DNR Capital believes a focus on quality will enhance returns when it is combined with a thorough valuation overlay. We seek to identify quality companies that are mispriced by overlaying our quality filter, referred to as our ‘Quality Web’, with strong valuation discipline. We are high conviction, after-tax focused and invest for the medium-to-long term. We define quality companies as being those companies with the following five attributes:
- earnings strength (particularly improving return)
- superior industry position
- a sound balance sheet
- strong management
- low environmental, social and governance (ESG) risk.
DNR Capital believes that quality companies outperform for these reasons:
- Quality companies generate more capital that can then be reinvested to drive sustainable returns over time. This can be achieved via appropriate deployment of capital either internally or via merger and acquisition.
- Companies in structurally superior industries, with pricing power, can grow above CPI and are more protected against inflation.
- Higher quality balance sheets help to ride out cycles.
- The ability to value quality companies is enhanced by the sustainability of earnings.
- Quality companies tend to recognise the benefits of a good ESG policy. Financial analysts tend to ignore ESG risks in terms of valuing companies and identifying risks.
We seek to exploit the opportunities presented when quality companies are mispriced. Inherent in this is a belief that:
- Markets are too short-term focused. Investing in quality companies enables a medium-term to long-term focus.
- Share prices will move away from inherent value from time to time. A stock might be devalued on concern of deteriorating quality (which we reject).
- Improving quality might not be recognised by the market.
- The market might undervalue the long term opportunity that arises from a company’s ability to reinvest its capital.
- ESG tail risks are often not analysed and priced effectively by the market.
DNR Capital has produced a white paper entitled The Quality/Value Paradigm, which defines quality, discusses the history of quality investing, elaborates on which markets DNR Capital portfolios perform best in, and reviews the inefficiencies that can be exploited when investing in quality companies. To receive a copy of this white paper, please contact email@example.com.