We often highlight the significance of competitive advantages, or “moats,” when choosing investments. Moats can be various factors, like brand power, cost leadership, or unique technology, that shield a company from competition and improve the likelihood of long-term success. While strong leadership is crucial, even the best leaders struggle in industries without these natural protections. But strong companies are resilient. When forced to choose between management and moats, moats often win.
Businesses with a solid track record, strong competitive advantages, and capable management teams are likelier to weather market downturns and outperform the broader market over the long term. Having smart people running a company is important. Still, it can be difficult for even the best corporate leaders to outmaneuver competitors in industries where cost advantages, brand power, intellectual property, and other drivers prevent most firms from gaining a toehold. Strong management is crucial. Even the best businesses with a solid track record can falter under poor leadership.
One major misstep management teams often make is overpaying for mergers and acquisitions (M&A). Research suggests that M&A has tended to destroy shareholder value. Not every deal is bad, but research suggests they rarely strengthen a company’s competitive edge. Remember the merger of Time Warner and AOL? The real danger is when companies make a string of bad deals. This can hurt shareholder value and put the company’s finances at risk. Just as investors need to avoid overpaying for stocks, management teams must avoid overpaying for acquisitions.
That’s one of the reasons that if forced to choose, Cardinal would instead invest in a business run by mediocre managers but operating in higher-quality markets than in a sophisticated management team managing a low-quality firm. If forced to choose, give us a moat over management any day. As famed investor Warren Buffett has said, “Invest in businesses that are so wonderful that an idiot can run them because sooner or later, one will.” This quote reflects that seemingly simple businesses with strong brand recognition and loyal customers can be resilient even with less-than-stellar leadership.
As always, valuation matters; buying good companies at attractive valuations increases your potential returns and margin of safety. Markets are dynamic. External factors like economic conditions, technological disruptions, and regulatory changes can impact even the best businesses. That’s why diversification is crucial.
This year we have already added two exciting small-cap companies to the small-cap portfolio, bringing new potential for growth and diversification. NVE Corp, based in Minnesota, harnesses the unique properties of electrons to create high-performance sensors and couplers. These tiny marvels are used in various industries, from manufacturing and research to healthcare. They are like the nervous system of machines, ensuring everything runs precisely and smoothly.
Helios Technologies, on the other hand, is a global leader in precision motion control. Think of them as the invisible choreographers behind everyday things like medical equipment, elevators, and even amusement park rides! Their expertise in controlling movement empowers various industries with reliable and innovative solutions.
Both NVE Corp and Helios Technologies are innovative and boast attractive valuations and experienced leadership teams. This combination positions them well for continued success, potentially translating into positive returns for your portfolio.
We are confident that these additions reflect our commitment to a disciplined, repeatable investment methodology. Ongoing research and portfolio management will help us navigate the year ahead. As we start the year, we invite you to reach out for a portfolio review.
Thank you for your continued trust.