When it comes to equity investing, the best offense is usually a solid defense. As Charlie Munger (Trades, Portfolio) put it, “if you watch the downside closely enough, the upside will take care of itself.” Thinking long and hard about how money could be lost on the investment is how Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) was built over time.
To cap the (downside) risk of our stock investments at Hillside, we prefer to “partner” with companies demonstrating a prudent management gene embedded in day-to-day operations and long-term strategic planning. We look for such evidence throughout our research process, including direct interaction with the management team.
Hong Kong-based Perfect Medical Health Mangement Ltd. (HKSE:01830, Financial) is one of the largest medical beauty services providers in the region and became a Hillside portfolio company earlier this year. We have been in touch with management on a regular basis and found, unlike many of its competitors, the company focuses only on non-invasive procedures to avoid potential legal costs and high staff expenses. It also mitigates the “diworsification” risk. The management team even underweighted the “exciting,” rapidly-moving China Mainland market and instead turned to more developed regions such as Australia and Singapore to expand geographically for a more predictable outcome. The aforementioned reasons explain Perfect Medical’s consistently industry-beating financial results, in our opinion.
Credit Acceptance Corp. (CACC, Financial), also a recent addition to our portfolio, is another conservative growth story. The management sticks to what the company does best – underwrite auto loans for consumers with a subprime credit rating in the U.S. The company never ventured beyond its core market since it exited the U.K. and Canada back in the 2000s. Additionally, it has remained disciplined to only invest in loans with a projected return considerably exceeding the cost of capital throughout the latest credit cycles. One of the company’s annual shareholder letters specified, “if we couldn't earn more than our cost of capital, we needed to give that capital back to shareholders.” During the same period, many other financial institutions gained market share initially via aggressive loan underwritings but found themselves in trouble when tough times came subsequently – some of them had to leave the space with a loss and shareholder value being destroyed. In contrast, Credit Acceptance achieved double-digit annual growth rates in sales and earnings year in and year out. Slow is fast!
Our last example from our portfolio for this episode is Rational AG (XTER:RAA, Financial)- a German cooking equipment manufacturer. In a recent email exchange, the management implied to us the company would not look for an acceleration in business expansion, because a faster pace, while more “sexy” to Wall Street analysts, would dampen the quality of the offerings and customer experience. The management regards a high-single-digit growth rate as “manageable” and something they can budget for. Rational has been planning for long-term shareholder value by concentrating on building a brand-based moat even at the expense of the (lower but still decent) current growth. There should be no surprise to see consistently industry-leading customer satisfaction and loyalty for Rational’s products, keeping competitors at bay.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. I/We may have position(s) in any of the securities referenced in this article.
This article was written by the author and first appeared in Hillside Wealth Management's monthly newsletter.