MARKET DIPS SHOULD be viewed as buying opportunities for quality companies. If a business is high calibre, one would hope any equity valuation weakness is temporary and investor interest will revive the share price in time.
Telecom Plus (TEP) is a good example; a profit warning in 2015 was seen as a short-term issue, not a reflection that the business model was damaged. Investors ? and directors in a heavy way ? piled into the stock and it soon made up all the lost territory and beyond.
There are three characteristics that indicate quality, according to a new book by writer Lawrence Cunningham and fund managers Torkell Eide and Patrick Hargreaves. ?These are strong, predictable cash generation; sustainably high returns on capital; and attractive growth opportunities,? they write in Quality Investing: Owning The Best Companies For The Long Term. ?Each of these financial traits is attractive in its own right, but combined, they are particularly powerful, enabling a virtuous circle of cash generation, which can be reinvested at high rates of return, begetting more cash, which can be reinvested again.?
One company that fits this bill is FTSE 100 Irish support services group DCC (DCC). The money it spends on the business generates a far greater return than its cost of funding.
An interesting section in the Quality Investing book is a look at mistakes people make when buying stocks. This is particularly relevant for the current market sell-off. It says quality investing is best conceived as a ?bottom up? exercise, focusing on a company and its industry. The authors say mistakes are made when investors also engage in ?top-down? analytics and consider the state of international trade, the rate of inflation or the relative strengths of currencies.
?(Mistakes can be made) when large macroeconomic themes start wreaking havoc with stock prices, leading to questions about an investor?s exposure to factors such as trade, inflation or currency values. These macroeconomic trends do warrant close attention as they bear on given companies and industries. However, when top-down factors trump bottom-up analysis, it often leads to choosing companies and industries for the wrong reasons.?
