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“It is easy to find reasons to invest in a company. Simply read any of the press releases by the CEO or chairman … It is not so easy to find reasons not to invest in a company”


basic requirement is that ROE should be consistently above 10 per cent – ideally above 15 per cent. Another requirement is that there should not be too


much debt. Recall Babcock and Brown. Just before it collapsed, it had a debt to equity ratio of 450 per cent. Almost 80 per cent of the net profit was used to pay the interest bill. Yet it was being promoted by most analysts and financial commentators as a desirable investment. In looking at companies, we are wary of those with debt to equity above 50 per cent, and of those who use debt in ways that appear to be more for the benefit of management than shareholders.


Future risks of the company It is easy to find reasons to invest in a company. Simply read any of the press releases by the CEO or chairman, who have a vested interest in describing the company in a positive light. It is not so easy to find reasons not to invest in a company. Yet from an investor’s perspective, knowing about the risks involved could be the difference between a winner and a capital-killer. A methodology like that utilized by Teaminvest works well: start by developing a list of the risks of a business, then gauge the likelihood of these risks occurring in the next economic cycle and the severity of the damage should they occur.


Board and senior management About 50 years ago, Philip Fisher, one of the pioneers of investment analysis, wrote that the final question every investor should ask was whether the company had management of unquestionable integrity. He continued: “If there is a serious question of the lack of a strong management sense of trusteeship for stockholders, the investor should never seriously consider participating in such an enterprise.” It isn’t always easy to see from the outside whether


management has unquestionable integrity. There are, however, pointers that cause us to shy away from particular companies. One is through a careful reading of the section in the annual report on related party transactions. If there are a large number of related party transactions or if they are of considerable size, it is generally best to move on. Another pointer can come from the remuneration


report. The levels of the salaries and incentives given to senior management, particularly the CEO, are important.


60 FAMILY OFFICE: ASIA TOMORROW


Even more important is whether the incentives are properly aligned with the goals of the shareholders. As an example, a close analysis of some incentive packages show that management is rewarded for the activity of making acquisitions instead of whether any acquisitions genuinely increase the earnings per share.


Economic moat An economic moat, or sustainable competitive advantage, protects a company against changes in the buying habits of consumers, existing and new competitors, government legislation and the general economy. Types of economic moats include geographical, location, brand name, licenses or patents, cost of entry and management expertise. We measure an economic moat in


terms of its type, strength and durability. It is vital that a company has a strong economic moat and that there is evidence that the company is focused on maintaining it. Otherwise the company may move from a profitable market leader to an also-ran contender.


Family values Another consideration for some families is to choose companies with products and services that are aligned with the values of the family. This is one of the aspects of being a conscious investor; the other is having a clear awareness of why particular investment and portfolio decisions are made.


Preservation of capital using stress testing The key to preserving capital is stress testing. When an architectural engineer gives approval for the construction of a new building, they must give assurances not only that the building will meet the requirements of the new owner; it will also pass a range of safety requirements. Before any building work starts, the design has to be stress-tested for everything from the ability of the floors to carry specified loads to the building being able to withstand extreme winds.


15%


THE BENCHMARK RATE OF RETURN


ON EQUITY WHICH IS A DETERMINANT OF A COMPANY’S INVESTMENT POTENTIAL


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