Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 78

What makes a company attractive?

In every investment magazine and the business section of weekend newspapers you will see a list of hot stock picks from fund managers. Inevitably these picks won't represent the fund manager's top new ideas, but rather five large positions in the funds they manage. You will never see the fund manager's recently uncovered gems in print, as the managers will be busily building these positions in their portfolios and certainly don't want other investors driving up the price! In the interests of disclosure I have been guilty of doing this myself. In this piece, I take a step back and look at what actually makes a company an attractive investment.

Easy to understand

We are attracted to companies with business models that are simple and can be explained to any client in two sentences or less and where it can be easily identified how the company makes money. Woolworths' business model is very simple; they buy groceries and liquor from the manufacturers and have the cheapest mechanism for distributing these goods to the consumer.

This point is frequently forgotten during market and credit booms, where complicated businesses thriving off accounting or credit arbitrage can appear to prosper for a certain amount of time. In 2006 I had several meetings with Allco Finance's management in an attempt to understand the business. The company's share price had risen 120% in the previous year and not owning it in the portfolio was hurting performance on a relative basis. After the management was unable to explain how Allco made money sustainably, we did not invest. It was bankrupt in the GFC.

Low capital requirements

The best companies to invest in are those that require minimal ongoing capital expenditure to generate a profit. When a company is required to continually make investments just to stay in business, this represents less cash that is available to be returned to shareholders. Pharmaceutical company CSL requires minimal ongoing capital expenditure to produce its medicines outside the company's research and development budget and this has allowed the company to return $6.1 billion to shareholders since 2010 in dividends and share buy-backs. Conversely Qantas is a capital heavy business which constantly needs to invest (an A380 costs US$414 million) just to remain competitive in the aviation marketplace. Since 2010, Qantas' annual capital expenditure has been consistently ahead of the cash flow it generates from its operations, which explains why shareholders last saw a dividend in 2009.

Strong barriers to entry

Strong barriers to entry discourage competitors from entering into the market and thus reducing profit margins. Toll road operator Transurban enjoys high barriers from long-life monopolistic assets. There is zero probability of a competitor building a toll road adjacent to the company's M2 Hills Motorway in Sydney. Conversely, online accommodation company Wotif.com initially enjoyed strong growth after listing in 2006, but has seen its share price and market share fall dramatically, as larger global competitors improved their internet offer. In Wotif.com's case along with many other tech companies, the barriers to entry tend to be quite low. Generally high barriers to entry, if they can be maintained, translate into higher profits for shareholders.

Non-reliance on government legislation or a single customer

Owning companies whose business models depend on favourable government legislation can be soul-destroying for investors. Investors in Timbercorp and Great Southern saw these billion dollar companies disappear after the government changed the tax treatment of their agricultural schemes. More recently, salary-packager McMillan Shakespeare's share price fell 55%, wiping $600 million off the company's market capitalisation in 2013 after the government proposed changes to the salary packaging of car leases. Similarly, a month ago, former market darling Navitas' shares fell 30% after key partner Macquarie University announced plans to bring Navitas' university pathways program in-house. Alternatively food and beverage packaging company Amcor attracts very little interest from governments and has a large global spread of customers. Companies with these characteristics tend to have easily forecastable earnings with far fewer nasty surprises for investors.

Quality management

When we invest in a company we are effectively entrusting our investor's funds with a company's management and entrusting them to both grow that capital and provide a stream of income. A key part of the investment process is an assessment of a management team's competence to run the business and act in the best interests of shareholders. As a fund manager when I walk into a palatial office suite, not only do I see that my investor's money is paying for that flashy office with the harbour view, but also the management are unlikely to be serious in cutting costs during the down times. Walking into CSL's office in suburban Melbourne is like stepping into an unrenovated government office building from the 1960s and then in the boardroom it is clear that management are both highly competent and are focused on shareholders.

Furthermore in assessing all companies in our universe we examine executive remuneration versus total shareholder return and penalise companies that are paying management teams that are not delivering returns for shareholders.

We view that over the long term and across a range of market conditions, outperformance will be delivered by owning a portfolio of companies with stable and growing dividends and earnings that have an easily understandable business with barriers to entry that protect margins, have transparent financial accounts and trustworthy and shareholder-friendly management teams.

 

Hugh Dive is Head of Listed Securities at Philo Capital Advisers where he runs a $550 million portfolio of Australian shares. This article is general in nature and readers should seek their own professional advice before making any financial decisions. Companies mentioned are for purposes of illustration and education only.

 

  •   5 September 2014
  • 1
  •      
  •   
1 Comments
Tortoise
September 04, 2014

So you pretty much follow the Buffet principles.

 

Leave a Comment:

RELATED ARTICLES

How do different investing styles work?

Cheap stocks: how to find them and how to buy them

Learn your knowns and unknowns

banner

Most viewed in recent weeks

The growing debt burden of retiring Australians

More Australians are retiring with larger mortgages and less super. This paper explores how unlocking housing wealth can help ease the nation’s growing retirement cashflow crunch.

Warren Buffett's final lesson

I’ve long seen Buffett as a flawed genius: a great investor though a man with shortcomings. With his final letter to Berkshire shareholders, I reflect on how my views of Buffett have changed and the legacy he leaves.

LICs vs ETFs – which perform best?

With investor sentiment shifting and ETFs surging ahead, we pit Australia’s biggest LICs against their ETF rivals to see which delivers better returns over the short and long term. The results are revealing.

Family trusts: Are they still worth it?

Family trusts remain a core structure for wealth management, but rising ATO scrutiny and complex compliance raise questions about their ongoing value. Are the benefits still worth the administrative burden?

13 ways to save money on your tax - legally

Thoughtful tax planning is a cornerstone of successful investing. This highlights 13 legal ways that you can reduce tax, preserve capital, and enhance long-term wealth across super, property, and shares.

Why it’s time to ditch the retirement journey

Retirement isn’t a clean financial arc. Income shocks, health costs and family pressures hit at random, exposing the limits of age-based planning and the myth of a predictable “retirement journey".

Latest Updates

Weekly Editorial

Welcome to Firstlinks Edition 639 with weekend update

Thank you for the hundreds of responses to our Reader Survey and to maximise the sample size, we’re leaving it open until this Sunday. Here is an overview of the results so far.

  • 27 November 2025
  • 2
Investment strategies

Where to hide in the ‘everything bubble’

It might not be quite an ‘everything bubble’ but there’s froth in many assets, not just US stocks, right now. It might be time to stress test your portfolio and consider assets that could offer you shelter if trouble is coming.

Investment strategies

The ultimate investing hack: dividend growth stocks

Investors often fall prey to ‘amygdala hijacks,’ letting emotion trump reason. By focusing on dividend-growth with stocks instead of volatile prices, you can steady your mindset and let compounding do the work. 

Investment strategies

CBA or global banks?

CBA’s recent pullback highlights single-stock risk. Global banks trade at lower P/Es with rising earnings and dividends, offering investors both income potential and long-term value beyond the local market.

Investment strategies

Global dividends rising, but Australia lags

Global dividend growth surged in the third quarter, with median growth of almost 6%. Australia was a notable exception as dividends fell, thanks to flagging mining company payouts.

Economy

I called inflation's rise and fall and here's what's next

In 2020, I warned that surging US money supply growth would spark inflation. By early 2023, I said US money supply was dropping dramatically and that meant inflation would decline. Here's what happens next.

Superannuation

Are excessive super funds giving Australia “Dutch Disease”?

The irony is profound: a system designed to secure Australians’ futures may be systematically dismantling the economic diversity necessary for long-term prosperity.

Investment strategies

Could your children pass the inheritance ‘stress test’?

You devote years of your life working, saving and investing, striving to build a legacy that will outlive you. Before any wealth moves to the next generation, here are six questions every parent should ask themselves.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.