There is no value without quality. Benjamin Graham, back in the 1930s, was the first to recognise this. He observed that seemingly bargain stocks were often low-quality companies that ended up being value traps.
The key to investment success was buying cheap companies with quality characteristics. Warren Buffett, swayed by Charlie Munger, placed further importance on the quality of a business.
It is easy to agree the quality of a company's management is vital to success or failure. Identifying what exemplifies quality is not so easy.
Quality of management
"I try to invest in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will."
This is a well-known quote by Buffett that many investors have followed to the letter. Buffest has frequently cited the importance of management in his shareholder letters.
He explained the point clearly when he stated: "The lack of skill that many CEOs have at capital allocation is no small matter: After ten years on the job, a CEO whose company annually retains earnings equal to 10% of net worth will have been responsible for the deployment of more than 60% of all the capital at work in the business."
The quality of the people behind the business is of utmost importance and enabled managers to uncover opportunities that are under-appreciated by the market.
Take JD Sports. At face value there is nothing great about selling trainers - and hence why the stock is not commonly held among quality funds. Yet it has been by far our best performing position.
The key to its success has been its management. At time of writing, the company is severely disrupted by the Covid-19 epidemic.
Yet thanks to its capital discipline over these past years, net cash position and strong balance sheet the company is positioned to weather the storm much better than others within the sector and emerge in a strong position.
Balance sheet strength
JD Sports' strong financial position raises another important point: financial discipline. We believe whatever the adversity, companies that are most likely to survive are those that have powerful franchises and are in a strong financial position.
As Peter Lynch observed: "I learned this very early, it is very hard to go bankrupt if you don't have any debt."
Mergers and acquisitions
M&A and rollouts are viewed sceptically by the market and rightfully so.
Most companies going down this route tend to destroy shareholder value yet there are always exceptions to the rule.
For example, Assa Abloy is the market leader in locking solutions, a sector which benefits from the secular shift towards integrated lock solutions and software driven products.
In a highly fragmented industry, the company is set well to capitalise on its dominant scale, by acquiring simple complimentary bolt on acquisitions.
In aggregate, these add to roughly 5% top line growth per annum. The company optimises manufacturing and operational processes of its acquired businesses, which are usually small privately owned that tend to not run as efficiently.
Assa Abloy also adds value to these acquired businesses by integrating them into its extensive distribution network.
The company has demonstrated that, armed with powerful competitive advantages, shrewd capital deployment has enabled the company to derive high shareholder returns over time.