The investment managers Murray Stahl and Steven Bregman of Horizon Kinetics have a vibrant publication that they share periodically with their unitholders as well as to a more general audience. In these musings, they present their rationale for featured investment decisions as well as discussing their overarching investment principles and thought processes.
One topic that periodically comes is a concept that they call Predictive Attributes of Outperformance. It is a framework consisting of seven qualitative attributes, that they believe to be predictive on an above average investment return over the long term.
The attributes are:
- Owner-Operators: Numerous backtesting examples have shown that companies where management has significant ownership stakes – comprising a significant share of their overall wealth – tend to perform better than companies run by agent-operator managements.
- Scalability: Companies that have a low marginal cost require less direct investment to fund growth: “Scalability refers to the potential for a company to increase its operations (and revenues) substantially, without incurring substantial marginal costs or requiring significant capital expenditures to support the revenue expansion.“
- Long Product Lifecycle: Companies in industries where products are short-lived face a constant challenge. These companies must reinvent themselves in order to survive in the marketplace by developing new products. With each iteration comes the risk of losing their position in the market. Companies, operating in more predictable waters, where markets face a lesser risk of being disrupted also require less reinvestment in product development (think morning cereal, candles, etc).
- Dormant Assets: These are assets within a company that have not yet become productive to an extent that they produce a level of profit appropriate to that asset or that have the potential to be monetized at a value not recognized by its financial statement and therefore most investors.
- Spin-Offs: On occasion, when publicly listed companies go through operational restructuring, releasing themselves off business units of subsidiaries, they may opt to spin off those assets to shareholders as opposed to selling the assets to a third party. These spin-offs often result in forces that cause a structural mispricing in those securities. Restrictions of owners of the holding company stock may cause a sell off in the spin-off security. This applies, for example, to investment funds with strict investment criteria. Another factor is that spun off companies often have a more focused management that can utilize the potential for the subsidiary company, once given independence.
- Liquidation: When a company’s operations are brought to an end, and the assets of the company are redistributed to its creditors and stockholders. This can happen for a host of reason, for example, through bankruptcy proceedings. The object of a liquidation is to collect the maximum amount of cash to distribute. As the value and timing of a liquidation are uncertain, they usually trade at a discount to the projected liquidation value.
- Bits and Pieces: This refers to the ownership by a publicly-traded company of stakes in other public companies or marketable securities. There are numerous cases where the value of the parts (often referred to as Stubs) significantly exceeds the value of the market value of the public company in possession of those stakes. In cases where the management of the holding company has a history of monetizing value, this may culminate in highly rewarding investment scenarios.