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investment strategy hopefully by now you've figured out that we've got a simple three-step investment strategy which we try to stick to we try to only invest in good companies that is the most important thing that we do we try not to overpay when buying or owning the shares and then we do the really tricky bit which is nothing and which is never quite possible but we Endeavor to do it I'm going to take you through each of those basically to try and illustrate whether or not we're doing what we said we're going to do is the primary measure of a good company in financial terms which David touched upon in his introduction I I take from Warren Buffett's 1979 annual challenge letter the first and most important measure of a good company in financial terms is it makes a high return on operating profit profit a capital in cash with cash delivered in a reporting period divided by the capital employed is a high number in our portfolio at the moment it's probably 25 something like that it's a it's a high number basically um secondly it has a source of growth which enables it to reinvest those cash flows it's no good having wonderful returns of your business if you are land locked into a a very small segment Niche or geography and you can't deploy the cash that's being generated to grow the business you need both of those elements to make a truly great investment and last but by no means least you need a source of sustainable Capital manage to prevent the mean reversion if you make 25 Returns on Capital and you've got very good growth to enable you to reinvest at 25 people are attracted to compete in your business there's a perfectly good law of Economics called mean reversion which says that all returns revert to the mean in the end it's not quite right this is the law of course the answer is most companies return to revert to the mean or average and yeah there are a few companies that have got competitive advantage that enables them to fend off the impact of competition is High Returns on Capital um why is this important companies are just like us people are over complicate analysis companies have a cost of capital and a return on Capital uh if they make a return above their cost of capital consistently then the value of the company grows at the time if they make a return below their cost of capital consistently the value shrinks over time think of it in personal terms if you go out to your bank and borrow money at five percent and you invested in punishments for the last decade at 18 you would have become more wealthy right if you borrow for your bank at five percent and invested in somebody else's under two percent return you would have become poorer this is not we don't need to get into higher mathematics here or any particularly sophisticated level of thinking it's a fact this is this is the case yet since Warren Buffett wrote that in his annual report in 1979 I would say more people in the investment Community have ignored it than have used it foreign as I said return on capital is the single most important thing there's no point in engaging in a business that has low Returns on Capital I haven't bothered today because we've got limited time but we can show you a slide for the airline industry uh which never makes an adequate return on Capital and it is just a machine for losing money basically that is there is no point in investing in business however once you've got adequate returns you need to have a source of growth to enable you to reinvest it's no good having a business that makes 25 return on Capital but you can't sell any more of the product or service and nothing nothing for them to deploy more Capital into they just have to give you the the cash back basically so we look for companies that have got a source of growth for them to invest in when they invest in a very high quality companies franchise like that at high rates of return on Capital they do a better job for you than I can ever do um where does this growth come from we look for a business that has a a source of secular growth not cyclical growth not it goes up and it goes down everything has a bit of cyclicality but we're looking for for companies which both are the peak and the tropical business cycle are bigger than they were at previous parts of business cycle that grow not in every reporting period or every year but they do grow over time and it typically comes from one or more of these things consumerization of the developing World um you know all the statistics on this are clear when people in the developing world go past a certain level of disposable income they become consumers they're part of a developing economy they no longer spend all their time sourcing and preparing food they've got jobs in in factories and call centers and all kinds of things like that they need the the benefits of consumerization and they they aspire to become consumers as well and so that's a very big driver um of the of the growth for some companies um but in the developed world there's pre-minimization we may not be consuming more mostly but we consume better uh over time you know we may not drink more hopefully most of us don't but we might drink better quality we might upgrade what we do so whatever it is we're talking about consuming um is quite a good chance that we will go up the curve in terms of uh the brand of goods that we're consuming over time and premise it aging populations an awful lot of people look for growth in investment through young populations in fact that's part of the drive in the consumerization of the developing world but aging populations are pretty good too aging population have increased consumption for a number of things and not least forms of medical care and and so your aging populations can be quite a Big Driver of certain uh companies white space white space as you probably know is a term used by people in the marketing uh and sales business if they've got a map of a world or a country or surgery somewhere where they've got no representation no sales they've colorway on the map a white space there's lots of white space around the world for people to grow into I've given you three examples their eyes and what do I mean by that something like two-thirds of the world that needs vision correction doesn't currently have it they don't currently have access to reading glasses and other forms of vision correction they will get it in time and clearly that will be a source of growth to people's life as a little luxottica and so on who are in the business of manufacturing and retailing eye classes payments um we're often asked whether we prefer MasterCard or Visa or PayPal or Square or Apple pay or Google pay or and and the answer is yeah we've got a view on which one might be better than the other one and so on but the reality is they'll probably all do pretty well and the reason that all did pretty well is they've got an enormous white space to grow into something over 80 percent of the world's volume of transactions is still done in cash basically it will be if we ask our grandchildren that we describe to that oh so our grandchildren describe them to their children of us all that once upon a time we would uh get some uh some uh some material made from uh uh a pulp uh of uh of jute some of that and and plastic and turn it into this note and we'd have uh holograms on it and metal in it and Engravings on it to make it difficult to uh to uh fold and then we put it in armored cars and transported the banks we should dull it out to us to go and spend in shops we would pay it back into shops it was back into Banks and that's how we get into the system they'll look at us rather quizzically given that all they've got to do basically is walk up to a counter with their phone in their pocket and pay for something um and that clearly is the future toothpaste like eyes um you know again something like 60 of the world doesn't get used toothbrushes and toothpaste uh to clean their teeth they will as I am fond of saying on this one if you want to have an intimate relationship with somebody who started cleaning their teeth best you take it up I think would be my way of looking at it and so you know for people who are in this industry like Colgate there is a clearly a very long runway for one of the builders and and there are other Trends which are just out there which which we are light upon just put a couple down there pets uh if I had to pick one area of secular growth which appears to have a very very long way however it's spending on so-called companion animals or pets uh pets as any of you got them will know are on a journey to becoming full family members um our spending on pets is is rising very rapidly um I'll have to update this Statistics I know that I'm a few years out of date but uh in the year that I last looked which was probably about five years ago now time flies Americans spent 10 billion dollars per hour on diet pet food um now have a think about that for a moment there are not very many pets that can open the cup you could just try spending giving them less to eat but no diet pet foods are what they buy and of course for diet read more expensive and higher margin um and so on and so forth um you know 40 of American adults live alone so then particularly during things like the pandemic a pet is is an important point of contact basically if you wanted a a cat or a dog in America during the the lockdown you would have actually gone on a waiting list of testing is something we like as well people do more and more testing as time goes by is there horse meat in your burger um covid-19 is obviously giving it a big boost as well uh International Trade so it leads to a lot of boosting uh testing of Commodities and goods and so on and sometimes these two things cross over one of our companies is the world leader in Veterinary diagnostic testing equipment um testing pets is very important for two reasons one is I said they're on a journey like they're human owners more and more of them are being given health care which is as good as or even surpasses their human owners in terms of what's spent on it and the other thing is testing is more important for uh for pets than it is for the human animal for a very simple reason they can't speak it's no good asking them how they feel where the pain is so you have to do more testing to get an accurate diagnosis de calidad pregnant
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