Each week, a professional investor tells MoneyWeek where he’d put his money now. This week: Michael Ulrich, fund manager, F&C UK Mid-Cap Fund.
A key part of our investment process is meeting management – and not just to get hold of next quarter’s earnings targets. Instead, we want to assess management’s ability to allocate capital in a way that creates value for shareholders.
A strong management team with a sensible, coherent strategy that can be passed down the line is often a starting point for a successful investment. But the managers of some of our most successful companies talk to us not about their ability to pass down grand edicts of strategic vision, but about their willingness to hand down the power to set strategy to those closer to the coal face. Rather than rely on one entrepreneur at the top, these firms encourage entrepreneurial spirit across their businesses.
In these companies, a relatively small head office provides direction, a framework for financial control and governance, and the appropriate central functions. They capture the entrepreneurial spirit by devolving key decisions to the senior managers of their operating companies, who share responsibility for strategy and are remunerated accordingly. We think these following three companies have this balance just right and should do well.
Conglomerate DCC (LSE: DCC) is involved in distributing products from heating oil to consumer electronics to medical devices. This may seem an unwieldy array of low-margin businesses, spanning disparate sectors. But DCC has many of the traits we look for.
Firstly, distribution is a scale business: the largest player often has a network advantage, which means it can offer better service or lower prices. DCC is a market leader in many of its niches. Secondly, it has strong financial discipline, with a focus on cash generation and return on capital employed. Thirdly, it has a strong entrepreneurial culture. The focus is on doing a thousand things well on the ground, rather than on implementing a plan handed out from the centre. Divisional managers develop their own strategy within the group financial framework.
Stagecoach (LSE: SGC) makes most of its profit from its UK bus operations. It operates around 8,000 buses in Britain. It has strong positions in many local markets, enabling high usage rates of its buses and depots. It boasts industry-leading margins and a record of strong earnings and dividend growth.
Its success is in part due to a decentralised structure that devolves power to local managers, allowing them to respond quickly to changes in markets and to develop routes and pricing strategies that will grow passenger numbers and in turn group profits. The business is highly cash-generative. Management has made some attractive acquisitions, and returned a significant amount of cash to shareholders.
Ultra Electronics (LSE: ULE) comprises 29 businesses in 180 technology niches including defence, transport, energy, and security. Earnings per share have more than quadrupled in the last decade, and revenues have grown every year since it floated in 1996. Ultra spends heavily on research and development, while the business is built bottom-up, with its operating companies responsible for spotting new market opportunities.
There are less than 30 staff in head office as each management develops and agrees strategy. The company’s defence markets have been tough in the face of US budget constraints, but for the patient investor, this could be a good time to buy.