Contact Insights – June 2022 – Bang for your buck!
A View on the Macro
The quality of a business is often a reflection of the quality of its earnings profile. There are three metrics we consider useful in assessing quality of earnings; ROE (Return on Equity i.e., profit as a percentage of total ownership), ROIC (Return on Invested Capital i.e., operating profit after tax as a percentage of debt & equity less cash) and ROCE (Return on Capital Employed i.e., Earnings before interest & tax as a percentage of total assets less liabilities). When a business generates returns well above its cost of capital, this illustrates to Contact Asset Management that the operating model has favourable and efficient characteristics. Sustainably high returns often demonstrates that management is deploying the resultant cashflows effectively to grow shareholder value through the cycle.
Capital light business models that do not require additional capital to fund continued growth are incredibly attractive investments, but this alone is not enough. It is the efficiency of capital deployment within the business that is important. The following graphic provides an overview of Contact’s Investment Process. The Quantitative and Qualitative metrics we value are a favourable Principal Activity relating to how the business makes money and the variable mechanics of these core business drivers; a reliable and growing dividend stream, Financial Strength underpinned by robust Balance Sheet, a Management team with demonstrated track record of performance that is financially aligned with shareholders, appropriate ESG metrics and Valuation support that provides opportunity for outsized returns. As we work through our bottom-up analysis, we find that the analysis of the returns being generated manifests through so many other investment characteristics. Businesses that generate attractive returns often have a competitive advantage, a sustainable dividend profile, strong financials, and capable management teams.