“Never trust the story unless confirmed by price action”
– Mark Minervini, Author & US Investing Champion 1997 & 2021
arvy’s teaser: In today’s special edition, we present 15 essential charts that we look for in a “Good Story & Good Chart” business. Happy reading or watching!
Webinar by the CFA Society Switzerland
Table of Contents
Good Story
Moats
A «Good Story» starts with a company that has a durable competitive advantage or what Warren Buffett would call a moat.
Typical moats are:
- Intangible assets, such as patents
- Network effects
- Switching costs
- Cost advantage
- Efficient scale
Chart 1: Market Performance by Moat Rating and Moat Source
Source: Morningstar
A moat allows a company to keep the competition at bay and helps to achieve high and robust gross margins – the ultimate signal of pricing power.
Companies with high gross margins have greater leeway in coping with inflation.
See the example below and its impact on profitability.
Chart 2: Impact of input cost inflation on Hermès and Volkswagen
Source: arvy, Koyfin
The moat should be underpinned by management with integrity and «skin in the game». Not only for me as a co-investor in my own strategy, but also for the companies I buy into, I want people to have fire in their eyes for their company, their product and their vision.
Such characteristics are often found in founder-led or family-run businesses.
Founder-lead
Chart 3: Founder-Led Companies Outperform the Rest (based on S&P 500)
Source: Bain & Company, Harvard Business Review
Companies in which the founder or family still plays an important role as CEO, chairman, board member, owner or advisor are superior and exhibit more enduring performance.
Why?
We can trace it back to the way they built the company from the inside out. The DNA. The corporate culture. It affects everything. It will influence the success of the company on the outside for a long time.
Corporate culture is the cornerstone of any successful business.
Period.
Chart 4: Fortune 100 Best Companies to Work For
Source: Great Place To Work
Capital Allocation
Beyond that, Warren Buffett mentioned in his 1979 annual report that by far the most important financial metric and most important task of a CEO remains the following: The right allocation of capital.
It gives us an idea of the returns we can expect from a company in the future. For instance, if a business has shown a 6% return on invested capital (ROIC) p.a. over 20 years, it is unlikely to deliver more than 6% annually to shareholders.
Look for industries where there are high ROICs.
Chart 5: ROIC by Industry for the Russell 3000, 1990 – 2021
Source: Factset, Counterpoint Global
Share price follows earnings and sales growth over time. Seek organic growth in companies, though acquisitions can be acceptable if proportionate.
Noticeable, long-term focus reduces the significance of «multiples», justifying higher prices for quality organic growth.
Chart 6: Sources of Total Shareholder Return for Top-Quartile Performers, S&P 500 (1990 – 2009)
Source: BCG Analysis, Morgan Stanley Research
Free Cash Flow
Cash is king.
It is the lifeline of a business. With strong free cash flow generation, companies can do great things, provided the CEO and top management make the right decisions:
- Invest capital with a high return
- Make smart acquisitions
- Reduce debt burden
- Buy back shares
- Pay dividends
As for valuation, focus on free-cash-flow yields. There is less accounting gimmickry here than with profits.
After all, profits are an opinion.
Cash is a fact.
Chart 7: Valuation Metrics, The Power of Free Cash Flow Yield, 1991 – 2022
Source: Factset, PACER ETFs, Data calculated based on the top 100 companies in the Russell 1000 Index for each valuation metric.
Net Debt
This one is simple.
We do not want to own businesses with a lot of debt. We do not want businesses that rely on leverage to make money.
Gordon Gekko preached this back in the 1980s.
A movie worth recommending…
Chart 8: The movie Wall Street, 1987, with the corporate raider Gordon Gekko
Source: arvy, Unsplash
Structural Tailwinds
Why invest in struggling companies and fight the trend when we can choose those with favorable tailwinds?
Let’s take a break here and summarize a “Good Story”:
A broad economic moat, management with integrity, low capital intensity and high returns on invested capital, good capital allocation, high profitability, low debt levels, attractive historical growth and a strong secular tailwind: If you can acquire companies with these characteristics at a fair valuation, you will see great results over time.
Yet…
Chart 9: Example of structural tailwinds
Source: arvy
Good Chart
… one can easily fall in love with a «Good Story» because it has a larger subjective component.
Consequently, we take an objective solution at hand – the “Good Chart”.
Recognizing a clear regularity in market action, at arvy, we focus on four factors that we have seen time and again in the best-performing stocks over the past 140 years:
- Accumulation and relative strength
- Strong price development
- Price linearity
- New highs
Chart 10: arvy’s proprietary screening of the equity investment universe
Source: arvy, per Q4 2023
Relative Strength
Accumulation and distribution are reflected in the main cycle concept we follow: Stan Weinstein’s stock price maturation cycle.
You will find this price behavior repeatedly in market leaders.
Stay tuned for the last chart.
Chart 11: Stock Price Maturation Cycle by Stan Weinstein
Source: Stan Weinstein, Secrets for Profiting in Bull and Bear Markets
In 1989, Warren Buffett called Peter Lynch because he wanted to include a passage from his highly recommendable book, «One Up on Wall Street».
It was, «Selling your winners and holding your losers is like cutting the flowers and watering the weeds». Or as Lynch opined, he cited his biggest mistake.
Look for quality stocks with price leadership. Stocks that outperform.
Once identified, let them run.
Chart 12: L’Oréal and its relative strength line (green) vs Euro Stoxx 50
Source: Tradingview
Linearity
The fact that a company’s share price has increased by 100% in the last ten years says nothing about whether the growth has been continuous or over a short period of time.
We prefer consistent continuous growth.
Stock market sayings like «The trend is your friend until the end when it bends» are not just pretty phrases.
Chart 13: Focus on the bottom and neglect the top, price linearity reflects strong fundamentals
Source: Tradingview
New Highs
All big gains in a stock’s price come from new highs. A stock cannot make a big move without making new highs.
In between, you lose money or time. If you want a chance to own a future winner, you must own it when it makes new highs, otherwise how could Apple have become a multi-trillion company?
Bottom fishing and picking turnaround stories is not only unnecessary, it is not where the big money is made in the long run.
Chart 14: The money is made with new highs (green dots)
Source: Tradingview
Lastly, I would like to present you with one last chart that comes with one last message.
I back it up with my favorite quote from Jesse Livermore, the trading legend in his heyday in 1907: «There is nothing new in Wall Street. There cannot be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.»
Recall Stan Weinstein’s stock price maturation cycle from earlier? Not to mention that the charts are 300 years apart.
You see, chart patterns do not repeat.
But they often rhyme.
Chart 15: South Sea Bubble (1720) vs ARK Innovation (2021)
Source: arvy, Marc Faber, Tradingview
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