Backing companies led by quality managers has always been important in the eyes of professional investors.
But big investors argue that in a low growth world making the right call on so-called qualitative factors such as the quality of management has now become a crucial part of investing.
This is because in a low growth world companies have to be able to successfully launch innovative new products or take market share off rivals to grow revenues.
Companies adopting a business-as-usual strategy implemented by CEOs focused mostly on their next pay cheque will typically lead to revenue heading in a different direction.
Jason Orthman, deputy chief investment officer at Hyperion Asset Management, describes it as a quest to find CEOs who are more like “missionaries than mercenaries’’ when it comes to running their business.
“We are looking for people who think that their business is their life. People who look well beyond their three-year option package. We want them to look out 10 years.’’
Hyperion says that more than half of the listed companies the firm has invested in, whether in Australia or offshore, are still founder-led. Hyperion is willing to tolerate some non-conventional corporate structures in its pursuit of investments that are likely to outperform.
Vision not arrogance
Hyperion says it is looking for founders who lead with a vision but without arrogance, and, thanks to a track record of success, have the authority at all levels of the company, including the board room, to get things done.
“If you can find these people in combination with businesses that are very good, that’s the sort of business that we want to hold,’’ says Orthman.
On the global stage, chief investment officer Mark Arnold wonders whether Tesla and its founder, Elon Musk, typify what the firm is looking for – Hyperion doesn’t currently hold Tesla stock.
“Musk is probably going to change the world. Genius-type people are always going to have some flaws,’’ says Arnold.
“It’s not just management, it’s the broader culture of the organisation. People like working at Tesla,’’ he says.
Closer to home, Hyperion cite WiseTech as an example of a company led by a MD in Richard White who is engrossed in building their business over the long term despite a multitude of short-term potential distractions.
Orthman says founders such as White have the necessary self-belief to hold big equity stakes through thick and thin.
“He has been willing to back himself and has been reluctant to sell down any equity. You don’t see it often enough that people want to keep hold of their equity.’’
Hyperion acknowledges that investing in such entrepreneurial companies might not always make for a smooth ride. (Shares in Wisetech are down 27 per cent since a September high).
But they believe lumpy revenue growth can produce a better outcome than smooth earnings over time.
“It’s about what the earnings are going to be in 10 years time,’’ says Orthman.
Look past short term
Hyperion warns against overreacting to short-term factors. Periodically disappointing quarterly results from the likes of Amazon, Facebook and Alphabet over the years meant too many investors missed the value created over the long term.
Closer to home the firm cites the performance of REA Group as an example of a company that has outperformed over time despite enduring periods of a stagnating share price.
Having started in a garage in East Melbourne in 1995 REA now has a $13 billion plus market cap.
Joel Fleming, a fund manager at Yarra Capital Management, is another manager placing great emphasis on assessing the skills of a listed company’s CEO.
He says too many CEOs are focused on promoting their company’s potential upside when the best managers focus on protecting against downside risks as well.
“Founders are very optimistic about what they can do because they are so passionate about it.
“Most CEOs we meet are very good promotors of what they can do but there can sometimes be a gap between what is promised versus what is delivered, particularly in terms of earnings and cashflow. The best CEOs tend to underplay what they can achieve,’’ he says.
Fleming, who specialises in investing in micro-cap companies, says a good management team also has the confidence to invest in their business in order to deliver long term outcomes.
He cites Nearmap an example of a company that invested heavily in overseas expansion over a number of years but is only now being rewarded.
“Looking at our large investment universe, we tend to avoid companies which place a strong focus on keeping costs flat. We like companies that look to invest in platforms and systems to deliver on an opportunity. Rob Newman and the Nearmap team have done precisely that.’
Patience and flexibility
But Fleming says good managers also have to exhibit patience and flexibility, being able to adjust a business model to exploit new trends.
“Business is an iterative process. It’s rare to come across a business that will succeed regardless of who is running it.’’
He cites radiology IT systems company ProMedicus, led by co-founder Sam Hupert, as an example of a company that was able to seize an opportunity when it was presented to make a transformative acquisition that led to a period of strong share price returns.
Fleming says companies that have been sinbinned for poor decision making sometimes deserve a second chance – particularly if they have demonstrated they have learnt from their mistakes.
According to Fleming, sleep disorder solutions provider Somnomed provides a good case in point. After the launch of a direct-to-consumer model in the US fell flat, the company took the difficult decision to walk away and refocus on its core market.
Despite having burned significant capital, Fleming applauds Somnomed’s efforts to win back the trust of its customers, with the company rebound ing strongly as investors recognise the significant market opportunity.
“Often a management team can move in and out of favour with the market. This can present an opportunity for investors with a longer term focus, ’’ he adds.
Ultimately, Fleming believes investors must look for a combination of prospective business models, good management teams and supportive tailwinds.
“When these three components come together they can be an incredibly powerful driver,’’ he says.
Stewart Oldfield is a director of industry intelligence firm Field Research.