History has shown that investing in smaller companies can produce excellent returns for investors. It makes sense that growing businesses can generate substantial value for shareholders, especially if they can be identified early in their growth phase.
However, smaller companies can also exhibit significant volatility in returns, so an active, fundamental, research-based process is imperative.
At Flinders, we believe that the way to identify the most attractive opportunities is to undertake consistent, rigorous proprietary company research and financial analysis. We are resolute in our focus on risk management and ESG assessment in order to maximise gains and limit losses, leading to higher returns for our investors.
We are also committed to remaining agile. This includes being disciplined in limiting our portfolio size to a level that allows us to fully exploit opportunities across the smaller companies universe, while being responsive in our decision-making process.
OUR STOCK RESEARCH FOCUS
It is our research process that drives our ability to identify opportunities. Importantly, the research is driven by our team of talented and experienced investment professionals.
Our research is in two parts:
- Proprietary research of the company – its growth opportunities, applicable strategy, quality of management, industry dynamics, execution risks and ESG assessment; and
- Financial analysis of the company – modelling of earnings, cashflow and balance sheet, and the valuation of the company.
Our research is focused on answering five key questions about every company we assess:
4. What are the risks?
Through our company, industry and market knowledge, we assess whether any material risks are at play, whether they can be managed and how they may impact future prospects and valuation. An important part of our risk assessment includes ESG analysis to address any long-term, systemic risks within a company.
From this research, we construct a portfolio of stocks in which we have a high conviction.
OUR FOCUS ON ESG ASSESSMENT
The analysis of Environmental, Social and Governance (ESG) factors plays a vital role in our company research and risk evaluation process. Understanding how a company is performing across a range of ESG factors helps to inform our assessment of a company’s long-term risks and opportunities.
ESG assessment does not sit outside of our investment process as an extra layer or screen – it is implicit in our investment activities and decisions – and has been since the founding of Flinders Investment Partners.
Analysing and understanding ESG factors in smaller companies is very different to top-100 companies. As part of our company research process we assess a company’s performance across a range of ESG factors and assign the following weightings in order to come up with an overall ESG Assessment Score:
Governance 50% > Social 30% > Environment 20%
OUR INVESTMENT PROCESS
There are 3 key steps in our investment process:
From nearly 2000 listed stocks in the smaller companies universe, we screen out companies with unacceptably high financial risk (measured by leverage ratios), long-term systemic ESG risks, poor liquidity or have a market capitalisation that is too small. This reduces the number of stocks to 300-400 that we can focus on.
There are two parts to our research approach, which help answer the five key questions about every company we assess . This provides the basis for the company valuation. They are:
- Proprietary research: An active company visitation program is a critical step in the process. This occurs with increasing frequency where we have a real interest in the company and even more if we include them in our portfolio. Additionally, we meet with industry groups, competitors and where we can, clients of the company. These visits drive:
- Our assessment of the company strategy, and management’s ability to successfully execute this strategy
- Our inputs into the financial analysis of the company (together with publicly available information); and
- How management addresses ESG factors in order to reduce long-term risks and protect shareholder interests.
- Financial analysis: We use our proprietary research to model the future earnings, cashflow and balance sheet of the company. Our modelling captures historical financials, and forecasts at least three years forward. For ease of comparison and peer review, our financial models are in a consistent format.
3. Portfolio Construction
The process for including a stock in our portfolio is in two steps:
- Investment Approval: A formal peer review is undertaken of stocks considered attractive and worthy of inclusion in the portfolio. Full models and the investment thesis are presented to the investment team for discussion and debate. This includes financial and ESG analysis plus the qualitative work undertaken at the proprietary research stage. The team will review this, along with the key assumptions and investment case of the stock. Stocks need to meet a minimum ESG score to be included in the portfolio. Stocks will either be approved, require more information or work before approval, or be rejected. To ensure robust debate and better investment decisions, both Portfolio Managers need to approve a stock for it to be included in the portfolio.
- Portfolio construction: Once a stock has been approved for inclusion, the position at which it is added is primarily driven by ranking the Assessed Company Valuation Report (ACVR) of the stock (relative to its current share price) against all other stocks under coverage. This rank captures the company’s forecast capital growth (i.e. the gap between our valuation and the current share price) and the expected dividend yield.
As a result, a portfolio of approximately 40 companies in which we have the highest conviction is constructed, overlaid by portfolio risk considerations, market conditions and portfolio guidelines.