A duo of stock pickers crushing 96% of their peers unpack their tactics for finding companies that customers love - and reveal their top picks
- The $211 million Brown Advisory Global Leaders Fund is in the 96th percentile of funds on a three-year basis.
- In a recent interview with Business Insider, Mick Dillon and Bertie Thomson - the fund's co-managers - unpacked why they place a premium on companies that are loved by their customers, and how they identify such firms.
- They also shared a number of company names that embody the qualities they look for.
- Visit Business Insider's homepage for more stories.
To assess how great or terrible a company is, go directly to the people who use its products and services every day.
That's the cornerstone of the investing approach adopted by Mick Dillon and Bertie Thomson. They're co-managers of the $211 million Brown Advisory Global Leaders Fund - which has bested 96% of its peers over the past three years, according to Bloomberg data. Additionally, it has perfect 5/5 scores on Lipper's ratings of consistent return, total return, capital preservation, expense, and tax efficiency.
As it turns out, this duo is doing a few things right. And at the heart of their strategy is finding companies that are solving unique problems and giving people reasons to keep patronizing.
"The customer is the most important person in any company's value chain," Thomson told Business Insider during a recent phone interview.
He continued: "We feel when you meet a CEO, CFO, or management team in an office environment, they always tell a fantastic story. So we have to corroborate what we're being told in a meeting room, on a roadshow, or company offices with what's happening in the real world."
Thomson and Dillon size up what they're told by management teams using four yardsticks.
The first is that they look into a company's so-called franchise quality. That means its customer outcome, and whether there's a sound business model that can keep people coming back over the long term. But at the same time, they avoid companies that have almost no competitors because that's a recipe for customer abuse, be it through outrageous price hikes, poor service, or other means.
Secondly, they apply a number of quantitative screens to stocks they're thinking of investing in. The metric that stands out here is at least a 20% return on invested capital (ROIC) or a pathway to achieve that return over time. They place a premium on ROIC because it demonstrates that a company is creating value for its shareholders and is generating a return that's above its cost of capital.
The third component of their test is quality management, which relates to the prudent use of excess cash. They investigate capital-allocation decisions that companies have made in the past to ensure there's no history of recklessness.
The fourth and final test is on valuation. As great as the prior three factors may be, Thomson and Dillon still want to buy stocks as cheaply as they can. Their preferred method of valuing companies is by figuring out its discounted cash flow - or the present value of its future cash flows - instead of the ratios that compare price to earnings, sales, or book value.
"As we often joke on the team, you can't pay dividends with earnings, you can't buyback with earnings, and you can't pay down debt - you do all those things with free-cash flow," Thomson said.
In all, they're looking for companies that are creating value for their customers, and expect that this will eventually translate to shareholder returns. They're able to hunt for these companies anywhere in the world because they have a global portfolio, and end up adding between five and eight new names a year out of up to 100 considerations.
"The conversion rate is very, very, low - and deliberately so - because we're long term investors," Thomson said.
He added: "If you think about it, over a five-year period, if you're buying a company with a 20% return on invested capital - which is what we're targeting - by year five you would have generated 100% of your initial investment with profits and cash flow."
They shared the names of some companies that embody what they're looking for in their fund: a great customer outcome, shareholder returns, and relatively low valuation. All the quotes below are attributable to Dillon.
Bank Rakyat Indonesia, a microfinance lender: "That company really solves customers' problems because otherwise, they have no access to credit. These people are non-credit-worthy or outside the formal banking system. The average loan size is $1,000 to $2,000. The people there have very low default rates, and it really helps people get their businesses started and off they go from there. That is a great outcome for the customer, and it's a unique service that does something very special.
"Microsoft does something great for its customers and we're invested there too. Sometimes we'll find something that a lot of other people are aware of and that's okay, too."