Investment Strategy
“A truly great business must have an enduring moat that
protects excellent returns on invested capital.”
- WARREN BUFFETT
Silver Silk Capital focuses on investing in undervalued high-quality businesses that have a strong-durable competitive advantage allowing them to sustain a high-return on invested capital, with a capacity to re-invest excess free cash flow at a high rate of return.
The economic moat, or competitive advantage is the cornerstone of our investment valuation process. As we want to invest in businesses that have a high return on invested capital that allows them to reinvest earnings back into the business at high above market rates of return, therefore growing in intrinsic value. A competitive advantage is necessary because that protects the business from competition, allowing it to sustain a high-return on invested capital. Because in a capitalistic society a high return on capital will attract competition which drives down the return on capital.
When opportunities present themselves where these businesses are mispriced in markets, for reasons such as investor psychology or investors concerned about irrelevant factors for a business’s value. These companies have historically resisted the reversion to the mean phenomena that is common in equity markets and business through preventing competition taking their market share due to the competitive advantages. This is important because in a capitalist economy, whenever an industry or business achieves a high return on capital, that inevitably attracts competition which then drives down the return on capital. Businesses with economic moats prevent competition from taking their business and harming their economic model. A high return on capital is the mark of a great business because the higher the ROC the more value the business is able to create through incremental capital reinvestment. We want to own businesses that produce a lot of cash while requiring little capital investment. Usually, businesses that have high return on capitals have an economic moat protecting their business and have pricing power. An economic moat and pricing power are what we look for in businesses which are also managed by owner orientated managers.
We therefore take a long-term approach towards investing in these businesses, because we do not know how long it will take for the market to recognize how much a business is worth. Given enough time investors fairly value a business according to its earning power. Therefore, we patiently hold our investments till the market price reaches intrinsic value, or till find better investment opportunities for our capital. Secondly, these businesses also grow their intrinsic value overtime, providing an extra incentive to stay invested for the long-term. These factors provide us the ability to compound our capital tax-free through staying invested, until the final tax-bill comes from divesting our investment.
“The economic moat, or competitive advantage is the cornerstone of our valuation process. As we want to invest in businesses that have a high return on invested capital that allows them to re-invest back into the business high rates of return”
That’s how we grow our capital above the market rate of return, by investing in businesses that can incrementally reinvest earnings at high rates of return. This grows their value over time. Owner orientated managers are important for ensuring capital gets intelligently allocated in these businesses.
A long-term time horizon is adopted with our investments, as we have a long holding period of several years in order for the businesses to grow in their intrinsic value and to wait for the market value to appropriately reflect the intrinsic value. This also reduces our portfolio risk because we are able to ignore short-term market fluctuations by adopting a long holding period.
A concentrated portfolio approach is adopted of holding 5-10 business. This allows us to concentrate capital in our best investment ideas.