This article is authored by MOI Global instructor John Carraux, Managing Partner and Portfolio Manager of Punch & Associates Investment Management, based in Minneapolis, Minnesota.
“The person that turns over the most rocks wins the game. And that’s always been my philosophy.” –Peter Lynch
Not long ago, several members of our research team took a scenic road trip down the Mississippi River to visit a small-cap company in Iowa. The company is a good-sized manufacturer with a gleaming new headquarters right on the banks of the river. As we do with many companies we are seriously researching, we had a full afternoon of meetings scheduled with the senior executives of the company, followed by a plant tour of a nearby division.
After the usual introductions and pleasantries with the CEO and CFO, we casually asked how often they hosted meetings with investors like us. “You’re the first to come visit us in five years!” was their reply. When we hear that from a company, it tends to get us excited. It’s also not that unusual.
We get excited about unknown companies in the same way that a beachcomber might get excited when his metal detector starts beeping over a clump of sand. The beeping alone doesn’t tell us what lies beneath; it could be a dime or a diamond bracelet. The simple fact that we are one of the few to take notice is significant. Taking notice of companies that are unknown, under-researched, and hard to find (the nearest airport was three hours away) isn’t all that unusual for us because those are exactly the types of opportunities we seek. Information is a valuable commodity in in- vesting, and the scarcer it is the more valuable it becomes. We believe that performing due diligence research that others are unwilling or unable to perform is a real competitive advantage.
Investors who make the time and effort to find, research, and invest in lesser-known companies—those who turn over more rocks, as Peter Lynch would say—gain insights into three critical areas that we think are significant drivers of value and, therefore, investor returns over time:
1. Corporate Strategy
Doing the hard work of traveling to companies, interviewing management teams, and touring facilities isn’t easy, but we believe that the unique insights that such activities usually render to the intrepid investor can translate into attractive returns over time.
When doing due diligence on a public company, many investors start by perusing the publicly-available regulatory documents of a company. These filings (Annual Reports, Quarterly Reports, Prospectuses, and the like) offer excellent information, and plenty of it. It isn’t unusual for a Fortune 500 company’s Annual Report to run several hundred pages long.
What quickly becomes apparent when reading these voluminous filings, however, is that much of it is written by two categories of authors: accountants and lawyers. There is usually an abundance of accounting arcana, and what qualitative descriptions there are of the company’s operations, reporting segments, and risk factors tend to be heavily redacted as if they were sterilized to be only as descriptive as required by law. Understandably, it makes little sense for a company to go overboard on explaining the nuances of its business and strategy in a public government filing that is accessible by customers, competitors, and the like. Excessive transparency could ultimately be detrimental to the company.
Investors, however, do need to know these nuances to make intelligent, rational judgments about the strength of the company and the sensibility of its strategy. We’ve found that the best way to gather these insights is through direct, face-to-face management interviews.
Management interviews should ultimately yield answers to two important questions: does the company have a cohesive strategy? And does that strategy truly differentiate the company from its competitors?
Amazingly, some companies do not have cohesive, sensible strategies. Quite simply, they lack an overarching vision for their enterprise, as well as the framework to translate vision into action. Especially among smaller companies, there can be a tendency to simply do business the way it’s always been done, or to seemingly run the company for the benefit of management’s lifestyle, or to lack serious directors or shareholders who are willing and able to hold the company accountable. We believe, that over time, this is surely a recipe for investment disaster.
Most of the time, though, serious companies have taken the time and effort to thoughtfully articulate where they want their company to be in the future and what the roadmap for getting there looks like. The articulation of this vision, and more importantly, the operating philosophy animating it, is critical to investment success.
Is management aggressive, willing to pursue a win-at-all-costs fight for market share? Or are they more conservative and tactical, picking battles where the odds of success are stacked in their favor? Is their attention to the opportunities before them more scattershot, or focused? Do they prioritize ethical business practices, or is regulatory compliance of secondary concern? How do they think about creating value for shareholders over time, and what are the metrics used to gauge this progress?
These are the questions whose answers often cannot be found in public filings. For those companies who do not command much attention from Wall Street, the answers to these import- ant questions must be ferreted out by investors willing to engage companies on their own terms.
Corporate strategy only makes sense when viewed through the prism of competition. A company’s ability to generate and sustain returns on capital is largely determined by the structure of the industry or industries in which it chooses to operate. The difference between a concentrated, monopolistic industry and a fragmented commodity one is enormous. Engaging a management team on the issues of competition can produce extraordinary in- sights for investors into both the quality of the company itself, as well as the quality of its competitors.
Whether a CEO respects, fears, or ignores a competitor can also be revealing. More than a few times, we have walked away from meeting with a management team more impressed with one of their competitors than the company itself.
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Punch & Associates is registered as an investment adviser with the U.S. Securities and Exchange Commission. Registration as an investment adviser does not imply a certain level of skill or training.. This information is confidential, and is intended for the exclusive use of the recipient receiving it directly from Punch & Associates. This information is not to be reproduced or re-circulated, and is for discussion purposes only. Further, this information is not an advertisement and is not intended for public use or distribution. The information is provided as of the date of delivery or such other date as stated herein, is condensed and is subject to change without notice. Information regarding market returns and market outlooks is based on the research, analysis and opinions of Punch & Associates, which are speculative in nature, may not come to pass, and are not intended to predict the future performance of any specific investment or any specific strategy. This document does not, and does not purport to, discuss all of the risks associated with any specific investment or the use of any strategy employed by Punch & Associates.