With a focus on the long term, we’re sticking with quality

With a focus on the long term, we’re sticking with quality

Sometimes, the gyrations of the stock market can make our investment decisions look a bit ordinary.  Take this year for example, in which a rebounding materials sector has easily outperformed the broader market.  However, such moves don’t affect our investment philosophy.  Our focus is strictly on longer term business fundamentals.

As most readers will know, our investment process starts with an assessment of business quality.  Over the long haul, we believe it makes sense to focus on businesses with the ability to earn excess economic returns, and thereby create shareholder value over time by investing for growth.

A good test of business quality is the ability of management to set prices.  For a business that can raise prices without a dramatic loss of customers, earning good economic returns tends to be straightforward:  if returns are too low, management need only move the ‘price’ lever to a more comfortable setting.

This orientation tends to keep us out of the resources space, where price and economic returns are very much hostage to supply and demand.  If management attempts to pull the price lever in these businesses, the result can be a sudden and complete loss of revenue.

There will be periods when the forces of supply and demand offer tailwinds to resources companies, and periods when they don’t.  However, over the long run, it is very difficult for management to hide from price competition, and this means that sustaining excess economic returns tends to be very difficult.

For 2016, conditions have been favourable for the resources sector.  Prices for a range of commodities have generally been rising, in some cases, sharply.  This stands in contrast to a generally bleak experience over the previous 5 years when prices were trending lower.

The impact of this can be seen in the following chart, which compares the performance of the S&P/ASX200 Index, with the materials sub-sector of the same index.  As you can see in the graph below, the materials sub-sector has given the broader market a thrashing.

This translates into weak relative performance for investors like ourselves, who remain focused on quality businesses.  However, we accept this as an inevitable feature of our investment style. Periods like this will come and go, and our view is that it is extremely difficult to reliably predict when they might start and finish. Accordingly, it does not make sense for us to try to trade around them.

As always, our focus is on delivering good long term results, and we believe we have a good chance of doing so if we ignore short term noise and remain true to our beliefs around quality.

Our beliefs do not preclude us from investing in resources businesses, but you should not expect a wholesale change in direction from us any time soon.

MORE BY TimINVEST WITH MONTGOMERY

Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.

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.