23 March 2019
Some stocks such as Walmart may look boring but they have stellar growth prospects. Photo: Bloomberg
Some stocks such as Walmart may look boring but they have stellar growth prospects. Photo: Bloomberg

Golden rule: You are what you buy

Value investing is far more than crunching data. Management and governance are a key part of a company’s value.

Martin Lau, chief investment officer of First State Investments (Hong Kong) Ltd., shed some light on how to spot a good company using methods other than the traditional practice of looking into earnings, debt and cash flow. That is looking at tax payment records.

A company that manages to perform well in the long term must be responsible for issues such as the environment, government regulations, employees and shareholder interests, among others, Lau said.

Lau has a habit of digging up the tax record of a potential target.

If a company tries to pay less tax, it might be doing it legally, but that could reflect on its integrity and thinking about operating a business.

In principle, Lau prefers companies that make profit and pay the correct taxes.

If a company tries many ways to pay less tax, it might apply the same approach to shareholders, he said.

You can know the personality of a person if he uses taxi receipts to reduce his tax payment.

Tax payment is just one way to gauge the integrity and thinking of a company.

Think twice before investing in a company that lacks good governance, no matter how good its assets might be and how promising its outlook. You might fall into a trap.

Whether the management is greedy is something investors should also look into.

If the board members are all friends or relatives, most of the company’s earnings are likely to go into their pockets. You can’t expect this sort of company to attract talent.

Alternatively, investors can examine the subscription records of the company’s share options.

Anthony Bolton, a legendary fund manager from Fidelity, says in his book, Investing Against The Tide, that he likes companies in which senior executives hold the bulk of shares. This ensures their goals are aligned with those of shareholders.

Sometimes, senior management of large companies have minimal stakes in the business, which means their motivation to perform is driven by reputation and status of running a big company, he says.

Meanwhile, investors should investigate whether senior executives have the hunger to motivate themselves.

Just keeping the status quo or being too eager to impress is merely play-acting, according to the book.

We all probably have heard the saying “you are what you eat”. In the investment world, it becomes “you are what you buy”.

Warren Buffet prefers companies that have sufficient market entry barriers and consumer products the market always needs.

These stocks will still be around in 10, 20 or even 50 years.

However, Peter Lynch, another renowned Fidelity fund manager, favors stocks that appear to be boring but could post stellar growth such as Walmart.

By contrast, Bolton focuses on counter-cyclical investment and those that capture market, industry and company trends.

These are totally different investment styles but they are surprisingly consistent in evaluating the quality of company management.

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Columnist at the Hong Kong Economic Journal

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