In the construction of your portfolio you need to think about diversification. I also believe that minimizing downside risk in the core of your portfolio is key to solid risk-adjusted returns. That is why I want to start my series of investment themes with the one I personally started with: core value.
Academically speaking, the best way to get solid risk-adjusted returns is to just by an ETF with an underlying broad market portfolio. However, this blog is not aimed at just telling you to buy an ETF and go on with that. This blog is meant to be a fun add-on to the portfolio of those who want to deviate from ‘the path of the ETF’.
Where to Find Core Value
What do I mean with core value? It is simply about businesses that can offer returns, no matter what happens, for a long period of time. The sectors where you have to look are those that offer products that serve a need of one person on the globe each and every day. The companies you want to look for are those within these sectors that have, or are creating, a strong market position by operating in a niche or by operating with a very strong moat. The companies can offer stable returns because their services are needed, while the size of the markets they operate in can offer seemingly unlimited growth.
These sectors are really large. Think about the following examples:
- Construction Companies: humans will always continue to build the future ($12.7 Trillion)
- Transport Services: people have legs, but other means just go faster ($6.6 Trillion)
- Food & Beverages Industry: you cannot go far without food and drinks ($6.1 Trillion)
- Water Management and Supplies: water is and remains the source of life ($696 Billion)
- Clothing & Apparel: it is illegal in most countries to walk around naked ($1.5 Trillion)
- Waste Management and Waste Disposal: where there are humans, there is waste ($2.1 Trillion)
- (Tele)communications Market: humans are social animals ($1.7 Trillion)
If you have more examples or ideas for core value industries, please let readers know about them in the comments and get the discussion going.
How to Spot the Core Value Company
The core value company is the one that can earn superior margins because it has a strong strategic positioning, or that creates a new product offering (with a great underlying business model) that can grow seemingly unlimited in these large markets.
Some important things to look at when assessing a company’s strategic positioning are:
- The Long-Term: Core Identity and Vision (background)
- The Industry: Porter’s Five Forces (background)
- The Short-Term: Business Model Analysis (background)
- The Management Team: Achievements/Credentials
A key question to ask yourself is whether a company has a strategy, or whether it is in what I call a ‘panic mode’. A company with a strategy is developing its product and looking for new markets. These companies can create a blue ocean or a niche that will offer larger profits. A company in ‘panic mode’ has no resources to look for growth and is only looking to cut costs or is turning to other financial trickery methods to maintain some shareholder satisfaction.
For example, a company like Apple ($AAPL) today is looking for new markets with services and wearables, while improving its core iPhone product. This is a company with a clear strategy. On the other hand, I (note: my opinion) believe McDonalds ($MCD) is a company in ‘panic mode’, exchanging its own restaurants for higher margin franchise restaurants and taking on debt for dividend payments and share repurchases to the point of negative equity.
I personally maintain a list of core value companies with a personal price target. When these companies go under my price target threshold, I buy them (these companies are of course still subject to economic cycles). Remember that markets always change, so I may add and remove companies from the list from time to time. It is very important to look out for companies that emerge in these spaces. An example of such an emerging company is Starbucks ($SBUX), which has successfully scaled its brand in the global coffee industry ($363 Billion) over the past decade, offering incredible returns to shareholders.
New Core Values
Core value investments can change over time, when new technologies emerge and take up a space in people their everyday lives. Think about the internet. In no crisis or economic circumstance people will cancel their internet subscription.
Core values can still be replaced on the long-term, so it is always good to stay vigilant. Think about the candle being replaced by the light bulb, oil possibly being replaced by wind and solar energy or other renewables, or telephone and video communication networks slowly being completely replaced by the internet.
Examples of Successful Core Value Investments
Core value investments are interestingly some of the most famous investments, resulting in some of the richest people in history. Think about the following people becoming rich through a core value company:
- Inditex ($ITX.MC): The richest man from Spain, Amancio Ortega, started an apparel empire
- Heineken ($HEIA.AS): The richest Dutch person is a member of the Heineken family
- Carnegie: One of the richest men of the 19th century, Andrew Carnegie, sold steel
- Telmex: Carlos Slim was the richest person in the world for some time with investments in the telecommunications industry
Some of these examples of course started out as private ventures. So let’s look at the following annual return examples of some publicly listed companies (10Y total returns):
- Domino’s Pizza ($DPZ): 43%
- Starbucks Corporation ($SBUX): 23%
- Nike ($NKE): 22%
- Chipotle Mexican Grill ($CMG): 21%
- Procter & Gamble ($PG): 12%
- McDonalds ($MCD): 15% (even though I don’t like it right now, I still could not keep it off this list)
Or, one I could not easily calculate the total return for with the tool: A2 Milk ($ATM.NZ), which started out at $0.25 (NZD) in 2017 and is currently valued at more than $18.00 (NZD) per share. Actually, I don’t need a calculator to show those returns are incredible for a company that is just selling milk products. And let’s be honest that their ticker is very well selected as it seems to be the ATM of the stock market.
Of course this list is subject to incredible success bias and there are a lot of companies in these spaces that fail to provide ‘alpha’ to their investors. Also remember that success in the past does not guarantee success in the future, meaning that some of the companies listed above can fail to provide ‘alpha’ over the next decade. That is why it is important to look at every single company on a stand-alone basis and to do your research to make sure you make an investment that can help you sleep at night.
Do you have some successful core value investments? Share them in the comments!
“Price is what you pay. Value is what you get.”Warren Buffett