“Product” refers to certain innate characteristics that makeup a high quality company. We search for these high quality companies because we believe that, counter-intuitively, high quality businesses tend to outperform low quality businesses over the long term with less volatility. Additionally, we believe these types of businesses tend to significantly outperform their lower quality peers during catastrophic periods. Generally, these companies possess one or more of the following attributes:
The above grid plots capital intensity and cyclicality of businesses. Every business can fit somewhere on this grid. We have chosen a few industries for illustration purposes. As a natural consequence, our process seeks to help us avoid the highly cyclical and highly capital intensive businesses such as airlines and autos. Brian Yacktman, Portfolio Manager, often cites the example found in the airline industry. "When you sum up all the profits in the airline industry since Kitty Hawk, they are negative, despite being one of the fastest growing industries when looking at revenues since that time."
While some businesses may lack these qualities, the process of calculating a forward rate of return (as discussed in Price section) helps us to develop a frame of reference for how much extra return potential we should require before purchasing lower quality stocks. This point should not be overlooked because one would not want to fall into the trap of purchasing a security that appears statistically cheap, regardless of the quality of the assets and without understanding the reinvestment rate or the long-term viability of the business. However, at a price, when the expected forward rate of return appears to sufficiently compensate for the additional risk, we may venture into lower quality fare.