Publications
Partners
There are some 500 shares on the JSE, but I only want to invest in about 10 to 12 of them. As I have written many times before, I only want the absolute best of the best. No second best, no maybes, only the proven best in their respective industries.
As analyst Jean Pierre Verster (formerly of 36One, currently on gardening leave after resigning in May) once said to me: “Just because a stock is listed does not mean you need to own it.” He’s right, absolutely right.
My process of stock selection is actually more about finding industries and stocks to avoid. If I can decide that an entire industry is just not investment grade (by my requirements of quality), then my workload is reduced.
So for me a large part of the investment process is to start with looking for reasons not to even bother with an industry.
Knowing that I want to avoid a sector means I don’t have to spend time looking at the individual stocks within that sector, which gives me more time to focus on winning stocks and industries.
This is important – we’re part-time investors and don’t have the luxury of spending all our time researching potential investments.
So how do you identify these sectors to ignore?
- Does the sector have an edge?
One of the first questions I always ask is what the industry’s edge is. Let’s take this into the construction industry: what is its edge?
In short, there isn’t one. Sure some within the industry have differing skill sets and/or experience, but surely anyone can acquire those.
The reality is that for this sector, the edge is about price, how cheaply you are able to complete a project.
Now if the only thing separating you from the competition is price, then you have no moat as the competition can just drop their profit margin and be cheaper than you.
Now, sure, this is a simplistic view, but broadly it stands. Construction companies have only price as their edge and that results in a race to the bottom that sees them slashing profit margins.
There is nothing attractive about that and that’s why I stay well away from the industry.
- Is there legislative risk?
Another issue I look at is legislative risk. Is there a danger that government will change the playing field and threaten profits?
Here the industry to look at is healthcare. This is a booming space as we humans continue to live longer and longer.
We’re also able to cure more ailments and illnesses and today consumers have more wealth to pay for treatment.
Add in regulations that make becoming a healthcare provider a long, complicated and expensive process, and on the surface healthcare is an excellent space to operate in.
Further, healthcare is not something the average person will skimp on and if you’re sick you’re very likely to do something about it.
What’s not to love? Legislative risk, that’s what. Healthcare costs that have been rising well above inflation, which is of concern to governments around the world.
We’ve already seen single-exit pricing in the pharmacy sector locally and we’re likely to see more crackdowns on healthcare costs across the world.
Hence the only space you’d want to look at in healthcare is generic drugs and drug distribution (and maybe retail). Aspen is hence the natural choice for further digging, as is Clicks, with its in-store pharmacies and UDP drug distribution business, while Discovery* is a company that would actually benefit from lower healthcare costs.
So with just a few minutes’ thought we’ve managed to remove 20 or more potential investments from the pool of some 500 investable companies, reducing our workload and helping us to find awesome stocks to buy.
*The writer owns shares in Discovery.
This article originally appeared in the 2 June 2016 edition of finweek. Buy and download the magazine here.
