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What we look for in a stock

Stephen Groff's picture

When we talk to our fundholders a common question is, “What do you look for in a stock?” I don’t want to lay out another high-level investment philosophy, since most investment philosophies all seem to sound the same. (When was the last time you heard an investment manager say they are looking to invest in companies with poor management teams and weak balance sheets?)

Instead, I would rather talk about one of our top holdings in Cambridge Pure Canadian Equity Fund and why we like it so much. Hopefully, this gives you a flavour of how we pick stocks and think about investing.

Sylogist

What they do is simple and boring – The company sells different types of software to governments, school boards and private companies. Examples include everything from teacher scheduling to fuel management to graveyard management. It may not seem particularly exciting to you and me, but it is important to their customers and that’s what counts.

Management is very well aligned – Management owns around 40% of the company. Management makes more money from creating shareholder value, not paying themselves excessive salaries or bonuses.

There are high barriers to entry – With high switching costs and people not wanting to learn new systems, revenues are "sticky" – long-term contracts don’t hurt either. This results in years of high-margin service and support revenues, as well as pricing power.

It generates lots of free cash – Software requires very limited capital investment to sustain high levels of free cash flow. This is the exact opposite of most resource companies, which require high levels of capital expenditure just to sustain current cash flows.

The balance sheet is pristine – Sylogist has no debt and a large amount of cash. This enables it to make attractive acquisitions if the opportunities present themselves; otherwise, the cash can be paid out to shareholders. Given the level of insider ownership, I trust them to make the right choice.

The valuation is attractive – Given the attractive business model, growth opportunities (both organic and acquisitions) and current free cash flow stream, the stock remains at a meaningful discount to what we consider to be fair value – for this reason we are significant shareholders (the largest after management).

If you come across companies that check these boxes, let us know. We're always looking for new ideas.

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