The philosophy used by Chawton Global Investors is derived from a group of historical practitioners one of whom, Warren Buffett, is clearly one of the industry's best practitioners. However, he and they, in both philosophical and practical terms, are largely ignored.
The primary inspiration for this movement was the U.S. based early twentieth century investor Ben Graham and is summarised in the following quote;
'Investment is most intelligent when it is most business like'.
Graham lectured at Columbia University and inspired a number of his students to set up in fund management all with great success. This was detailed in an essay by Warren Buffett; 'The Super-investors of Graham and Doddsville', a synopsis of which is set out under Insights. The essence of the approach is the mindset of thinking about investments in terms of productive assets held for the long term rather than a focus on relative valuation. As such, the Return on Invested Capital (ROIC) companies can achieve on current and future investments is the key metric driving the return for investors. Charlie Munger said:
“Over the long term it is hard for a stock to earn a much better return than the business that underlies its earnings…
….if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive-looking price, you’ll end up with one hell of a result.”
However, a business that achieves a high return on capital can still deliver poor investment returns. Perhaps the most important factor that distinguishes good management from poor is their ability to allocate capital well. As William N. Thorndike Jr writes in his seminal book “The Outsiders”:
“Two companies with identical operating results and different approaches to allocating capital will derive two very different long-term outcomes for shareholders.”
In essence, management should aim to allocate capital in projects or other investments that will achieve returns on marginal capital invested higher than the cost of capital. Similarly they should release capital from divisional businesses or investments where the return on capital is below the cost of capital. One of the options for investment of capital is the company’s own shares. This option should be evaluated in a similar manner; will the investment generate a return above the cost of capital at the prevailing market price. Surplus capital, which cannot be invested for an adequate return should be returned to shareholders through dividends. An ideal dividend policy constitutes a base dividend, set at a conservative payout ratio, supplemented by special dividends made when cash builds on the balance sheet after a period of strong profitability that may not last or due to a disposal.