Quality Discovery and <IR>

Posted
26 January, 2017

For a growth investor like Comgest, focusing on quality is one of the very few practical approaches to increase our odds of investing in companies that will indeed profitably outgrow expectations already priced in their shares. Notwithstanding the tendency of investors to look for simple answers to complex questions, companies can certainly do a better job at revealing their quality thanks to better reporting. But what is quality at its core? The UNESCO defines quality as “a measure of fitness to purpose”. And as Peter Drucker wrote, a business is defined by its purpose, which is to turn a social problem into an economic opportunity. How do you then turn a social problem into an economic opportunity?  You achieve this through innovation and differentiation. The innovation solves the social problem while the differentiation secures the economic opportunity. Through intelligent organizational design, innovation and differentiation then enable a business model to emerge and create sustainable value. So value creation always starts (or ends) with the customer; which is something investors forget too easily at their own perils.

What the customer buys and considers value is never a product. It is always a perceived utility, i.e. what a product or service does for the customer. Quality in a product or service has never been what the company puts in, rather it is what the customer gets out of it and is willing to pay for. As this value is never obvious or granted forever, companies should be more explicit about the outcomes they aim to generate for their customers and why. For long term investors like us, understanding this is absolutely key to assess the sustainability of profits. Unfortunately, companies are often unclear or too general when they communicate on this in their annual reports.

Importantly, the link between the quality of a company and its purpose and culture should be front and centre for the board of directors. When setting goals and assessing performances of senior executives, the board should ensure that the specific purpose of the company is clear and that everyone feels excited and accountable. Ensuring the executives have superior intrinsic motivations for the job and excellent business ethics will always beat any systems based solely on financial rewards and punishments.

A strong corporate culture and purpose creates a group of intrinsically motivated people brought together with an outstanding ability to give birth to genuine innovations, thanks to the trust that they share between them. It is a remarkable concept: only when individuals can trust the culture or organisation they belong to, will they take personal career risks in order to advance that culture or organisation as a whole. So in order to grow with quality, the goal is not to hire people who simply have a skill set you need nor to persuade customers who simply have money to spend it with you, the goal is to hire people who believe what you believe and who are excited to solve the problems of those clients who actually also share those beliefs.

Those traits are the ones that enable some companies to have corporate strategies and CSR / Sustainability strategies fully indistinguishable and which serve the greater good of civil society while making significant profits. And this is why Comgest has been a strong supporter of Integrated Reporting from day one.