• Government support drove an increase to spending on goods while services such as restaurants and travel were restricted. What will happen once government stimulus ends? Watch here.

What is quality?

03082020_Quality

What is quality?

The Montaka funds have a mandate to invest in high quality businesses. While this sounds sensible, quality can sometimes be a difficult concept to neatly define. We will explore how we assess quality and why a preference for quality businesses makes sense.

The concept of quality is not one that is unfamiliar to readers. We make judgments about quality on a daily basis. It might be when tossing up between one brand of yoghurt compared to another in the supermarket. It might be an assessment of a jacket in the store you’re considering purchasing. But if we were forced to verbalise why these products are high quality, there would likely be very little overlap between the description of the quality yogurt and the description of the quality jacket. However, we are simultaneously able recognise that both of these particular products are of a high quality.

The truth is that the concept of quality can be elusive and doesn’t always lend itself well to rigid frameworks. Phaedrus in Zen and the Art of Motorcycle Maintenance summed up this idea pithily when he said “…even though Quality cannot be defined, you know what Quality is!” However, as stewards of our investors’ capital, we are not afforded the luxury of resigning to a stance of quality being too hard to define. While it is necessary to judge quality on a case-by-case basis, there are indicators of quality that recur, and it is these broad building blocks of quality that can help us home in on above-average businesses.

Quality, at a high level, can be thought of in the following terms: (i) strong, predictable cash generation; (ii) high returns on invested capital; and (iii) strong growth prospects. Businesses that possess these characteristics typically operate in industries with limited competition, have assets that are difficult to replicate, and often have unforeseen growth opportunities that can cause the future earnings upside to be greater than first envisioned. Essentially, focusing on businesses that are deemed high quality has the effect of maximising the probability that the value of business will grow over time.

As share prices typically track earnings over long stretches of time, investing in businesses that are able to compound their earnings is likely to produce favourable investment returns (provided that one does not drastically overpay for a stock).

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George joined MGIM in September 2015 as a Research Analyst. Prior to joining MGIM, George was an investment analyst at Private Portfolio Managers where he covered global equities across various industries, using a value investing framework. George’s prior experiences include equities research and investment banking roles at both Citi and Greenhill & Co.

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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