Look for intrinsic value when buying a company

Moneyweb

Every investor hopes to buy an undervalued company and see it double or triple, hence the rise of funds focusing on a value-investing strategy.

However, valuation should not be the principal reason for investing, according to Denker Capital.

Denker SCI Equity Fund portfolio manager Ricco Friedrich said: “Our investment philosophy is centred on three things:

“Firstly we want to invest in a business with good economics where there is a moat [competitive advantage];

“Secondly we want to see an experienced and trustworthy management team; and

“Thirdly we want to buy at a discount to intrinsic value.”

“We focus on discount to intrinsic value. But this is the last thing we look at, not the first.”

Intrinsic value is the discounted value of the excess cash flows of the life of the company.

Friedrich says companies rarely have all three, usually only in a boom or correction.

A company with good economics generally has a higher return on invested capital and a number of opportunities to take R1 of cash flow and reinvest it at a high return on capital.

It is the management team that drives this, Friedrich says.

A company with a strong moat, decent growth prospects and good management team will usually trade at a higher price/ earnings (P/E) multiple.

But by focusing simply on low accounting valuation metrics an investor may be ignoring a quality business with the ability to grow fast. The intrinsic value captures these key value drivers, says Friedrich.