There is currently a trend towards short-termism in equities markets, both within companies themselves and with regard to investment horizons.
But evidence suggests that running against this tide and instead extending investment horizons and favouring companies that take a long-term approach to preserving and growing value over time provides a favorable pay off for investors.
Opportunities in long-term investing
McKinsey Global Institute’s Corporate Horizon’s Index, which measures the impact of long-term business and investment horizons in the US, shows that US companies with long-term perspectives increased their revenue by 47% more than others in their industry peer groups and their earnings by 36% more, on average1.
McKinsey also found that during the global financial crisis, these companies also remained disciplined, and continued to invest in research and development while companies with shorter horizons reduced their research and development spend2.
A growing and sustainable economic profit (a profit above all costs including the companies’ risk-adjusted cost of capital) is key to unlocking the compounding of cashflows to which long-term share price returns are inextricably linked, and these companies also earned superior economic profits. Between 2001-2014, long-term capital allocators cumulatively increased their economic profit by 63% more than other companies with shorter-term horizons3.
Companies that invest wisely for the long term to preserve and reinforce their competitive advantage and to sustainably expand their economic profits over time, will likely enjoy a higher and more stable trajectory of cashflow and economic profit expansion. We believe that these companies will be worth more tomorrow than they are today and investors that share a long-term investment horizon can exploit this to their financial advantage.
The benefits of bottom-up research
Due to the rise of intangible factors in determining investment value, bottom-up due diligence is also favoured over top-down analysis.
A bottom-up approach entails picking a company and carefully and painstakingly reviewing its position within the industry, its operating environment, its sources of competitive advantage, its capital allocation priorities and strategies, and its pathways to future growth.
This requires engaging with the target company itself but also with customers, suppliers, industry associations and other experts that can help build an accurate picture of the target company’s future outlook. There are no short cuts when it comes to due diligence and a bottom-up approach, but the benefits that can be obtained over the long term are, in our experience, material.
A bottom-up approach is extremely relevant to today’s investing environment where the rapid pace of transformative change means there can be vast shifts in profit pools within the broader economy.
While technology-induced disruption has always been apparent, it is now arguably accelerating in pace and impact. This is due to a confluence of technologies all occurring at once that are not unique to any one sector or geography, and instead are inter-sector enablers rendering traditional sector classifications increasingly irrelevant.
Given these profit shifts are largely driven by individual companies with highly disruptive business models, bottom-up research is best placed to forecast and exploit these important shifts giving investors an edge in the digital age.
1, 2, 3 McKinsey Global Institute, Where companies with a long-term view outperform their peers, February 2017.
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