The inverse to relying on the “unknowable” is to focus intently on the variables that are both discernible and can be quantified. This is why true value investors take a bottom-up approach to security analysis and scrutinize, in depth, company fundamentals, business momentum and catalysts for growth. What shouldn’t be overlooked is the role of strong governance and capable management.
This is an area that has improved exponentially, post Enron. That’s not to say that lapses in governance don’t occur. The collapse of UK construction company Carillion demonstrated this last year. But with greater regulatory scrutiny and the growth of the activist investor universe, directors are generally quicker to demand accountability when companies underperform.
It’s also a misconception to think management assessments are purely subjective. What can be most telling is the analysis that goes into how management deploys available cash flow. At a high level, there are generally five alternatives. From an operational perspective, it comes down to the historic “buy vs. build” question, as capital can be deployed to either fund organic capital investments or in M&A. When these paths don’t offer a compelling return-on-investment, cash flows should be used to pay down debt or can fund stock buybacks and shareholder dividends.