We think of a quality business in terms of durability, rational competition, and achieving an adequate return on invested capital (typically double digits on average) throughout the cycle. While technology is impacting nearly every industry around the world, some are particularly susceptible to a rapid pace of disruption. We seek to avoid these areas and instead focus on businesses, usually with significant tangible asset backing, that have withstood the test of time and face limited disruptive threats. These businesses may not be the fastest growing, but typically achieve at least average growth, yet are far more insulated to irrational competitive pressures and margin degradation.
We spend considerable time conducting company and industry due diligence to properly assess Porter’s five forces. We stress observable factors such as the supply of capital and underlying competitive dynamics versus relying on long-term demand projections, addressable market statistics, or trying to predict consumer preferences. Lastly, the business must have a sound balance sheet. We prefer operational gearing rather than financial gearing to enhance returns, as the margin of safety typically dwindles with debt.