This is an excerpt from our October 2015 monthly review.
What is Our Edge?
At Reperio, we are firm believers that to produce extraordinary results, you have to do something different from everyone else. What do we do different in an attempt to produce superior results?
It is something we think about a lot and we believe there are three key differentiating factors for our research. First, we have a business owner mentality focusing on competitive position, management (not focused on by traditional research providers), corporate governance (not focused on by traditional research providers), absolute intrinsic value (not focused on by traditional research providers more focused on earnings momentum and companies beating expectations), and ensuring there is a margin of safety before recommendation (traditional research providers top picks are what is currently loved by the market due to earnings momentum are their top picks the opposite of our approach.) We look for high quality stocks with poor sentiment.
Second, we have a long term investment horizon. Jean Marie Eveillard once estimated that 95% of market participants are focused on the short term. Given 95% of participants are focused on the short term; the vast majority of research providers will be catering to those participants in an effort to win their commission dollars. Theses traditional research providers are obsessed with the next three to six months and companies with earnings momentum that can beat consensus. Our long term investment horizon coupled with our business owners approach gives us a tremendous advantage.
Third, we attempt to play a game where the competition is the weakest, i.e. Emerging Market Small and Mid Cap companies. Just like any competition, if you play a game against very strong competition, it will be much harder than playing against weaker competition. When you are looking at US large caps you are competing against large buy side, sell-side, and hedge funds. This is very difficult competition and while there are inefficiencies in these markets they are relatively small. When looking at small and mid caps in Emerging Markets, competition is from the sell side, the buy side, and the public. Many of the names in the small and mid cap space have very little if any analyst coverage. Analysts that do cover the names are more likely to be less experienced as most traditional research providers take the approach of trying to gain a small slither of a big pie and therefore put their best analysts on the bigger names. The combination of short term orientation, and weaker experience leads to little competition. With buy side institutions, the vast majority has 100 or more names in their portfolio and has to know three to four times the number of companies. This puts little emphasis on in-depth, independent research on smaller companies within Emerging Markets. Additionally, 95% of buy side institutions are closet benchmark funds (over 100 stocks in the portfolio with big overweights and underweights being 1 to 2%). This place a greater emphasis on the larger names that are in the index decreasing the importance of small and mid caps even more. So buy side is very little competition. The public typically are traders and have very little understanding of business so they are not much competition.
Our edge is illustrated by our PC Jeweller recommendation. At the time of our recommendation in PC Jeweller, no large sell side institution covered the company and the smaller sell-side institutions were focused on the short term regulatory concerns leading to potential weakness in the short term and downside to earnings expectations. Our business owner mentality with a long term view saw a company that showed incredible resilience during an industry downturn (stable and high profitability) with a very strong balance sheet and innovative management with skin in the game. There was short term looked uncertain due to regulation but the long term growth rate potential was tremendous given limited competition from organized retailers and a store opening target of 15-20% growth per year. Despite the strengths of the company, it was valued under 5 times EV/EBIT.
Zensar Technologies is a similar story. It was a company that was coming off a period of indigestion after a large acquisition, which happens often. Growth had slowed a bit which potentially put often the very few sell-side institution covered the company with no coverage from any big institutions. The business owner with a long term investment horizon saw a company with very strong leadership in an industry with incredible profitability due to switching costs with industry low turnover due to a differentiated activity in an industry where the key resource is people and management was guiding 15% top line and operating profit growth for the foreseeable future. Zensar was also trading at under 5 times EV/EBIT eliminating a lot of the risk associated with the investment thesis but in the short term there were concerns putting off the sell-side.