Wilson Asset Management (WAM) was established by Geoff Wilson in 1997 and today comprises three listed investment companies — WAM Capital (ASX: WAM), WAM Research (ASX: WAX), and WAM Active (ASX: WAA) — and one unlisted fund. The recent merger of Premium Investors with WAM Capital has boosted total funds under management (FUM) to around $700 million. Since inception in August 1999, the flagship WAM Capital has achieved a return before all expenses, fees, and taxes of 18.5% per annum.
Motley Fool contributor Tim McArthur recently sat down with WAM Chief Investment Officer and Portfolio Manager, Mr Chris Stott. In the second of this three-part interview (see Part 1 here), Chris discusses his methodology.
Q: Chris, WAM offers 3 LICs — WAM Capital, WAM Research and WAM Active. Each has a slightly different mandate. What are the differences?
A: At WAM we select investments under one of two strategies – research driven and market driven. By offering the three LICs, investors can select the strategy that is right for them. The WAM Research portfolio is 100% research driven, WAM Active in 100% market driven and WAM Capital, our largest portfolio by value, is a hybrid of the two strategies; 50% research driven and 50% market driven.
Q: The WAM Capital portfolio appears more skewed towards the market driven strategy. How much of this skew is created by lack of opportunities to purchase quality, growing businesses at value prices or by your view of current market risks?
A: What is important to remember is that we apply very strict criteria for additions to the research driven ideas. Given where we are in the economic cycle and the low earnings growth outlook, this affects the ability of stocks to rate well under the research driven strategy. The high cash balance is really a function of investment ideas within research driven — in other words, the cash weighting is an outcome of our process and shouldn’t be construed as a bearish view. I’d add that we have often operated with an allocation to cash and it hasn’t restrained our ability to outperform.
Q: Getting down more to specifics, Chris, which characteristics are most important for you when identifying a potential investment?
A: Well, we are looking for smaller companies where we think there is potential for growth. We like net cash businesses. We focus on the free cash flow the business can generate and we want top-class management. We also want to identify a catalyst – this could be a change in management or an earnings surprise, for example. Ideally another characteristic would be the company being “undiscovered” or “unloved”.
Q: You mentioned an aversion to debt. Do you outright avoid stocks with debt? What metrics do you focus on?
A: It’s a case-by-case basis. Some companies are much better positioned to pay down debt than others. However, as a general observation I do believe that companies with low debt perform better over time.
Interest cover is a ratio we focus on because it highlights the ability of a company to pay off its debt.
Q: What are some of the more common reasons stocks you are attracted to get cheap enough for you to purchase them?
A: Sometimes we are looking at stocks that are “turnarounds”. These have risk and so are priced accordingly. Skilled Group (ASX: SKE) was one such company. Also a loss-making division can hurt a company and its share price. Realestate.com.au (ASX: REA) was losing money in one of its divisions, after it divested it, things improved. Unloved or undiscovered can also make things cheap.
Q: Are there any industries or sectors you tend to avoid?
A: Not really. We will search everywhere to make money for our investors; having said that, given the structural issues we have rarely invested in the printing or retail sectors.
Q: Management contact is more difficult for individual investors, and perhaps a key advantage of running larger sums of money. I read recently that two Analysts from Perennial Value Management took a course in reading body language to better prepare themselves for management presentations. What is the most important advantage you get from meeting with management?
A: The most important takeaway from meeting with management is the opportunity to “eyeball” the individual. At WAM, we view our role as taking money which has been entrusted to us by investors and allocating that money to the managers of the companies we invest in. So, we want to understand the individual that we are entrusting our investors’ money with.
I would also say that regularly meeting with a manger allows us to check their consistency. To give you an example of what I mean by that, my colleague Matthew Kidman (who is still a member of the WAM board) visited management at the now defunct ABC Learning Centres. For a long time Matthew was told by management that the focus was occupancy levels — that this was the key metric to judge the business by. At a later meeting, Matthew was told occupancy levels were no longer relevant; there was a new metric to focus on. Matthew came out of that meeting and knew ABC was to be avoided!
Q: Have you uncovered in the last year or so any management teams that have particularly impressed you?
A: They’re not necessarily uncovered in the last year but management at McMillan Shakespeare (ASX: MMS) have done an amazing job, taking the share price from $3 to $17. Realestate.com.au management improved the business model. Skilled Group management have done an impressive job at turning the business around. And Reckon (ASX: RKN) while we don’t own the stock any more, the CEO has done a great job there too.
Q: Do you also spend a lot of time talking to competitors and customers?
A: Definitely. Competitors and customers are not biased. They have no filter. If you’re investing in Reckon you’ve got to go and speak to MYOB.
Q: What themes are you finding attractive at the moment?
A: Certainly the Internet is a theme that interests us. The move towards an online, paperless society and online sales offers investment opportunities. Also companies with exposure to the USA.
Q: WAM states in its investment material that it “seeks stocks with low PE but with the potential to grow earnings at 1.5 to 2 times their PE. For example, a company on a PE of 10 would need to have EPS growth of 15% – 20%.” How far out are you looking regarding the metrics above?
A: Two to three years.
We’ll be back tomorrow with the final installment of our interview with WAM Chief Investment Officer and Portfolio Manager Chris Stott.
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