .
Another example is Resmed, which has been a great business for many years. We continue to believe that the solutions that they provide, particularly roundabout the connectivity of their devices which is resulting in a world where people look for care and effective care in the home, and because of the software combination with their unique particular solutions, makes them well-placed for both market share and the growth in their product demand over multiple years.
Treasury Wines was a bit different. We first invested in that way back in 2012. The business spun out from a beer company where people had very low expectations for the industry, but we think there was a whole range of catalysts, from the supply demand in the industry, effective utilisation of its brands, and monetise them in a more careful way directing towards where the growth was in the merchant markets. With all those very longterm drivers, the business has very much come out to play in the recent years, not without its hiccups dare I say, from the management and otherwise, but very much the existing management team is delivering those very same things we identified way back then.
If you would like to read more from Will and the global equity team at NIkko AM, please visit the Nikko AM website
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