Insights from Stephen Wood,  Senior Analyst and Damen Kloeckner, Associate Analyst.
The extreme volatility facing global equity markets, largely the product of economic and political uncertainties, have triggered widespread fear amongst investors. It is precisely in times such as these that opportunities arise for disciplined value investors. With the market presenting value, many high quality businesses have become available at attractive prices.
Given this volatility, we wanted to review the principles that govern our investment process – in both good times and bad.

Returns plus capital preservation

Never forget the purpose of your investment; what you are trying to achieve. We are absolute return focused managers, and seek to achieve an annual return of 10%. We strive towards this benchmark by seeking value, appropriate diversification and sensible risk management.
With consistent performance and compounding of returns, we strive towards a 100% return over 7 years.
Capital preservation is critical, and we will hold cash in the absence of opportunity. The recent correction has proven the power of cash. When markets sold off we were in a position to take advantage of new opportunities.
We believe that a diversified portfolio of high quality businesses, purchased at discounts to value, will maximise the likelihood of achieving sound through the cycle returns.

The portfolio selection process

There are over tens of thousands of companies listed worldwide. Of those companies, around 3,500 pass our initial, basic screening process. Of those, around 500 are consistently profitable and are passed through our proprietary valuation system, StocksInValue. Within that group, around 100 stocks are considered investment grade, having been passed through in depth research and screening.
Quality is paramount to discovering businesses that will return superior value over the long term. From this pool of high quality stocks, we seek out businesses that are trading at a discount to their intrinsic value. We define intrinsic value as a precise assessment of a company’s sustainable profitability (as measured by its normalised return on equity) relative to the book value of its equity and discounted relative to its unique risk profile.
Clime Investment Criteria
1. Business Model
We seek out businesses with established and sustainable competitive advantages, and with high barriers to entry. How a business makes its money determines the quality and course of its earnings.
2. Profitability
We forecast each business’s medium term sustainable level of profitability and compare it to the sector, industry and market averages. Higher profitability relative to peers is typically indicative of a competitive or operational advantage.
3. Profit Growth

We assess the trajectory of each business’s earnings growth and the quality of its future prospects. We consider the maturity of the business, its ability to enter new markets and its ability to make value-adding acquisitions.
4. Cash flow
The strength of a business’s cash flows shapes its balance sheet, self-fund growth initiatives, initiate capital management activities and return value to shareholders. We place a premium on high cash flow generation.
5. Debt
Debt too shapes a business’s balance sheet and capital management flexibility. We assess companies’ debt relative to its equity, cash flows and available cash. Those with higher leverage typically have greater risk profiles and are more sensitive to market movements.
6. Capital Management
What senior management and the board do with a business’s available capital plays a large part in how (or whether) value is returned to shareholders. It also determines the nature and extent of the business’s growth and profitability.
7. Governance and Management
Good governance and management is one of the most important aspects of any business. A good management team ensures its interests are aligned with those of the business’s shareholders.

One such example of this is Computershare Limited, ASX:CPU (View valuation)

  • CPU is an ASX 50 company with a market leading position across a number of countries around the globe and the majority of its earnings are recurring in nature.
  • Sound financial metrics with an average NROE of approximately 21% over the past 5 years and view that these levels are sustainable.
  • Whilst earnings growth is currently limited, an upswing in corporate activity and interest rates should lead to earnings growth in the medium term.
  • CPU has generated $1.1bn in cash flows from operations over the past 5 years, facilitating healthy dividend payments and self-funding growth initiatives.
  • Debt remains reasonably low at approximately 2xEBITDA (earnings before interest, tax, depreciation and amortisation) providing the company with flexibility to pursue growth or capital management initiatives.
  • The company has been active in utilising excess cash flows to carry out on-market buybacks in the absence of alternative growth options.
  • CPU has a long serving and experienced management team and board, many of whom own shares in the company.

Complimentary Portfolio Assessment

Complimentary Share Portfolio Review

Is it time you review your current financial situation? Clime would like to assist by reviewing your equity portfolio for you.