For example, if the current P/E of a $30 stock is 10, historical P/E is 15, and the projected growth rate in earnings is 10% with a 3% dividend yield, our analysis projects a $65.88 share price in four years net of all dividends. This amounts to a compounded growth rate of 24.7% per annum.
The following factors narrow the investment pool further for inclusion in the fund (reverse logic applies to our short investments):
- Strong Customer Loyalty
Prospero looks closely to see whether a company is delivering real value to its customers and whether that value is expected to change over time. We believe it is possible to gauge the value a company is providing by looking at statistics such as customer retention rates as well as consumer satisfaction surveys.
Prospero has found that companies with high levels of customer loyalty grow faster and more profitably. Existing customers are more likely to purchase additional services as well as make recommendations to others. Repeat customers are also typically easier and less expensive to process because both parties have learned from their prior interaction. Lastly, high customer retention means that the company can concentrate on expanding its consumer base as opposed to replacing prior customers. - Recurring Revenue Business Models
Prospero believes that companies with a high recurring revenue element to their business (e.g., monthly subscription fees) are more stable. As a result, such companies are often more profitable and better equipped to achieve sustained growth. For example, continuing customer relationships enhance a company's ability to successfully introduce new products and services. Recurring revenues also provide more forward visibility about the future prospects of the business. This enables disciplined, long-term investors such as Prospero to benefit when others misprice a security due to non-recurring setbacks.
- Sustainable Competitive Advantages
Globalization and rapid technological change has made it increasingly difficult for many companies to sustain a meaningful competitive advantage. Yet, without such relative advantages, companies are unlikely to earn superior returns on capital over time. Prospero looks for companies with distinguished management teams that proactively use technology to fortify or augment their relative market positions. We also seek out companies that protect their revenues. This may include the implementation of low-cost production and distribution systems, the sale of strongly differentiated products and services, and/or a clear focus on specific niche markets.
- High Cash Returns on Invested Capital
Businesses that generate cash as they grow have several distinct advantages. Such companies can:
- reinvest in their own businesses and thus stimulate more rapid internal growth;
- make complementary add-on acquisitions without diluting existing shareholders; and
- distribute some of the excess cash to shareholders.
Strong cash flow also reduces the likelihood of financial distress, which is especially important when markets decline and new financing is unavailable. In fact, companies with strong cash flow are able to take advantage of temporary market setbacks by repurchasing their shares in the public market at attractive prices. This increases the ownership percentage of the remaining shareholders and enhances their long-term returns. - Excellent Management Teams
Prospero believes that strong leadership is one of the key factors in determining the future prospects of a company. Yet, this dynamic indicator is invisible on corporate balance sheets and must be accessed through in-depth analysis by a knowledgeable investor such as Prospero. Strong management attracts other strong managers and enables a company to anticipate important industry trends. Conversely, poor management can destroy significant value by failing to recognize industry changes, under-investing, or making ill-considered acquisitions.
Prospero also believes it's important to invest in companies in which the interests of management and shareholders are aligned. This is best achieved when management owns a large percentage of the outstanding stock.
Prospero also adds value by covering small and mid-size public companies that do not attract quality research by large investment banks. This lack of coverage, combined with the size constraints and short-term investment horizons of many large institutional investors, provides a fertile environment for Prospero to uncover superior companies trading at significant discounts to intrinsic value.
After investing in a company, Prospero actively monitors the investee company, as well as its customers, suppliers, and competitors. When appropriate, Prospero also seeks to effect change within investee companies by maintaining an active dialogue with management teams and advocating a specific course of action (e.g. the divestiture of a subsidiary) when necessary.