SORBUS VECTOR: Manager commentary November 2022

Nov 8, 2022

May we take this opportunity for the benefit of any new investors in our VECTOR fund, to reiterate our investment approach and ethos:

We are looking to grow our investors’ money over the long term by investing in companies that have the ability to increase their profits across the business cycle, i.e. through good and bad economic times and so emerge stronger and more resilient in the latter. 

Such companies have durable earnings power because of their sustainable competitive advantage and are also able to generate true real cashflow for their shareholders.

The two metrics (among others) we tend to use to identify above average returns are a high return on invested capital and a high gross margin.

A high return on invested capital indicates how effective the business is in allocating and using its shareholders money to produce returns.

A high gross margin gives an indication of the strength of the business franchise i.e. a defendable business moat that allows them to earn an above average return. As Warren Buffett points out, “not all businesses are equal, some are just simply better than others”.

When we talk about true real cash flow, we mean cash that is available after all investment needs are covered within the business. This surplus cash can then be used to pay shareholders dividends and special dividends and/or for acquisitions to improve their business and increase returns (though we dislike serial acquirers as they often fail).

Finally, to emerge as winners in a difficult economic climate, means having a strong balance sheet to start with and not a lot of borrowings that can potentially endanger the business.

The requirements above mean, for example, we do not buy loss making businesses (unless a one off event such as a write off or charge in assets tips them into a temporary loss). 

Historically, we also do not buy mining or oil exploration businesses or blue sky type companies such as biotech where potential profits may be very uncertain or years away or where the business model is yet to be proven (think many of the modern day businesses or hot IPO’s in recent years such as Uber, Justeat, Snap etc).   

We have skin in the game as SORBUS PARTNERS have a serious investment in the fund. This aligns our interests with that of other shareholders and ensures we treat this as our money because some of it literally is.

We are an owner managed boutique. This means we do not answer to other owners and so risk coming under pressure from such sources to change our investment strategy in the pursuit of returns which we think are not sustainable or invest in very risky businesses. 

In line with this, we are happy to hold cash if we are unable to find attractive businesses to buy at what we would consider a sensible price (though we internally limit this to a maximum of 20% of the fund in cash).

We are sensitive to the price we pay. We know from decades of investment experience that paying high multiples of annual profits increase the risk of making an investment mistake.

We retain our objectivity by not generally meeting management of the businesses we are interested in as they can often be quite charismatic and cheerleaders for their business (as one would expect!) and also tell the same story to all investors. So we prefer to focus on their results and their ability to communicate this to the market.

Historically again, our traditional hunting ground is in UK mid and small cap businesses though we have never qualified as a small cap OEIC (80% at least invested in such) and so retain the freedom and ability to take advantage of investment opportunities across the market spectrum, including large cap stocks which we added to last autumn. 

We have also intervened on occasion to effect change in a business at boardroom level to the benefit of shareholders.

Whilst the past year has been difficult for us and many other equity investors. It is reassuring to us as proof that our investment methodology works that, as at the quarter ending 30th September, we are ranked 1st out of 243 funds in our UK All companies sector over 3 years, and 4th out of 234 funds over a 5 year period by Trustnet.