Managers Gary West & James Inglis-Jones will invest in a concentrated portfolio of companies with strong cash flows that they believe are likely to beat investors’ profit expectations.
West and Inglis-Jones both joined Liontrust in March from Polar Capital to develop the company’s European investment strategy. Previously, they worked together at JPMorgan Fleming, where West was Co-head of European equities and Inglis-Jones was a senior portfolio manager.
The starting point of their investment strategy is that managers of companies can make mistakes when forecasting profits, which impacts on whether a company reinvests its profits and if it does, where this money is invested. The stock market relies on profit forecasts, which leads to investors valuing future profits on inaccurate information. These mistakes create investment opportunities for the fund managers.
The managers focus on company cash flow as this reveals important information about the company’s investment decisions. They will buy companies with strong cash flows, which indicate strong growth in future reported profits, while selling companies with weak cash flows that indicate the reverse.
The managers measure cash flow in two ways – cash flow relative to operating assets and cash flow relative to enterprise value. Companies with good cash flow relative to operating assets generate high returns on any cash invested and do not need to make big investments to back their forecasts.
Cash flow relative to enterprise value ranks companies according to how investors value a company’s cash flow. Companies with high cash flows relative to their market value are priced cheaply because investors have low expectations for profit growth, which suggests cautious forecasts have been set that can be beaten.
Looking at cash flow in this way enables the managers to generate a list of a list of stocks that comprise the best 20 per cent of stocks within a universe of 1,000. The mangers then make sure they understand what is going on within the companies and the context in which a company’s investment decisions are made. They then select a final portfolio of 30-50 stocks.
Speculation surrounding mergers and acquisitions is having a positive effect on stock prices in Europe and this perfectly illustrates Liontrust’s point that the market reaction to news coming out of companies affects share prices. However, this fund will only be as successful as the accuracy of the cash flow analysis behind it.