James Sharp Investment Process

There is a collection of striking empirical evidence that shows the benefit and importance of time in the market. Factors, whether these be political, economic, financial or other events such as Covid-19 will always affect momentum and cause volatility in share prices. However, history indicates a positive risk premium, suggesting that time in the market pays. We therefore adopt a long-term approach to managing portfolios.

To construct a bespoke solution that is tailored to your individual needs, we will need to establish your attitude towards risk. All investments in theory carry a level of risk. These will differ from company to company. In general, it is newer businesses that are establishing themselves and in the early stages of growth that carry the highest risk. Initially a business will have lower sales, little profits, and high costs. If the business becomes successful, profits will begin to increase, costs will decline, and the business will start to become profitable. Once a business has matured, it will start to make consistent sales, at reduced costs, with higher profits. Risk is lowest at the mature end as the business is established, and often distributing profits out to shareholders, however this means the potential for capital growth is reduced. Risk is highest at the early stage and growth end as the business may fail to make it through to maturity, however, if it does, the rewards will be high.

Modern portfolio theory states that rational investors are risk adverse. This means that if a rational investor takes on additional risk, they will require a higher return to compensate for taking such risks. We have created four distinct categories which we place our investments into given their characteristics. This enables us to give a baseline for the direction of travel the company may take and also an idea of the risks involved in each business. By having exposure to a variety of different styles of business we can increase diversification within a portfolio and a smooth, more stable performance should result. We are keeping a close eye on our core categories, and aim to maximise the returns for an investor, given the risks they are willing to take. The four “core” categories are outlined below.

1. Quality
2. Disruptive Potential
3. Consistency
4. Special Situations

Quality

These businesses will have demonstrated the ability to create shareholder value consistently over many years.

Analysis will focus on quantitative measures such as.

• Balance sheet strength
• Tangible net asset value growth.
• Higher than average operating margins.
• High cash flows and cash profits.
• High returns on invested capital

We additionally look to establish an investment thesis which confirms the ability of the company to continue to generate shareholder value over the long term. Understanding the markets which the business operates, and the competitive advantage (such as an established brand) is a key element. A business which has a defendable competitive advantage is a key attribute to stock in this category.

Would also undertake some qualitative analysis, to assess the likelihood that the companies market sector is not likely to see significant change that would alter the dynamics of the business model, and hence increase the likelihood that historic performance will continue.

These would generally be investments we would buy and hold for the long term.

Disruptive Potential

These businesses are likely to have demonstrated consistent growth over several years. They may operate in markets which are in secular growth or are disrupting other markets via the use of technology and innovation. Would need to see some evidence of the same quantitative performance in recent years, as used for assessing “quality” stocks, but would place less value on these figures, particularly regarding valuation.

Analysis will therefore primarily focus on qualitative measures such as.

• Is the sector they operate in seeing significant change?
• Is the company well placed to benefit from this change?
• Is this change permanent rather than temporary?
• How likely is the company able to capitalise on the growth opportunity?
• What is the businesses competitive edge?
• Can the growth be achieved organically?

These would generally be investments we would buy and hold for the long term assuming our assessment of the growth characteristics is being maintained.

Consistency

The ability for a business to maintain and sustain income and growth in income distribution is the main factor for consideration. An assessment of the underlying characteristics of the businesses ability to continue to distribute income from profits is undertaken. We will look at the company’s dividend policy and dividend history. Companies which share similar characteristics to quality stocks may be of interest. Companies with assets which generate long term cash flows, such as property companies or utilities business may meet the criteria after analysis.

Income stocks will be companies which also qualify under the “quality” quantitative analysis, but that have also demonstrated a history of paying a high proportion of their annual cash flows and tangible asset growth out in dividends. If this is not the case would want to see evidence in their recent reports and announcements, committing themselves to high dividend payments via a change in their future dividend policy.

Special Situations

These are businesses which would not fit into a specific category but offer characteristics which are attractive based on a very specific rationale. Due to the nature of this category, it is harder to define. We would explain the investment rational in our research and analysis. And documented in the memorandum of advice.

Examples of these types of rationale are as follows.

• The stock is ‘cheap’ on a quantitative analysis basis. Such as a very low-price earnings ratio or the share price is significantly lower than the company’s asset value per share.
• We anticipate consolidation in a particular sector and the company could be subject to a bid or other corporate event which would create shareholder value.
• A change of management with a track record of delivering results.
• A company which has fallen out of favour with the market, but the pessimism is excessive given the business fundamentals.

We would generally hold these investments for a shorter period or until the thesis has played out. The shareholder value creation we expected has been delivered. Alternatively, it has not played out as expected and our analysis was not realised, or we have re-assessed the likelihood of value creation accruing.