AT CADIZ ASSET MANAGEMENT, OUR FIRST RULE IS, ’DON’T LOSE CAPITAL’
This focuses our attention on where to start when analysing any business. Understanding a business’s balance sheet, its debt levels and when debt repayment is due, is vital to understanding whether a business will survive these tough times. During this structural shift to a more normalised world of higher interest rates caused by elevated inflation, corporate balance sheets and earnings will be tested.
At Cadiz, we continue to interrogate the company’s balance sheet for each of our investments, stress-testing their ability to manage their debt obligations and cash requirements. We are pleased to report that we are comfortable with the balance sheets for all the investments we hold.
INVEST IN QUALITY BUSINESSES THAT HAVE PROVEN TRACK RECORDS AND COMPOUND RETURNS OVER TIME
When equity markets fall, there is initially indiscriminate selling. Over time, investors distinguish between quality stocks that are likely to survive these turbulent times and the poorer quality stocks that are often highly leveraged with weak business models. At Cadiz, we focus much of our attention on understanding the qualitative characteristics of a business, in order to assess the risks the business will endure. We focus on understanding the following:
• How does the business make its money and what are its competitive advantages? Are these competitive advantages likely to persist, or could they be eroded over time?
• Does it have too much debt and can it repay the debt?
• Does it have a competent management team aligned to shareholders’ interests?
• Does it have a proven track record of generating superior returns on capital and are these returns likely to persist?
• Where is the company in its business cycle – capital cycle and earnings cycle?
Superior quality businesses usually trade at a premium. As equity prices fall, however, this creates an opportunity to buy these quality businesses at an attractive valuation.
We use these opportunities to increase our exposure to good quality businesses by either adding to existing positions or adding quality counters to the portfolio. This will strengthen the portfolio’s ability to weather the storm and compound returns over time once the world economy recovers.
MAINTAIN A DIVERSIFIED PORTFOLIO
After the stellar market rally in 2021 in which the local FTSE/JSE All-Share Index (Alsi) hit new highs (up 24% for the year and global markets up over 30% (MSCI World Index) in SA rands), 2022 has seen a sharp reversal in global market returns. Year-to-date, the S&P 500 and the MSCI World Index are down over 21% in USD. The South African market has fared a little better than its global peers, however, – down 13% in USD. This reversal is temporary and is not all bad news.
When international markets strengthen, some industries will recover faster than others. While it is difficult to tell which industries or stocks will be winners in the short term, we believe that the portfolio of diverse businesses our clients are invested in have solid long-term growth prospects. This, combined with highly attractive valuations, sets up our portfolios for good long-term returns.
Markets can be very volatile over the short term, but history has shown that those that are willing to be patient and invest for the long term will be handsomely rewarded.