Lately you can’t open up any financial publication or website without seeing some investor prognosticate about what companies or industries are most ripe for this business strategy or that. Right now tax inversions are the craze. Just before the financial crisis it was private equity buy-outs. And divining potential stock buybacks never, ever goes out of style.
We wrote a little bit about inversions in the past. Is it a good business strategy? Perhaps. Lots can be said for lowering a tax bill and plowing cash back into new growth strategies such as new equipment, etc. or just plain giving the cash back to investors.
But is identifying potential investment candidates that might benefit from a change in business strategies like an inversion a bankable investment strategy? Not if that is your only goal in my view. However, in a strange way, I think looking at companies in that light is a healthy thing for the investment industry as a whole because it does get investors to get back to the basics.
How? The cynic in me sometimes thinks that we investors strive to make the due diligence process as complex and opaque as possible sometimes to justify our existence. Instead, I have always thought that the due diligence process was actually quite elegant—the vast majority of time we compare and contrast business models and structures. Period. And in reality, the differences in successful business models and structures are usually observable and repeatable across business sectors.
Often in my observation successful investments are based on answering a number of basic questions. These questions include but are not limited to: Does the model work over time? Is it differentiated? Is it defensible? Is it diversified? Do they have a solid business structure as measured by cash flows and healthy balance sheets to not only maintain but grow the model? Can a company change its capital structure to optimize those cash flows?
Ironically when I look at companies and think about if they are ripe for a tax inversion, I often start with those questions. Then I realize what I am really looking for is a well-run company that has a defensible business model that is difficult to replicate anywhere in the world, has the smarts to be fully knowledgeable of their business options, and has financial flexibility to endeavor those strategies. In other words, what I am looking for is a good, solid company that has a lot of solid options for its business. Tax inversion or not, that’s what we all strive to find as investors.