A quant scan for good capital allocators

Over the past few weeks I’ve been doing some in-depth due diligence on a potential investment that operates in the advertising industry. A key focus of my DD process is the sustainability of customers and their associated annual spend – recurring revenues from loyal, sticky customers are high on my priority list. A quick way to check the durability of a firm’s revenues is to take a look at how they performed during the most recent recession – in this case, the 2008 Global Financial Crisis. While the company I’m looking at performed “ok” throughout this period, one thing I did notice was the exceptional performance of two peers – WPP & Omnicom. Not only did both firms manage to maintain/grow revenues throughout the period, they aggressively repurchased shares as their stock prices collapsed, generating substantial shareholder value in the following years. This is a sign of a tremendous capital allocation decision, because, companies on average tend to destroy value through share buybacks. Making aggressive purchases at market peaks, when multiples are high, and sitting on piles of cash when Mr Market offers bargain prices for their stock.

This got me thinking, wouldn’t it be interesting to go through a list of companies that reduced their share base throughout the 2007 – 2009 period? While it may not necessarily signify superior capital allocation skill for each firm in the list, surely it would throw up a few interesting ideas. At the very least, it should highlight companies that remained prosperous throughout the worst economic downturn since the Great Depression.

Criteria

• Limit universe to Western Europe & the UK (this is my area of focus)
• Exclude companies with a current market cap >US$1bn (this is my area of focus)
• Exclude companies with current insider ownership < 2.5%
• Exclude companies who weren’t listed as at 1/01/2007

Results

The above criteria generated a list of 1,087 securities. I then wanted to sort the results to find good capital allocators. I defined this for simplicity as those companies which reduced the number of shares outstanding over the period from FY07 to FY09. Three hundred and twenty two companies passed as good capital allocators under this crude definition. This percentage, roughly a third of the total population, surprised me because, in my experience, good capital allocators are few and far between. The number could probably be reduced by excluding financials which may have had some funny business going on with their capital structure over the period, but nevertheless, it’s still a large number.

Now the fun part begins – going through each firm, one by one.

“The person that turns over the most rocks wins the game” – Peter Lynch.