Common Characteristics of World-Class Companies
Unlocking durable growth in emerging markets demands a sharp focus on evaluating individual companies. Learn how Matthews Asia Portfolio Manager John Paul Lech evaluates companies to uncover opportunities.
The characteristics of world-class businesses are consistent regardless of geography. Good companies worldwide share common traits, what I call the ‘Five C's of a Good Company’: competitive position, capital allocation, capital structure, cash flow, and character.
Analyzing the strength or weakness of a company’s competitive position and reviewing the depth of its competitive moat and how likely it is able to sustain or expand is one of the key questions we ask. There are companies where it's relatively easy to get started, and a lot of competition. These companies compete solely on price and sometimes they’re in favor, sometimes they’re not. Barriers to entry are low, cost of capital is low, and competitors come in and out.
There are other companies where because of the product, the intellectual property involved, or the manufacturing process, the competitive topography is relatively fixed. We focus on competitive position and what that looks like. We tend to favor companies that are in a competitive topography where it's not as easy to enter.
If you visit Washington, DC and view the national archives, you’ll see "The past is prologue". I think that’s true with companies as well. A company with a history of taking capital, that it has either internally generated or externally raised, and investing it in a judicious fashion and growing their business, that's a strong sign.
There are other companies that keep raising capital and it ends up being value-destructive. I think it’s key to evaluate how a company has allocated capital when considering what the company is going to look like in the future, which ultimately is what we're investing in.
I started my career in fixed income and lived in Argentina in 2001 during a financial crisis. Perhaps life experiences lead me to prefer companies that have a lot of cash on their balance sheet versus debt. One way to state that would be that they're running ‘lazy’ – or suboptimal—balance sheets, but I find that through economic cycles, it's better to have cash on balance sheet that allows them to take market share and invest during the downtimes. It allows the company to have the foresight and ability to make better long-term decisions. So we prefer to look for business that can strengthen their competitive position during hard times or times of volatility.
The reason many investors allocate to emerging markets is for growth. However, growth for growth’s sake is not a strategy. It has to come back to the bottom line and cash. A good business should be able to produce cash from operations and fund its growth organically from the cash it generates. Some of the highest growth companies have attractive cash flow potential.
A company’s character is important—and it’s more than just its financials. In my experience, a high-quality, well-run company—run holistically for the benefit of all of its stakeholders—tends to survive better in a time of stress, grow better in a time of prosperity, and generate more cash than a company that has a bad character.
I ask three key questions: "Is this a company that I want to be in? Is it being run for everyone, including non-controlled minority shareholders like myself? And is the price somewhat fair?" These are the basic governance questions. If you've been in this business a long time, you've seen companies run into issues with their regulators, employees, unions or other agencies. Part of holistic analysis is understanding what makes a company a good place to work, a good place to consume from—all of these things relate to character. This evaluation has become ‘flavor of the day’ and it's something that we've been doing for a long time.
At its heart, investing in emerging markets is about looking forward. Identifying companies that can power their own growth as opposed to being dependent on external financing is an important part of capturing the opportunity. Investing in emerging markets requires the ability to identify good companies at good prices, as well as the ability to look past the noise of the marketplace and maintain a long time horizon.