From competitive advantage
to desirability

Ultimately, our goal is to answer one question: how fast can a company grow its profits sustainably over the long term? This is one of the most important factors in determining what a business is worth. As a reminder, our investment philosophy is centred on identifying differences between a company’s market price and its intrinsic value. Accurately estimating a company’s sustainable growth rate is a critical part of determining that intrinsic value.

Beyond the sustainable competitive advantages discussed previously, we also evaluate several additional dimensions of business quality and long-term growth potential:

Industry economics: Three factors shape the attractiveness of an industry:

• Structural profitability. Some industries are inherently more profitable than others. A stock exchange, for example, generally enjoys more attractive economics than a retailer.
• Industry stability. Certain industries experience more predictable demand and earnings. A brewer typically operates in a more stable environment than a mining company.
• Threats of disruption. Industries facing significant disruption are generally less attractive than those with more durable competitive positions. Consider the challenges facing traditional pay-TV businesses compared with companies operating in more resilient markets, such as razor blades.

Business quality and execution: We then assess the quality of the business itself, including its capital allocation, management’s ability to execute, and the coherence of its overall strategy. This is often the most dynamic part of our framework and one we monitor particularly closely.

Growth potential: We consider whether an industry is likely to grow faster or slower than the broader economy over the coming decade, and whether an individual company is likely to outperform or underperform its industry.

An important discipline throughout this process is maintaining consistency in our assumptions. The combined growth outlook across all industries should align with our broader economic expectations. Similarly, within each industry, our company-level assessments should remain balanced. Just as 80% of people believe they are above-average drivers, investors must guard against the temptation to view too many companies as above average.

Unit economics and capital efficiency: We also assess a range of quantitative and qualitative measures, including:

• Incremental returns on capital – the returns generated on new capital deployed by the business.
• Capital intensity – the amount of investment required to support future growth. Toyota, for example, must first build additional factories to sell more vehicles, whereas Visa can process significantly more transactions with near-zero extra investment in its existing payments infrastructure.
• Operating leverage – the extent to which revenue growth translates into profit growth. Microsoft incurs negligible incremental costs when selling another Office licence, whereas a services business such as Bidvest typically requires more personnel to generate additional revenue.

Risk: Finally, where appropriate, we apply a risk adjustment. This may reflect regulatory risks, such as a telecommunications company that must periodically renew spectrum licences, or geographic risks, such as Taiwan Semiconductor’s exposure to geopolitical developments.

Identifying changes in future prospects

While some of these measures are subjective, we use objective metrics wherever possible to reduce the influence of human bias. Investing is inherently forward-looking, however, and the judgement of an experienced analyst team remains essential.

As with our work on sustainable competitive advantage, the greatest investment value often comes not from a company’s current characteristics, but from how we expect them to evolve over time. Historical information is typically already reflected in a company’s share price. Superior investment outcomes are more often driven by identifying improvements or deterioration in a company’s future prospects before they become widely recognised by the market. We believe our framework enhances our ability to identify these changes.

From desirability to valuation

We combine all of these considerations into a single measure of a company’s overall investment attractiveness. This score plays an important role in determining the long-term growth rate we incorporate into our valuation models and, ultimately, the price we are willing to pay for a business.

Importantly, even a highly desirable company will only feature in our portfolios if that desirability is not already fully reflected in its market price.

Within South Africa, our framework currently ranks companies such as Prosus, Richemont, Clicks and OUTsurance among the most attractive businesses. Globally, Microsoft, Visa, S&P Global, Taiwan Semiconductor and ASML (which we don’t currently own) also score highly.

Together, these assessments shape our view of a company’s intrinsic value and allow us to focus on the gap between that value and the market price. It is this gap that ultimately drives our investment decisions.