Stephen Yiu is the Chief Investment Officer at Blue Whale Capital and Lead Manager of the Blue Whale Growth Fund.
Stephen co-founded Blue Whale Capital with Peter Hargreaves, co-founder of Hargreaves Lansdown, in 2016. The Blue
Whale Growth Fund was launched in September 2020 and is a long-only global equity fund focusing on developed markets.
Stephen adopts a high conviction, active approach based on bottom-up, fundamental research.
It’s become increasingly popular to talk about investing in “Quality” as a style factor, indeed, we ourselves often talk about investing in high quality companies. However, just like people often confuse value investing with simply buying cheap stocks, in our mind, high quality companies are more than just businesses with stable earnings.
This is why we’d like to introduce our “Beautiful Companies” concept to help focus on what makes high quality companies great. In this post, we go on a brief detour into classical aesthetics before applying this to our mission of generating consistent significant outperformance by investing in truly beautiful companies.
Our interpretation of beauty is most closely aligned with the Ancient Greek idea of kalos kai agathos (the beautiful and good), where both form and function are important: a beautiful sword might be adorned with jewels but must also possess a sharp edge, a beautiful person might have excellent bone structure and perfect teeth, but must also be in possession of a noble character. For something to be truly beautiful, it must also be worthy of admiration. Beauty lies beyond competence and cosmetics – there must be excellence and cultivation too.
What is a beautiful company?
We find it helpful applying the Greek concept of Beauty when assessing company quality.
"Nothing forced is beautiful" – Xenophon, on Horsemanship
We avoid companies where beauty is only skin-deep. We see them in “narrative stocks” where the share price is sustained by stories, not fundamentals. The hype generated by company management or other stock promoters could last several years but ultimately, economic fundamentals will exert themselves.
These are companies where the majority of their value comes from unreasonably assuming dominance in uncertain, unproven – or sometimes unknown – future markets. We consider the likes of Tesla, Airbnb and Peloton to fall into this category.
"The object of education is to teach us to love what is beautiful" – Plato, The Republic
For us, the goal of investment research is to identify beautiful companies. A truly beautiful company must not only have a compelling narrative but also the fundamentals to back it up. We look for exceptional businesses that are well managed, operating in attractive industries and that can grow sustainably.
These companies often deliver products or services that provide exquisite value for customers, have a clear roadmap to sustainable growth, have low risk of disruption, have low exposure to macro and geopolitical risks, do not depend on the debt cycle or leverage to stay profitable, and importantly, have the numbers to back it all up.
They often achieve this through an ability to deliver innovation over the long term, investing in delighting their customers, operating in low or benign levels of competition, possessing high standards of governance and management that are reliable, capable and well-aligned with stakeholders.
We admire companies that are able to demonstrate all of these characteristics and we consider them beautiful. Most important of all, and what takes our concept of beauty beyond mere quality, is our focus on the management and culture of a business. Management and culture within a business is the equivalent of a noble character in people. There is no beauty in a business if it is poorly run just as there is no grace in a pretty face with poor character.
Buying beautiful companies
A detailed discussion of how we put in practise our Beautiful Companies concept could fill a book, but we list below some examples that help to illustrate our process.
"The beauty you see is a reflection of you" – Rumi, 13th century Persian poet
With truly beautiful companies rare and those at attractive valuations even more so, it is not often that we have the opportunity to buy them. However, there are times when beauty is underappreciated by the market and at these times, we act decisively.
In late 2017, Autodesk was going through a fundamental transition in the way it sold its design software. Part of the transition meant that quarterly earnings reported in November looked comparatively weaker than they would have done under prior sales methods and share prices took a tumble. Our existing work on Adobe suggested that this transition was indeed a beautiful one as it would strengthen the company’s ability to retain customers and continue innovating. We established a position in March 2018 and saw the transition play out as expected. We are glad that this was also reflected in Autodesk’s share price performance.
"You ain’t a beauty, but hey you’re alright" – Bruce Springsteen, Thunder Road 1975
What makes truly beautiful companies rare is the combined criteria of an exceptional business with admirable management. This means that possessing a portfolio of 30 such companies at attractive valuations is a highly unlikely event.
Facebook is a great example of how we bridge the gap between the theoretical and the practical. The company itself is exceptional – as the world’s largest social network, it single-handedly created new ways for people to connect with each other and consume content. While the quality of decisions made at Facebook can at times be questionable (we took issue with the second part of their now-retired motto of “move fast and break things”), we do clearly see that management has made a gradual ascent in maturity from adolescence to something more resembling adulthood. This is why Facebook has a position in our portfolio.
Beauty and Value
In managing the Blue Whale Growth Fund, we bring together our Beautiful Companies concept with our valuation framework aiming to generate consistent significant outperformance. Identifying beautiful companies ensures that business fundamentals support growing revenues and cashflows while our valuation framework is designed to ensure that we are not overpaying.
As we wrote previously, an investment decision without a fundamental understanding of a business is no better than investing on the roll of a dice. We have invested significantly in our investment team since fund inception to make sure our research function is extremely well resourced. As our funds grow, we will continue to reinvest in our research capabilities to continue uncovering truly beautiful companies.
Blue Whale Growth Fund is manufactured by Blue Whale Capital LLP and represented in Malta by MeDirect Bank (Malta) plc.
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