Let me start by saying that I have no affiliation with Empire or any of it's staff, other than that The Prince has chanced across this blog before. Not that it matters though, as it seems that they are not currently accepting any new clients or funds.
So, to start off, I'd say that one of the reasons that I'm looking forward to this review is that their investing strategy is quite similar to my own, but with some interesting differences. Let's look at their strategy in a nut shell:
- Filter - Find the good and excellent companies to invest in. Ignore the rest.
- Value - Calculate value based on quality, quantity, and what people are willing to pay.
- Assign Risk - utilise a margin of safety.
- Observe - Concentrate and watch the select few closely - like a hawk.
- Act on Buy Signals - Purchase on every buy signal.
- Assign Capital - the second defence against risk is allocating the right amount of capital.
- Watch and Review - keep concentrating.
- Act on Sell Signals - Sell quickly on the sell signal.
- Start Again - reinvest your capital to compound your returns.
Overall, this is a very sound, and likely profitable, strategy. Essentially it comes down to the basic value investing principle of buying high quality businesses at reasonable prices. I like simple strategies like this.
Let's now take a more detailed look at each of their process steps...
Filter - Find the good and excellent companies to invest in. Ignore the rest
What a great place to start. I do exactly the same thing. If you don't initially filter down to a set of quality companies, then you are ignoring the benefits of owning a great business over the long term, and instead are treading down the path of speculating on junk in the hope that you can sell it to a greater fool. I have briefly talked about this before, and believe that the former is a positive sum game, and that the latter is a zero (negative after fees) sum game. Focusing on quality companies maximizes your money making opportunity during the hold phase of the investment.
So, how do they define "good" and "excellent" quality companies? Well, they don't really say. But the standard criteria includes such things as:
- Growing profitability
- High returns on equity, and high returns on total capital
- Manageable debt
- Increasing shareholder equity over time.
Update: Just as I'm reviewing this post for publication - I see that the The Prince has documented their approach on macrobusiness. Surprisingly, it's an 8 part binary questionnaire that determines quality rather than weighted numeric formula. I guess they have more time to analyze all the companies that I do. I also wonder if they've missed any great companies..
The last bit is important as well - "Ignore the rest". I have created my own top 50 companies in the ASX based on the above quality attributes, and would never consider buying a company outside the top 50. In a similar way, they have produce a shortlist of Good, Very Good and Wonderful companies, and would never buy a company that is not one of these.
Value - Calculate value based on quality, quantity, and what people are willing to pay.
I'm not sure that I entirely understand or agree with this one. More specifically, if that had said "Value - Calculate value based on quality" then I would completely agree, but I don't understand why "quantity, and what people are will to pay" come into it.
At a guess as to what "quantity" means, I can only guess that it refers to the limited availability of some opportunities because of the low stock turnover. Some stocks have days in between trades. However, I have no idea as to why this would influence their valuation of the company?
Similarly, "what people are willing to pay" is essentially just the market price, and it changes all the time. Again, as a strict value investor, I cannot see why they would let other peoples valuations affect their own. What happened to "think independently"? I created a thought experiment to build my own understanding of valuations, and because I always remain in control of timings of my transactions, I can trust my own valuations.
I calculate a value for the company based on my conservatively calculated expected return over the long term. I do not consider the value-to-others at all - only the value-to-me. I'd be interested to further understand what they mean here..
End of Part 1. To be continued...
Update: Empire Investing Part 2 here.
Posts
Hi Dave - first up thank you for noticing what we are doing at Empire!
ReplyDeleteI just want to make a few points to help you understand where and what we are doing:
1. We've recently updated the website from a Web 1.0 system to a WP CMS to better transmit what we are doing to our followers. There is some content missing (valuations are forthcoming) and some old newsletters we wrote in 2009/10. 2 of those newsletters explained carefully our quantitative and qualitative approach to valuations.
2. As you pointed out, we use a binary "Quality Ladder" but within that is a quantitative method. We do look at many metrics - ROE obviously, but also ROFE, ROIC, debt-to-equity, equity-per-share growth etc.
3. As for "what people are prepared to pay" I answered this in your post on intrinsic value. What people are prepared to pay are the aggregate decisions of the market of what they consider something is valued. There is SUBSTANTIAL statistical evidence (try COH for starters) that this has a high probability of being correct (nothing is absolute in investing - some value investors get a bit cocky about their "valuations" and need to be careful. It is better to be approximately right than precisely wrong.)
4. We calculate value like you do: based on forecast earnings (and the robustness/risk factor thereof), reinvestment rate over a long timeframe - usually 5 to 10 years. We use Margin of Safety to ensure we are not driving over a 3 ton bridge in a 2.9 ton truck.....
5. Finally, whilst we are closed to new funds and investors, we are looking to open a fund within the next 12-24 months. The current capital at stake is the majority of our own wealth - so we are not doing this as an experiment, although we publish all our results.
Please do not hesitate to ask any questions