Our CEO, Mark Freeman, recently sat down with The Barefoot Investor, Scott Pape, to discuss AFIC’s approach to investing, the history of our company and how we think about the future.
Scott referred to the interview as ‘A Special Briefing from a Legendary 92-Year-Old Aussie Investor’ – it was an inspiring conversation and we wanted to share a glimpse of it with you by taking a candid look at the six filters we use to evaluate investment opportunities.
- 1. Uniqueness of assets (competitive advantage)
We look for companies that have unique assets that give them a privileged market position. Companies that provide a product or service that is difficult to replicate or substitute, or companies that are in the process of establishing this privileged position, tend to deliver better returns to investors.
“We find that companies with a privileged position in their market – or that are developing a privileged position – tend to produce a higher return on capital (ROC) and return on equity (ROE).” – Mark Freeman
- 2. Long-term sustainability
This goes beyond assessing the company in isolation, we review the industry that our companies operate in to establish headwinds and tailwinds. We are not likely to invest in an industry that isn't exposed to a situation or condition that we believe will move growth, revenues or profits higher.
- 3. Level of independence
This means the companies we invest in need to be able to run their business unencumbered, they cannot rely on a limited number of large customers, be strongly dependent on certain commodity cycles or rely significantly on subsidies or funding from government. These these dependencies may become restricted or non-existent which would significantly impact the viability of the investment, and we are not comfortable exposing the portfolio to that type of risk.
“Every business has some sort of encumbrance, but some have a lot, and we avoid those.” – Mark Freeman
- 4. A history of consistent earnings
This has always been important in the companies we buy. All our core holdings have a healthy, long history of earnings which paints a good picture of how the company has performed through different challenges and market conditions. Companies with a long history of consistently strong earnings tend to maintain their ability to operate. We are a little flexible with this rule when it comes to ‘nursery’ or growth stocks that we think have the potential to develop into solid companies.
- 5. Quality of Management
We talk about management quality a lot, it has always been a key driver for us and always will be. We score the management and Board of all companies we invest in.
“We especially like companies which have what we call ‘owner-drivers’, which is where the owner is still the building the vision of the company.”
- 6. Financial strength
This involves analysing cash flow and ensuring the company has a strong balance sheet. We also consider several financial instruments which help us gauge a company’s financial health such as the debt-to-equity ratio, earnings before interest and tax, the company's profit margin and the return on capital. The more financial data that we can collect on our prospective investments, the better informed our investment committee will be when deciding to invest.
This framework guides all our investment decisions, it allows us to score and rank every one of our stocks throughout every economic cycle.
When we look back at our long history, at all the challenging market downturns created by circumstances that are unique and hard to predict, we can only remain optimistic.