Caleb Nolan and Partners' approach to investing is based on the belief that superior long term performance is driven by above average, sustainable earnings growth.
Industry structure and the company's relative position within the industry are critical determinants of that performance. While attempting to ascertain the absolute level of expected earnings growth is important, we also focus on the inherent risks associated with achieving that level of profitability. The economy, industry and markets are dynamic and constantly subject to change. A company's ability to cope with such changes is greatly enhanced when the competitive structure of the industry in which it operates is favorable. We believe that by identifying the more structured industries, we can:
• Identify companies less prone to earnings risk, and
• Identify those companies that have a far greater ability to take meaningful corrective action to minimise the impact of such changes as and when they occur.
Firstly we have analyzed share market returns of the ten best performing companies over the past ten years, as well as over other time periods. Our analysis has consistently shown that almost 90% of the total shareholder returns of these stocks can be attributed to earnings growth. Changes in valuation (i.e. expansion or contraction in capitalisation measures such as price earnings ratios) accounted for the balance of the total shareholder returns.
There is strong evidence showing that industry dynamics heavily influence the level and sustainability of corporate profitability. Our research, together with other academic studies into industry structure and company returns shows that companies operating within well-structured industries generate consistently better returns than those operating in industries with poor fundamentals.
Our investment process has delivered strong returns to its clients over the medium and longer term. We take a longer term view when researching ideas and our focus is on generating sound investment ideas utilising a highly experienced team with in-depth industry knowledge. Our success is linked to our client's success.
Understanding industry dynamics is our key focus. This analysis is performed by the entire team and provides: • Quantifiable industry data
• Identifies industry trends
• Delivers independent research on industries beyond company sources
Our research exposes the key industry structural challenges that all businesses face. Understanding where the bargaining power resides helps identify where value is created or lost.
In more detail, our industry analysis can broadly be broken into the following:
Micro-Industry Segmentation - The industry is divided into its constituent micro-industries. A micro-industry is defined by its unique value chain and encompasses all participants that might source the same group of suppliers to serve the same customer base and fulfill the same customer needs. The micro-industry is the basic unit of analysis.
Growth Outlook - We identify the growth drivers, which can be broadly divided into political, economic, social and technological factors. Using this analysis, the micro-industry's growth and the sustainability of that growth is determined. Caleb Nolan and Partners seeks to invest in micro-industries which can deliver sustainable, above market growth.
Relative Concentration - The level of competitive intensity within a micro-industry is assessed. The past and current behavior of component firms is also analyzed to indicate the competitive environment pertaining to a specific micro-industry.
Barriers to Entry & Substitutes - The ease with which new participants can enter a micro-industry is analyzed. Barriers to entry may take the form of patents; regulation; economies of scale making it difficult for others to compete; ownership of scarce assets necessary to compete; or forward and/or backward integration which gives the participant greater ownership of the value chain.
The in-depth company analysis builds on our industry work and further identifies:
Micro-Industry Positions - A company's micro-industry positions are assessed in terms of market share, trends in share and robustness of market positions. The analyst must also assess the positioning of the business along the value chain within the micro-industry.
Competitive Advantage - A company's particular competitive advantages within its business must be identified. Competitive advantages can be derived from scale economies, proprietary technology and/or intellectual property, brand strength, innovation or uniqueness of the business model. The sustainability of a company's competitive advantage is also considered.
Corporate Strategy - The key differentiating features of a company's corporate strategy including; the uniqueness of the business model or resources, the level of industry or market focus, the company’s success in exploiting industry dynamics and its track record in delivering shareholder value.
As a growth manager, it is always important to have a realistic and robust assessment of valuation. When valuing a company the analyst is required to produce four separate valuation methodologies, including three relative value measures and one absolute or intrinsic valuation. The four methodologies are:
• Market implied growth analysis: We assess the relative growth of a company against the growth implied by its price to determine any mispricing. For example, where the internally assessed growth is greater than the market implied growth, the company will appear cheap regardless of price or multiple
• Break-up or Sum-of-the-Parts analysis: Using international and domestic industry peers we assess the Sum of the Parts valuation of the company.
• Discounted Cash Flow (DCF) analysis: A DCF delivers an absolute value or intrinsic value of a company using Caleb Nolan and Partners' forecasts of future free cash flow and discounts these cash flows to a net present value using the company's estimated weighted cost of capital. Where valuation measures provide conflicting signals, it is the analyst's responsibility to justify inconsistencies.