See full coverage of the Morningstar Investment Conference here.
At the Morningstar Investment Conference, one manager interviewed the CEO of a company he is invested in, explaining his process and illustrating the questions and topics that need to be answered; Morningstar interviews managers on their funds in a similar fashion so here we provide our insights into how managers screen for, research and assess companies.
At the MIC, Tim Steer of Artemis grilled Geoff Drabble, CEO of Ashtead Group (AHT), on his recent results and future plans for the company. In many ways, this was little different from the way the Morningstar analysts interview fund managers. We like to know what prompted their decisions, what have been the contributors to fund performance—both good and bad—and what their thoughts are going forward.
First-hand Research
There are many ways in which fund managers will conduct their company research. Face-to-face contact is often considered a vital part of the process, but those investing at the top end of the market-cap scale sometimes argue that there is little value to be added from meeting companies, as they’re so widely researched in the marketplace already.
Contrast that with investing in small- and micro-caps, and it’s a totally different story. Meeting with management is critical in assessing the state of the business as one individual can make a big difference to a firm’s success. Furthermore, there is far less analytical coverage of small companies so there is potentially a much greater chance for a fund manager to add significant value.
Screening for Investments
It’s common for the research process to start with some financial screening of a fund manager’s investment universe. There is no single approach here: some screen their whole market using a handful of traditional measures such as price/earnings, price/book, cashflow, EBIT (earnings before interest and tax) and ROCE (return on capital employed).
Others use different metrics for companies according to their sector or industry, in the belief there’s no ‘one size fits all’ approach. Whatever the method, this is usually just a filter to drown out the ‘noise’ and to get to a shorter, realistic list of potential investee companies.
Due Diligence
After narrowing down their investable universe to companies of possible interest, it’s then about kicking the tyres of a business and really getting to grips with its operations. This can be in the form of analyst teams making site visits, and meeting not just the investor relations personnel and top management, but also the workers at the firm, as well as its competitors, suppliers, financiers and customers.
Some managers like to do all this themselves, others will use their analytical support and thus preserve their desk time.
When to Make a Move
It doesn’t end there, though. Even when an investee company has been chosen, managers will likely have a target share price in mind—whether or not that’s a formal part of the process. They will have their own view on what a company is worth and what is already included in the share price. Then they need to consider the resultant risk that a position will add to their fund and have a view on that company’s weight in their portfolio. They must also consider liquidity—depending on the market capitalisation and free float of a company, it can take time to build a position to the desired size.
The conclusion? There’s more than one way to skin a cat. And we think there’s more to fund selection than just a manager’s stock-picking process.
