The key to identifying a great company? Wrap upyour research before you meet the managers, Mark Slater tells Merryn Somerset Webb.
The investment world is keen on labels. I never meet a fund manager who tells me that he just likes to buy good stocks and hold them for a bit. Instead they tell me they are growth managers, value managers, income investors, momentum managers, quality managers, or some mix of the lot. But once you ask a few questions about their strategy it tends to turn out that, the deep value lot aside, they mostly mean much the same thing: everyone wants to buy growing companies at less than their intrinsic value.
Figuring out what that value is is a pretty subjective matter and it is that subjectivity that can make a stock look like good value to one manager and horrible value to another. So the first thing I ask all managers is exactly what it is that they mean by the label they have given themselves. The most important of the funds that the hugely successful manager Mark Slater runs is, for example, labelled a growth fund. What does it mean to him?
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"We're trying to buy businesses that have a degree of dynamism in terms of earnings growth, but we're trying to buy them cheaply, so what we're looking for is growth at a reasonable price." See what I mean? Isn't that, I ask, what pretty much everyone is trying to do? Even investors who say they are after yield are obviously after a growing yield and to get that they have to see growth in the business. "To a degree, yes," says Slater. But the difference for him (a difference you see in his results, by the way) is that he really does try to use "value factors" to "introduce a significant margin of safety".
That means screening the entire UK market to find businesses with "a degree of consistency" of growth in the past and the ability to do the same in the future. They also need to be "converting profit into cash and also generating free cash flow". He also looks at the price/earning (p/e) ratio and price-to-growth ratio. Nothing on a p/e of more than 20 makes the grade, which knocks out many stocks the market now considers to be "growth" stocks.
These parameters in themselves knock out 90%-95% of the universe right away, leaving a "manageable shortlist" that can be looked at in a more qualitative way. That means looking for high returns on capital, "which is normally indicative of a good-quality business", and, ideally, one operating in a niche where it does something particularly well. Finally, and possibly most importantly, "we try to identify some positive factor that gives us confidence that growth will continue and that can come in all kinds of shapes and sizes".
Meeting management
Does this involve endless meetings with management? At the end, yes, says Slater. But it is the "least important part". This is interesting: other fund managers are forever "blahing" on about how vitally important it is to them to see the whites of managements' eyes. Why isn't it to Slater? "Management teams, if they're any good, are trying to sell the business to you."
That makes them conflicted (they aren't ever telling you the full truth). See them too early in the process and their patter may "sway your judgement" on the business. So much so that in the past "our biggest mistakes tended to be related to meeting management too early if you meet them at the end of the process, you know the question. You know which gaps you want to be filled in. You know what you don't know, or at least you think you do I think it's a much healthier way of going about things."
So after all that, how many stocks does he end up with? Typically somewhere between 35 and 50 with 35%-45% of the money in the top ten holdings "so there is a reasonable degree of concentration in the best ideas". Is there any particular rationale behind capping the number of stocks at 50? It is partly, says Slater, a reflection of the fact that you can't have an infinite number of good ideas. But there also "just aren't enough good companies" for there to be much more in the portfolio. "It's pretty sad, isn't it?"
The price of growth
We move on to the 35-50 stocks that count. What's made the grade? One of interest to me given I've just taken our rabbit to the vet for his vaccinations is CVS Group, the UK's leading veterinary business. Spending on pets is discretionary, of course, but it is also "a priority spend people tend to look after their pets pretty well" and the margins on pet care are "fantastic" (I know this the vaccination cost £65 and there's another in only three weeks' time). The industry is also still very fragmented and CVS is the leading consolidator. All in all, "it's just a great model" one that generates lots of cash and offers "good visibility for us as investors in terms of future growth".
How much do we have to pay for that growth? It is now trading on a forward p/e of around 21 times earnings. That, I point out, is higher than the 20 times entry price he told us about earlier. It is, but once in, Slater will "run profits beyond that". To where? What price makes something a sell?
That's not so simple: "we will run profits quite aggressively", but to where depends on the quality of the business and the growth rate. "We tend to find the best businesses outperform on the upside in terms of expectations. They're also very hard to replace. So if you're quick to take profits, you very often end up buying the same company back a year later." That means that "as long as the price doesn't go mad, we will hold for a very long time". One pleasing result of that is low turnover in the fund: the average holding period is about five years.
Another "niche-y" business Slater loves is Restore Group, which he's owned now for many years. It is the leading player in the "boring, simple" business of document storage. The paperless office is, says Slater, "a complete myth". Scanning is still expensive, we all use paper and our documents still need storing. And once we store them, "they're going to be there for over 20 years".
So the business effectively produces an annuity stream. Restore is also an acquirer. "We're not great fans of highly acquisitive businesses, but when companies can do bolt-ons in their area it's much lower risk" and this is exactly what the firm is doing. "It's been able to buy lots of mom-and-pop operators all over the UK and consolidate them on a highly accretive basis... it's a very attractive thing to do."
Trump could be a pleasant surprise
Are these firms or many others in the fund likely to be affected by politics, I ask: Brexit, Trump and so on. "No," says Slater. However, the good news is that Trump "can't do anything but surprise on the upside". The policies Western economies have been following since the crisis "clearly haven't worked" so it "isn't a bad idea to try something new". Brexit isn't much of a worry either: so far at the operational level it "has had a minimal impact". Perhaps that is because the whole thing has only just begun? Perhaps, says Slater.
But if the economy now slows, who is to say that it is a referendum issue? "The direction of travel of the economy was not great anyway. Growth was clearly going to slow. Now maybe it'll be a little bit worse. But who knows?"
I tell him I like his optimism. He says it isn't hard to be optimistic when everyone else is so very gloomy. It is "fascinating that everywhere one goes, people are in cash". The less bullish part of the equation is valuations overall they are at the "upper end of the normal range". But even there there is good news: the earnings recession we have seen in the US and the UK over the last two years "does seem to be ending". So we have widespread gloom, cash on the sidelines, solid corporate performance, a rising market and very little interest in equity markets from anyone. "That has to be good."
Fact file: Mark Slater
Mark Slater co-founded Slater Investments in1994. The firm now runs three funds open toindividual investors the MFM Slater RecoveryFund, the MFM Slater Income Fund and the flagshipfund, the MFM Slater Growth Fund (the one wemostly discuss in the interview above). The fund'sperformance has been fairly flat over the last 12months, but it has returned just over 97% over thelast five years (the IM UK All Companies index isup 69.5% over the same period).
Trustnet, whichmeasures the performance of a manager rather than of a specific fund,notes that Slater has returned an annualised average of 8.6% a year overthe last 17 years. The growth fund has received a huge number of awardsfor its performance.
