What I’ve Learned in 15 Years of Investing in Small Businesses
In early March, Spirax-Sarco Engineering’s 2020 results sent the share price up 380p. What caught my eye wasn’t the size of the jump – less than 3.5% from £110 – but that 380p was way more than I remember paying for shares in the group, which makes systems for steam and pump management, for the small -cap trust I started racing in the late 1980s. Since then, shares have grown 50 times, excluding dividends.
It made me dig into old reports to see what had survived and thrived. There might be lessons to be learned from my 15 years of managing UK small cap funds, a job I started in the late 1980s. My style had been based on long-term growth companies “reassuringly expensive” with a sprinkling of high-risk turnaround stories. Certain investments, such as Spirax-Sarco, have been maintained and I would still maintain them today if the trust and I had remained in place. Others still had an expiration date on them.
Many participations were then resumed, some after outstanding performances, others having collapsed. Some I gave up (usually wisely) and some were duds. But what stands out are the long-term winners who survived. These alone would have provided reasonable long-term performance if held until today. It backs up Baillie Gifford’s research showing that just a few companies explain all of the long-term performance of the US stock market.
With the exception of Aveva, which has grown 80 times in 25 years, these companies were not in the technology and biotechnology sectors. Some of the stocks in these industries performed spectacularly in the short term, many rallied, but none survived. I have always been suspicious of small mining and energy companies, believing that their global ambitions were unrealistic. The ones I invested in did well but were all taken over. Finance was another sector to be wary of: few companies can maintain a competitive advantage for long. Wealth manager Rathbones performed well, although its stock fell 40% from its 2017 peak.
A simple but brilliant idea
Shaftesbury’s share price is down more than a third from its 2018 peak, but has still risen tenfold since the Levy family began investing in central London ‘villages’. Their simple but brilliant thesis was to never invest more than a 15-minute walk from their offices in order to keep a close eye on buildings, tenants and opportunities. By focusing investment on closely related areas, they could turn them into destinations, push for local street and footfall improvements, and increase the value of villages. Homebuilder Berkeley, which initially sold high-end, built-to-order homes before embarking on urban regeneration, had a comparable policy of adding value through landscaping and enhancing site appeal; its shares have multiplied by 100 since 1990.
Several of the long-term winners are, like Spirax-Sarco, in the industrial sector, including Rotork, Renishaw and Weir. Investing in these at a time when British industry was in relentless decline was counter-intuitive, but innovation and application of the latest technology was key to their success.
I bought Rotork in 1990 after a day trip organized by Severn Trent Water. This included a visit to an unmanned, fully automated water treatment site that depended on Rotork valve actuators to control the process. It was also clear that rebuilding Kuwait’s oil infrastructure would be a boon for the likes of Rotork. Shares have since risen more than 100 times. Weir’s shares have risen 30 times since the late 1980s, despite being 30% below their 2014 peak. Oxford Instruments was a perennial disappointment but its shares have nevertheless increased tenfold in 12 years.
Renishaw, 50x, was also volatile largely due to its vertically integrated business model. The company was based on the invention of a probe for ultra-precise measurement and developed in various applications of technology. Contrary to popular belief, Renishaw did not believe in contract manufacturing; they argued that only by going through the whole process themselves, including designing and producing the machine tools, could they learn how to do it better and learn new ideas.
Person-firms can rarely maintain a competitive advantage for long. Rathbones, founded in 1742, was clearly worth the benefit of the doubt, as was Savills, founded in 1855. Estate agency is a cyclical market but international expansion has made it less so and shares have increased 20-fold.
Spirits go upmarket
Simple and obvious good ideas have always been worth supporting even if management had to learn on the job. Dechra Pharmaceuticals, specializing in veterinary products but with ambitions to expand its pharmaceutical arm for companion animals, was listed in late 2000 at 120 pence and quickly rose to almost £2. The shares then fell 75% over the next two years, but are now trading at almost 30 times the IPO price. A more recent example is Fever-tree, bought by the private equity arm of Lloyds Bank in 2013. The press was outraged that a government-bailed bank was spending £25m on a company with profits of just £1 million.
I asked a friend who worked in the private equity business of Lloyds. He explained that the spirits market was fragmenting and moving upmarket. People would not want to consume high quality spirits with standard mixers, providing an opportunity for a new brand. The business was launched in 2014 and is now valued at nearly £3 billion.
Another happy hunting ground was roll-out businesses. Find a retailer or restaurateur who has identified a good concept in a few locations and has the potential to roll out the idea nationally. Fads don’t last long, economies of scale don’t always apply and once chains mature they tend to decline. It is therefore important to sell on time. Next, launched by George Davies in 1981, is the exception that proves the rule.
The business model of Cityvision, a chain of video rental stores, relied on recycling old stock into new stores, so it required an exit when expansion reached its peak. The Pelican Group’s first restaurant, a brasserie in St Martin’s Lane, London, was set up by a former colleague (previously a civil servant). His family sold to new management who rolled out the concept as Café Rouge and multiplied my money sevenfold. A month after selling, they accepted an offer from a major brewery, grateful, like me, it was time to get out.
French Connection was recommended to me by a friend in the fashion world during an evening between parents. Within a week I had visited Stephen Marks in his Chelsea office and purchased the shares. He had recently adopted the FCUK brand, inspired by the logo that the French Connection in-house football team had chosen for their strip. Stocks soared, but it was never going to be another Next. Superdry and Ted Baker have since similarly burned, although Boohoo is thriving – for now.
Don’t bet the farm on recovery stories
Strong and stable survivors such as Marshalls (landscape products), Travis Perkins (builder’s merchants) and Greene King (pubs) were good long-term investments, but stumbled and became ongoing recovery stocks of road.
Games Workshop grew 20x in five years, but had been a salvage stock three times before. The allure of the takeover is the prospect of multiplying your money in a share that everyone hates, but it’s not an area to bet the farm on.
I was charmed by Bluebird Toys by its CEO, Torquil Norman (father-in-law of venture capitalist Kate Bingham) who had been a popular client during my short time in corporate finance. The success of “Polly Pocket” has multiplied the shares, until then on the rocks. The boys’ version, ‘Mighty Max’, is named after me after a humorous exchange at the Earl’s Court Toy Fair. I cashed out soon after.
My most spectacular success was the most reckless. I bought two million shares in Cannon Street Investments at 2 pence, down more than 99% from their peak in late 1992, on the sole basis that Tom Long, whom I knew as former CEO of Souza Cruz (a subsidiary of British American Tobacco) had become chairman. Shares soared tenfold in a year or two as a messy, over-borrowed conglomerate was streamlined through divestitures. I then sold.
Regrets: I’ve had a few
My biggest regrets are not the duds I bought but the big companies I missed. Channel Express originated in the mid-1980s as an airfreight company. His boss, Philip Meeson, had been a Red Arrows driver and then started importing 2CV cars from France and selling them from a lot on King’s Road, London. The site was converted into a BMW dealership and later sold. Even though Meeson was clearly a serial entrepreneur, I didn’t see a long-term investment thesis there. The company is now called Jet2 and the shares have increased more than 100 times.
Another regret was Asos. At the beginning of 2004, we identified this e-merchant, whose idea was to reproduce clothes worn by celebrities at a lower cost and quickly, hence the name “As Seen on Screen”. We recommended the stock to our clients in the monthly newsletter at 25p…and suggested taking profits after they had doubled in six months. The shares then went up 100 times in ten years but have been on a yo-yo ride since then. I hope some customers did not sell.
What are the lessons? The best long-term investments are not get-rich-quick companies, but those that offer long-term compound growth. Holding them takes courage and patience as stocks are often volatile and can stagnate for long periods of time. It is tempting to give up and sell. If an investment is not suitable for the long term, it is better to be clear about this from the start because it makes the sale easier.
Buying to salvage can also be extremely profitable, but these are rarely “eternal” investments. Finally, good investments are found not through diligent research and endless company pitches, but through occasional recommendations, chance encounters, and inspiration, not sweat. As John le Carré wrote: “An office is a dangerous place from which one looks at the world.”