Spence Asset Management is a Registered Investment Adviser
May 2008
“What Sort of Businesses Should We Own?”
So often when we are out and about we are asked what we think about the “market and the economy.” It has always been a popular topic. The news media is aware of the popularity of this question and accordingly it spends a significant portion of its time and effort speculating on the outlook for the “market” and the “economy.”
Though we concede that we do think about the “market and the economy,” what we really spend most of our time thinking about is what sort of businesses we should own. We have found that spending a lot of time, energy, and resources thinking about the market or the economy is often very counter-productive. Given the information at his disposal, if Fed Chairman Ben Bernanke is unsure about the market or the economy, why should we think we can be sure? Still many investors continue to fret.
Some might read the first two paragraphs of this newsletter and wonder why we would want to ignore most of what the media has to say about the market and the economy. Our reasoning is fairly simple: news outlets bombard the airwaves with interviews of so-called “experts.” We can only chuckle each time we find ourselves listening to opposing views on the “market” or the general “economy.” One expert will scare the heck out of us citing all the reasons why the world is truly coming to an end. Then another equally impressive expert will counter the first’s well reasoned arguments with an explanation of why all these fears are overblown and the height of the mass anxiety actually represents a “great buying opportunity.”
Often we suspect that millions of observers are actually sitting in their homes or offices alternating emotionally as they listen to both “experts.” Shifting between utter despair and a vague sense of opportunity seems to be one of the most popular national pastimes.
Trying to remain above the constant market and economic chatter can be tough, even for seasoned investors. Some find it nearly impossible to realize that owning shares of stock is not the same as owning casino chips. Terrible markets and terrible economies are not “bad luck streaks.” Terrible markets do not destroy wonderful businesses. And alternatively, great markets or great general economic conditions do not save terrible businesses.
In our analytical discussions each Tuesday morning, we spend virtually no time talking about the economy or the market. Instead, we try to dedicate the vast majority of our time to the process of weighing one simple question; “What sort of businesses should we own?” And most often, we arrive at the conclusion that we should continue to own the shares of the businesses that we already own.
Now that tax season has come and gone it might be a good idea to share our thoughts on what sort of businesses we should try to own and why we might own them.
We look at businesses from four different perspectives. We look at the basics of their:
• Products and services, customers, competitors- essentially their business strengths and their weaknesses
• Management including how they communicate, how they allocate capital, and what sort of behaviors they exhibit in decision-making
• Financial statements, looking for financial characteristics we prefer and making note of those that are red flags
• Market value since the price we have to pay for what we think we are getting does ultimately matter
Beyond these evaluation processes, we realize that owning businesses must be framed within the reference of what sort of things people need and prefer as well as recognizing what customers will be willing to pay for. Here are a few thoughts on people and their needs:
1. We think people are concerned about their health. People all over the world are driven by the urge to live rather than die. This is a basic instinct of humanity. There are many companies providing health care related services. Specifically in this area we believe:
• Diagnostic testing is a service that saves lives.
• One of the first diagnostic steps in health care and preventative maintenance is taking a close look at the patient’s blood. Blood testing requires the ongoing use of special assay kits. The need for these items and services is recurring.
• Health care service companies generate a steady stream of waste, and health care waste disposal presents particular recurring challenges.
• Human beings have always accommodated companion pets. Pets are particularly integral to an aging population where children are grown. Pets are a source of comfort for the elderly and they also require ongoing and recurring health care.
2. As people use products and services they must pay for them. While currency and check-writing continue to be part of the international payment settlement system, we see the world gradually transitioning towards electronic fund settlement procedures. The use of debit and credit cards has been expanding steadily for many years and it would seem to us that this trend will continue. We think owning businesses that profit from this ongoing and constantly recurring trend along with the sheer volume of transactions makes sense.
3. The need for asset management services is also a continuous process simply because changes in the competitive market conditions are continuous. Most investments must be managed on a recurring basis. Decisions on deployment of new investment capital or redeployment of existing capital into bonds, stocks, or income producing real estate must be made intelligently. As individuals must, out of necessity, take responsibility for their own retirements and/or financial futures, we think it is wise to own shares of companies that provide these services.
4. Managers of stocks, bonds, and income producing real estate require up-to-date information to make critical decisions. Each time the earth rotates; more information is added to the data pool. We see the demand for the basic service of providing up-to-date information as one that will be continuously recurring.
5. Managing many of the most basic functions of any businesses in a complex world can be problematic. Specifically the need for services that assist companies in areas such as; payroll, employee benefits, and inventory control are continuous. Companies that can efficiently assist others in the management of data and critical processes are essential because they are recurring and can help reduce personnel costs.
6. We are reminded of the legacy of Thomas Jefferson each April when we pay our income taxes. Jefferson was a man who said he believed the government that governs least governs best. TJ must be spinning in his grave. Then again, after railing at how much power the federal government wielded during his predecessor’s term, we are reminded that it was Jefferson himself who expanded the power of the central government through his presidency. We have found that regardless of which political party is in power, government has proven itself to be a reliable customer. In state capitols and in Washington D.C. the demand for income producing real estate and basic human services is a constant. Government is truly a growth industry.
7. With world population growth and demographic shifts, transportation has always been a tricky business. As human preferences change and the cost of energy goes up, the logistics of moving products from producers to consumers is a constantly recurring challenge. Transportation companies and retailers must constantly deal with changing conditions and patterns of behavior. Businesses that are positioned to smooth out the disruptions associated with the challenges of these logistical problems should continue to thrive.
8. Energy remains the greatest unsolved problem of our time. Debates over how to best protect our environment may rage, but energy consumption seems to rise fairly steadily. It would seem that services that lead to the finding of sources of energy and the maximization of recovering previously found energy will have a place in the markets for the foreseeable future.
9. As the world becomes a smaller place and intermediaries look for ways to manage risks, the demand for the services provided by companies that can provide reliable, central locations for transaction exchanges seems to be steadily rising. We see no interruption in this trend.
In our own managing of shares of common stocks, the trends mentioned above can serve as a point of reference for our thought processes. So it is that while we are not sure about the “market” or the “economy,” when we feel we have identified solid management, strong financial characteristics, and reasonable valuations, these are the sorts of businesses we think we should own.
Jim Spence, Charles Wagner, Jack Spence, Eric Walton
Spence Asset Management, Inc.
2455 E. Missouri Ave. Suite A
Las Cruces, NM 88001
575-556-8500
Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC
Investment Advisory Services offered through Spence Asset Management, Inc., a Registered Investment Adviser
Cambridge Investment Research and Spence Asset Management are not affiliated
The views expressed here are those of Spence Asset Management and are subject to change with market conditions. The information contained in this newsletter is derived from sources believed to be accurate. You should discuss any legal, tax, or financial matters with the appropriate professional. Neither the information presented nor any opinion expressed constitutes investment advice or a solicitation for the purchase or sale of any security. Market forecasts cannot be guaranteed. Past performance does not guarantee future results.
Jim Spence, Charles Wagner, Jack Spence, Eric Walton
Spence Asset Management, Inc.
2455 E. Missouri Ave. Suite A
Las Cruces, NM 88001
575-556-8500
Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC
Investment Advisory Services offered through Spence Asset Management, Inc., a Registered Investment Adviser
Cambridge Investment Research and Spence Asset Management are not affiliated
The views expressed here are those of Spence Asset Management and are subject to change with market conditions. The information contained in this newsletter is derived from sources believed to be accurate. You should discuss any legal, tax, or financial matters with the appropriate professional. Neither the information presented nor any opinion expressed constitutes investment advice or a solicitation for the purchase or sale of any security. Market forecasts cannot be guaranteed. Past performance does not guarantee future results.