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Why value investors plan for the worst rather than hope for the best

13/06/2017

Andrew Williams

Andrew Williams

Investment Specialist, Equity Value

Time is an important commodity when it comes to investing and exciting growth companies with shaky finances tend to have a lot less of it than more solid ‘deep value’ businesses

Time is famously said to be a great healer – and its powers are not, we would argue, limited only to curing physical and emotional knocks. The better a company’s finances – that is, the stronger its balance sheet and the less debt it has – the better able it will be to weather difficult markets or rough patches of its own. In short, time will be on its side.

The results of a recent poll of founders of new businesses carried out by data analyst CB Insights are therefore especially troubling. Asked, if their start-up was “burning money”, how long they could last before having to go to the market to raise more cash, 21% were confident they could survive two years, 13% reckoned 18 months, 27% thought just a year and 39% were hopeful they could manage all of six months.

In total then, two-thirds of new business founders did not believe they could last a year before throwing themselves on the mercy of the markets to raise more money. Here on The Value Perspective, we find that a startling number because, while we spend our lives looking at ‘deep value’ distressed businesses, the key risk that concerns us is not their share price volatility but the chance we will permanently lose our money.

As such, the companies we invest in must be confident – as must we – that, if (when) they hit the tough times any business experiences sooner or later, their balance sheets are strong enough to see them through and, if they have any debt, they have a credible plan to reduce it. This approach of planning for the worst is the polar opposite of investors who, in buying into exciting new start-ups, are merely hoping for the best.

If the CB Insights poll is anything to go by, time is not on their side.

Author

Andrew Williams

Andrew Williams

Investment Specialist, Equity Value

I joined Schroders in 2010 as part of the Investment Communications team focusing on UK equities. In 2014 I moved across to the Value Investment team. Prior to joining Schroders I was an analyst at an independent capital markets research firm. 

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