Four things to look for in a company

Tom Gayner is the Executive VP and CIO of Markel, an insurance company in the United States. In a talk he gave at Google (link below) he gave investing advice based on his experience. At the beginning, he discussed the importance on learning accounting, given that it is the language of business. From there, he mentioned a little about his evolution as an investor, going from quantitative metrics as an investing method to taking into account qualitative variables and not only finding value, but also identifying value creation through time.

Gayner mentioned that there are four things that help him to identify value:

• Profitable businesses with good returns on capital that do not use much debt – Gayner mentioned that every part of this sentence is important and has learned that if any of the variables in it fails, money can be lost. The profitability part is necessary to develop products and attract/retain talent, on top of growing and developing the business (a business that is not profitable eventually fails). Using debt can help when the tide is going for us, but in tough times it is not optimal as interest expenses can pressure the company and make it suffer unexpected losses. Gayner went over the 2008-09 period when several companies tried to renegotiate their debt and the market was unwilling to lend them money. He also mentioned that going into debt has to do with character, given that it is money from third parties and he prefers companies that use their own money. He mentioned that from the four characteristics, profitability is the one in which he would spend the most time with questions like: What will happen to this company over time? Is this business getting better or worse? He mentioned that when we find a great business, we should avoid being penny pinchers, or someone that pays too much attention to what he pays, given that the intrinsic value of the company will continue growing.
• The quality of management – He mentioned that we looks for 1) integrity/character and 2) skill, given that one without the other is useless. He mentioned that it is critical to see both characteristics not only in management, but also in every relationship we have.
• Reinvestment dynamics – He spoke about the power of compound interest and how well it is seized by a company. This has a lot to do with the nature of the business, given that some do not have the ability to scale up and retain the same levels of profitability. He mentioned that there are good businesses with low reinvestment opportunities, but their awareness of this situation make them reinvest in other businesses, such as Berkshire Hathaway, which started as a textile company.
• Price/valuation – He mentioned that a lot of people start here, with Excel spreadsheets and other quantitative factors. Gayner mentioned that this is not enough and that common valuation mistakes involve: 1) overpaying and 2) not buying because the price never approached the “acceptable” valuation range while the intrinsic value of the company continued rising.

What do you think of Gayner’s comments?