Capital Returns

As bottom-up investors, however, we are more interested in the capital cycle as it affects individual companies than in aggregate corporate profitability.

more (in P/E terms) for the business with high returns on equity and superior cash flow generation.

With regards to the workings of the capital cycle, investors focus on current (and projected) future profitability but ignore changes in the industry’s asset base from which returns are generated.

Importantly, these barriers often strengthen over time, as high returns on capital throw off abundant free cash flow which is in turn reinvested in the business.

Conversely, a focus on competitive conditions should alert investors to opportunities where supply conditions are benign and companies are able to maintain profitability for longer than the market expects. An understanding of competitive conditions and supply side dynamics also helps investors avoid value traps (such as US housing stocks in 2005–06

Spain and Ireland, whose real estate markets had even more pronounced upswings, ended up with excess housing stocks equivalent to roughly 15 times the average annual supply of the pre-boom period.

It should never be forgotten that, in its most basic form, investing is always and everywhere about price and value.

A basic industry with few players, rational management, barriers to entry, a lack of exit barriers and non-complex rules of engagement is the perfect setting for companies to engage in cooperative behaviour.

As a result, we discovered that our approach has worked best when we invested in a relatively large number of stocks, holding onto them for long periods of time.

out, the “value/growth dichotomy” is false – at least, to a true value investor, whose aim is not to buy stocks which are “cheap” on accounting measures (P/E, price-to-book, etc.) and to avoid those which are expensive on the same basis, but rather to look for investments trading at low prices relative to the investor’s estimate of their intrinsic