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Investment Commentary: Quality Investing and Cult(ure) as a Competitive Advantage

By Yuval Ezer, CFA

The phrase “winner takes most” is often used to describe how large technology companies dominate their markets, such as Google in online advertising or Apple in mobile devices. These companies are growing larger and capturing the majority of their industry’s profit pool. A recent study titled, “Are US Industries Becoming More Concentrated?” shows that over the last twenty-five years, more than 75% of US industries have experienced increased concentration levels, with the top four firms in almost all industries significantly increasing their market share. This trend of increased power is not limited to the tech industry; it can also be observed in industries such as cable, beverages, waste management, agriculture, and commercial aerospace, just to name a few. Even though they seem competitive, many of these industries actually operate with only a few dominant players or as local monopolies, leading to rising profit margins and higher returns on tangible assets, which widen their competitive advantage. The study also indicates that investing in the most highly concentrated industries generates significant excess returns. At Foster Victor, we focus on high-quality companies with wide economic moats and favorable industry dynamics, and not coincidentally, many of these companies are in highly concentrated industries.

A company with a lasting competitive advantage tends to maintain a higher return on invested capital (ROIC) over time because of structural advantages and managements’ capital allocation skills. Besides ROIC, other quantitative attributes that define quality include margin structure, free cash flow conversion, balance sheet metrics, and the capital intensity of the business. However, many aspects of quality are more qualitative and challenging to measure, with culture being one of the most important attributes. Culture is defined as the customs and achievements of a particular people or social group. Will Guidara, restaurant owner and author of the book, “Unreasonable Hospitality,” aptly describes culture as a shared internal language, avowed dedication, and unconventional commitment to the organization and one another. While this definition sounds like a cult to many, Mr. Guidara counters with the idea that “Cult” is in fact short for “Culture,” which just speaks to how people rally behind great leaders with a common goal and purpose. From our experience, investing in culture involves studying the history of companies and how they build enduring organizations under various management regimes and business cycles, which involves assessing the talent pool, leadership style, board composition, insider ownership, and performance culture. Qualitative attributes are often subjective, but investors can gain insights into a company’s culture by following it over many years, attending conferences and industry events, and reading annual reports and quarterly earnings call transcripts. We believe that culture, as a key attribute in investing, is frequently overlooked and underappreciated due to many investors’ short-term mindsets. However, as long-term owners of businesses, understanding a company’s history and culture is critical in assessing continuity, innovation, leadership, and long-term success. This is particularly relevant in today’s environment, where technological disruptions are rapidly changing business models across many industries.

Companies with strong cultures are adept at pivoting and reinventing themselves to maintain a competitive edge. Amazon (AMZN) is a prime example, no pun intended. While the company needs no introduction, we believe that Amazon’s success can be credited to several key cultural attributes that have shaped its unique identity as a founder-led organization, including customer obsession, long-term thinking, owner-operator mentality, and shrewd risk-taking. Each year since its inception, Jeff Bezos, in his annual letter to shareholders, reminds investors of the ‘Day 1 mentality.’ It means that despite being nearly 30 years old, Amazon treats every day as if it’s the first day of a new startup. These attributes have helped the company innovate, scale, and maintain its position as a leader in e-commerce and cloud computing, which in turn resulted in significant value creation for shareholders. We have held AMZN since the inception of our strategies, tracking the company for the greater part of a decade. It serves as a great example of the cultural attributes we seek when considering deploying capital in our clients’ portfolios.

Our investment approach emphasizes the importance of industry concentration, economic moats, and culture in identifying companies poised for long-term success. By focusing on companies’ quantitative and qualitative attributes, we aim to capture excess returns over time. Through thorough analysis of companies’ histories and cycles, we seek to identify resilient businesses that can adapt and thrive in an ever-changing market landscape. Culture plays a crucial role in sustaining competitive advantages and driving innovation. Our long-term orientation and commitment to understanding cultures provide us with a unique advantage in navigating market uncertainties and delivering sustainable performance.

Shannon Dermody

Shannon DermodyTEST

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