If you want to pick successful stocks, you’re going to need to spend a long time researching them, according to the portfolio manager at one of Australia’s leading investment firms, Magellan.
Chris Wheldon manages Magellan’s High Conviction fund, and he told Paul Colgan’s The BIP Show podcast that it takes an army of around 30 analysts to dissect companies, and determine which ones will make up the Global Fund’s 20 to 40 positions.
“Everything we do at Magellan, including portfolio construction, is grounded in the objectives that we have,” Wheldon said.
And the core of those objectives, is: absolute returns for clients over the long-term, and capital preservation.
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That means finding incredibly high quality businesses anywhere in the world, that are run by high calibre management teams, and buying them when we think they’re at a meaningful discount, Wheldon said.
So the investment team’s task is two-fold: find high quality businesses, and then try to buy them when they’re cheap.
“At the end of the day, we want businesses that can generate great economics for their shareholders - being our clients,” Wheldon said.
What makes a quality stock?
This part isn’t as simple as looking at a company’s balance sheets, or their share price over the last few months.
“We look at metrics like return on capital, just to get a sense for the economics and the compounding potential of that business,” Wheldon said. “So that might be a quantitative screen that helps narrow the universe a little.”
But numbers don’t tell the full story, either.
“We definitely marry that quantitative approach with a lot of internal qualitative work,” he said.
And due to having so many hands on deck, the firm is able to delve into certain businesses, and understand their “ecosystem”, including the value chain, which means looking at the company’s competitors, suppliers and customers, and understanding the trajectory of that business, and its position in that industry.
That means meeting with chief executives and chief financial officers of businesses, and other members of the executive team, to determine whether the business’ governance structure is viable.
There are four main boxes that businesses need to tick to be deemed a “quality” stock by Magellan: agency risk, economic moat, business risk and reinvestment potential.
Agency risk means the company’s management structure, while economic moat goes towards the sustainability of the business and any competitive advantages it has.
Business risks simply means anything that could impact the firm’s earnings and cash flows, and reinvestment potential means thinking through the company’s ability to reinvest its capital at very high rates of return, effectively doing a “compounding” job for Magellan and its clients.
“If that business passes and is approved by our investment committee, it can then be invested in,” Wheldon said. “But neither Hamish [Douglass, chairman and co-founder of Magellan] nor I or any of the portfolio managers at Magellan can invest in any security that hasn't first been approved by the Investment Committee.
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