As the world continues to guess what inning of the cycle each industry and market is in, we reflect on why evaluating management’s capital allocation priorities and abilities is so important to our research process. Because our investments have a long-term horizon, we are focused on management’s ability to make prudent, long-term capital allocation and operational decisions.
A portion of our analysis of management’s philosophy and ability occurs prior to each investment. We speak with senior management of prospective portfolio companies before we enter the position, and we do a thorough review of each member’s prior history with public companies to assess how they have managed those businesses, and in particular how they’ve allocated capital in differing environments. After we have initiated a position, we continue to speak with management to assess its capital allocation philosophy against today’s conditions and any that we foresee as possible. Each company and industry will require a unique analysis, and each management team is evaluated in light of business necessities and long-term goals.
To complicate matters, each company’s stated capital allocation priorities can vary widely. Some companies, like 2020 Bulkers Ltd., pay out dividends to equity owners a certain percentage of its net income for a given period. This model provides us with an easy-to-calculate expectation of where capital will flow over time and allows us to plan how we may reinvest dividends either in that company or elsewhere in the portfolio. Other companies engage in a complicated web of paying dividends, buying back common stock on, paying down debt principal, tendering for outstanding debt, retiring treasury shares, deploying capital for acquisitions, and reinvesting in the business. This, understandably, takes quite a bit more time for our research team to study and evaluate, and in our opinion can result in increased execution risk.
While a multifaceted approach to capital allocation may increase risk and complexity, we do not endorse a single capital allocation strategy for all companies. We also concede that management will have a more complete picture of what is necessary for the company. Consequently, we continually speak with management about its stated priorities and evaluate its philosophy and practices versus our view of what is appropriate for the company at the time.
Each discreet mechanism for capital allocation has many facets that we discuss at length internally to form questions for company management. Because of the importance capital allocation has on keeping a company a going concern, we spend an outsized amount of time and effort to ensure that we select companies with management who are prudent capital allocators and are consistent and accurate communicators of its plans. Ultimately, we invest in businesses that are fundamentally sound and well positioned for long-term growth. Our research team continues to evaluate new ideas and portfolio companies considering this objective, and thorough study of a company’s capital allocation is a key part of that evaluation.
As always, please reach out to MIAM if you are interested in partnering or you would like to discuss a particular company or idea.
Sincerely,
The MIAM Research Team
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