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Recipe for an idea

11052018 eggs

Recipe for an idea

Continuing with the culinary theme, this blog is designed to be a recipe for generating ideas. Before we go into details – it is important to consider the question – how do you like your eggs? For just as people have unique preferences here – different recipes are required for various investment styles. This blog goes through some idea cooking guidelines for five separate styles:

  • Quality Poached Eggs

The classic high quality poached egg is more art than science. Quality measures for stocks can be subjective and generally involve less quantitative analysis. One investor may see quality in cooked through low leveraged poached eggs, whereas another may only consider those with the runny consistency of companies with high barriers to entry. The recipe for finding such eggs is hard to shortcut. It requires analysing the competitive landscape and market position of any company. Whilst you can certainly screen companies on a quality basis – softer analysis is also required in order to appropriately rank them.

  • Hot Cold Quant Ideas

One of the world’s most renowned recipes is the l’Arpège egg of Alain Passard (served at l’Arpège in Paris). Whilst it appears to be a delicately boiled egg – the yolk is in fact poached and the white is turned to a vinegar infused cream. In the same way, quant ideas require separating stocks into their components and simmering them separately. Eggs are chosen by screening the universe of companies for ones with favourable characteristics, isolating these components and weighing their importance. You may look for components like high free-cash-flow generation, strong momentum or low leverage. This style of egg requires the sous vide machine of databases of stock characteristics.

  • Scrambled Growth

Scrambled eggs are everywhere, but identifying them requires good imagination. A good indication of where to scramble up such eggs would be to begin by looking at companies with strong top line and cashflow momentum. Companies achieve top line growth by: (1) being in a growing market (2) taking market share. You can find category (1) eggs in growing, and ideally misunderstood market segments. This was certainly part of our thinking in May last year when we wrote about Speedcast[1]. It has exposure to our growing need for data connectivity and is overweight faster growing segments such as cruise ships. Eggs in category (2) have strong competitive advantages that allow them to take market share – that’s certainly something the exceptional game development studios Aristocrat[2] has and the momentum of products such as lightning links and dragon link are a natural outcome.

  • Boiled Income

This mature egg format is about collecting dividends. Search for companies with enough growth to sustain a reasonable payout ratio. To find such an egg it’s prudent to look for quality mature companies with a high payout ratio – but also ones that can do this without going into debt. A good starting point would be to look at dividend yield and then remove any “at risk” eggs – no one wants a smelly egg.

  • Fried Value

When looking for deep value – a good method is to start with what’s been fried of late. Deep value investing is about finding golden yolks among burnt charcoal. It requires a strong stomach as it’s a counter-consensus order. Look at what stocks have come off the most in your investment time-frame and search for overlooked yellow yolks ready to bounce back.

Hopefully that gives you some ground work to start preparing your eggs of choice.

[1] Why we like Speedcast

[2] Aristocrat’s advantage

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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4 Comments

  1. Thanks Roger. A thoughtful response as always. We’re in furious agreement about the subjective nature of ethical filtering and the complexities involved in designing financial products around it.

    We all have our own version of a ‘line in the sand’, or at least I would like to think so. For me, though, and I suspect I am not alone, a broad formula that makes sense of this is one that isolates companies whose entire – or majority – business model is based on knowingly doing harm to the community.

    The tobacco companies fit this description, as does Aristocrat Leisure, for instance. Reliable research shows conservatively that 40% of money lost to poker machines comes from ‘problem gamblers’ and these are very specifically targeted by the machine designers.

    The “it’s legal, and they have a choice” argument pushed by the gambling lobby fails at the first hurdle. The families, children, parents, friends and close work colleagues of pokie addicts do not have a choice about family breakdown, domestic violence, fraud, depression and suicide. These are all consequences…collateral damage, and the kids in particular don’t have a choice.

    I don’t like Woolworths and its huge grip on poker machine outlets, but this argument does not apply to them as it is not their sole, or majority, business model.

    My personal interest in this is as a member of a coastal community (when I’m in Australia) fighting against a powerful lobby trying to build another of those giant pokie casinos on a beach in place of the community surf club. The collateral damage to a community is deep and irreparable, but it’s difficult to fight against clubs, associations (and State Governments) that are addicted to the pokie profits.

    So that’s my formula. When everything you do, your entire business model, is based on the premise of doing demonstrable harm to the community, then you are not an investible company in my book.

    I still believe there is some role for your excellent team in this area, but no doubt there’s a lot of discussion, soul-searching and research to come. It would be an interesting thread. Cheers.

    • Thanks Ric, I am not sure I can draw a line in the sand where you have…You make the observation that “The families, children, parents, friends and close work colleagues of pokie addicts do not have a choice about family breakdown, domestic violence, fraud, depression and suicide” but then you say that owning Woolworths is ok because those same machines don’t represent a majority of the Wollies business – its a sideline? So you appear to be saying that hurting people is ok if its a sideline business. Would that tolerance than extend to, say, fund managers who mostly own ethical and socially responsible businesses? The point we ultimately arrive at of course is a deeply personal and subjective set of lines in the sand.

  2. Thanks Lisa. Some of us also like our eggs Free Range. Real free range, with a maximum stocking density of 1,500/hectare, not the joke Free Range (10,000 birds per hectare) which now fits the description thanks to regulatory capture by the big Supermarkets and producers. The point is this; I don’t think I’m alone in suggesting that your talented team should work towards a value/ethical fund, even one with ‘light green’ screens. The current ‘ethical’ offer in Australia is pretty much a group of index huggers (read – the big banks…choke, splutter). There’s a pretty sizeable market out there for people – like me – looking for a blend of strongly researched value Investing, but with an ethical overlay. I have been a strong supporter and client of RM since the start, but would be your first customer lining up for such a fund.

    • Hey Ric,

      Really like your thinking. I however find most ethical/SRI policies completely unsatisfying. In reality, socially responsible and ethical investing is entirely subjective and it is inappropriate to subscribe to a fixed set of rules.

      At Montgomery we have not invested in timber producers but does that mean we should not invest in any bank that might or could lend to a timber mill? I am pleased that we are not invested in tobacco or weapons manufacturing or distribution. What about uranium? On the one hand Australia is so stridently opposed to uranium that it will be retro-fitting the latest french-made hi-tech nuclear submarines with old old-tech diesel engines. Elsewhere however, nuclear is relied upon a source of reliable, if not clean, energy.

      And what of alcohol and betting? It is most definitely the case that alcohol and gambling are a problem for some individuals. And it is also the case they represents a source of enjoyment and entertainment for many others. Both are currently legal too so where does one draw the line? Is betting at casinos unacceptable but buying a lottery ticket ok? Teenagers becoming inebriated on sweetened alcopops is unacceptable, but sharing a glass or two of wine or champagne with friends, or having a cold beer after a hard day on the harvester, is ok.

      Ultimately, whatever an investment manager says about ethical investing, it is more important that they themselves are ethical and socially responsible.

      I am pleased to say that we are both environmentally aware and community engaged. We donate a meaningful portion of our pre-tax profits to charity every year and I am motived by the idea that we have not inherited our resources from our parents but have borrowed them from our children.

      I suspect our stance on this very important subject will evolve over time and am delighted to answer any further questions about the matter. For now I remain of the view that the matter is an entirely subjective one and therefore difficult to define in a way that is acceptable to all.

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