When I last spoke with value investor Whitney George, he had just joined Sprott Asset Management.
Whitney is looking for great businesses capable of generating a lot of cash but that are going through a slump.
Temporary setbacks can cause shares in good companies to become cheap as investors exit the story.
Of course, you need to figure out which companies are genuinely good businesses that are likely to recover.
That’s why Whitney spends a lot of time looking at the talent behind the company and trying to ensure that they’re aligned with his interests.
What brought a value investor with no specific interest in natural resources and precious metals to Sprott’s door? He was looking to move his fund to a new company, he explained. Sprott “checked all the boxes,” in his view.
We talked about applying value investing today, and how he ended up finding a new home at Sprott.
Henry Bonner: What got you interested in Sprott as an investor, and why did you decide to come over and join the company?
Whitney George: As a long-term investor in asset managers, I got to know Sprott during the crisis in 2008. I had actually done a lot of work with the predecessor Sprott Securities and so I knew a lot about Sprott’s research and idea generation.
My style is to try to find companies with strong financials, strong balance sheets and high returns on capital. I am essentially looking for operating leverage without financial leverage.
Asset management is a business that I’ve been in my entire career and probably one of my favorite industries as an investor. But because it’s such a good business, you need a bear market for valuations to come down to levels where there are good opportunities.
Of course we had that across the board in ’08. It was a great time for investing in great businesses, particularly asset managers.
The first round (of investing in Sprott) was very successful, and I got to know the company better and better. Through all this time, I’d gotten to know Peter Grosskopf (CEO of Sprott Inc.), Rick Rule and Eric Sprott. The management business is a people business, and I found them all to be of the highest level of integrity.
When I decided to make a career change, my first call was to Sprott because it represented to me exactly the kind of organization that I wanted to spend the rest of my career with. There is the alignment of interest with customers which I share, as I’m the largest investor in the products that I manage.
Do you prefer to invest in asset managers in a particular sector, as opposed to the producers?
Well, at different times and different prices, I could be interested in just about anything. There’s not the same history in other industries, like mining and a lot of commodities-related industries, of earning sustainably high returns on capital and generating lots of free cash flow. They’re capital-intensive businesses. Asset management is people-intensive but not capital-intensive.
Asset management produces high returns on invested capital because it doesn’t require very much capital, and certainly it offers fantastic leverage to the various markets where they operate, whether precious metals and natural resources or emerging-market fixed income or private equity.
There’s a lot of upside in the model without a lot of capital required. They have the ability to generate a lot of free cash, which they can share with their shareholders.
What are some of the specific items you watch for when you’re looking at a new company?
When I invest in any company, it really starts with the company fitting the statistical model that I’m looking for. Typically you don’t get good value when everything is going right. Usually there’s some issue that’s bothering the market in the short term.
You look to understand what the current issues are, how the company got to be where it was to begin with. Its history, its philosophy, its management, its culture, and its governance are all part of the initial due diligence.
After that comes an assessment compared to peers. Is this a security that’s down by itself or is there a broader theme going on? Is this the best opportunity within that space to participate in whatever is causing the near-term angst? What are the conditions for that to change and what is a reasonable timeframe for those conditions to change?
You want to find sick companies that are going to get better and get through their problems.
Then, of course, you look at how management is handling those stresses. Are they being opportunistic? Are they expanding their franchise in a difficult environment or are they retrenching? Are they firing all their people to save costs as opposed to reinvesting in the business and being opportunistic at that point in time in their own cycle?
Do companies often have some of their best opportunities in a bear market? Is that where you see who the best companies are in a sector?
The answer to that question gets back to one of my favorite Warren Buffett (Trades, Portfolio)’s quotes: “When they drain the swimming pool, you can find out who’s wearing a bathing suit.” Certainly difficult market conditions are a much better time to judge the core strength of a franchise, brand or a company, as opposed to when everything is going well and it’s easy to look good. So buying into a bear market clarifies the likely survivors versus the victims.
Do you take an activist approach? Do you try to help companies “fix” themselves?
For me, to take an activist approach would indicate that I’ve made a bad miscalculation. It’s generally not a good idea to invest in companies where you think you know how to run their business better than they do.
When I get into that position, it’s because I’ve missed something. I’ve made a mistake and usually there’s a better opportunity out there. It’s probably time to move on. It’s not that I won’t add my input or counsel where requested, but it’s really not my job to manage other people’s businesses. It’s my job to invest in the best businesses I can find.
continue reading: http://sprottglobal.com/thoughts/articles/whitney-george-find-great-companies-that-are-sick-but-have-the-ability-to-recover/
