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The Importance of Quality

The Ham-Sandwich Proof Business Model

Annabelle Miller
Annabelle Miller

Investing over the long-term requires a nuanced understanding of what distinguishes a merely good business from a truly great one. The essence of making astute investment decisions often boils down to the ability to discern quality, a trait that ensures a business's resilience and profitability through various market conditions. By examining diverse and successful business strategies, we uncover principles that guide the identification of exceptional companies capable of thriving under any management. Here, we highlight examples to help understand how quality, in its multifaceted dimensions, becomes the bedrock of enduring investment success.

In our recent article, Quality Investing: Not Just a Wallflower, we highlighted that by recognising these fundamental characteristics that define quality companies, investors can more confidently weather market cycles. An understanding of what makes these companies tick is crucial for long-term success, allowing investors to reap greater rewards by focusing on these quality attributes.

The common typical factor approach to identifying such quality businesses involves analysing numerical measures to distinguish quality businesses including high return on investment (ROI) and high return on equity (ROE). However, integrating these quantitative metrics with qualitative insights is crucial. It is important to overlay the quantitative with the qualitative. 

Qualitative characteristics of quality business models lie at the centre of highly profitable franchises that are uniquely positioned to weather the volatility of market cycles and economic regimes. To unearth these exemplary business models, some of our investment team have shared their qualitative insights.

The Ham-Sandwich Defense

Investing for the long term is an art that hinges on the ability to distinguish good businesses from truly exceptional ones. Warren Buffett's advice to Bill Gates, suggesting that the hallmark of a sound investment is a business that could thrive even if managed by a ham sandwich, underscores the significance of quality.

This principle forms the cornerstone of our investment philosophy, emphasising resilience and profitability across market conditions. For investors, the underlying message is to invest in companies that have such strong fundamentals and competitive advantages that they can succeed and endure even with less-than-stellar management.

It’s important to understand both the narrative of an investment and the numbers that support it. Investing on narrative alone, ignores reality. Investing on numbers alone, ignores potential. Qualitative information helps understand and capture the narrative behind the numbers — crucial in forming a critical assessment.

The essence of a truly quality business model goes beyond just quantitative metrics. It's the qualitative characteristics—such as brand strength, customer loyalty, and market positioning—that often determine a company's ability to withstand the test of time and management challenges.

Case Studies: Demonstrating Quality Across Industries

Our investment team's qualitative insights further reinforce the belief in quality as a guiding principle for investment. By asking ourselves “which business model we would choose if limited to just one”, we uncover preferences that reflect deep convictions about the enduring nature of quality investments.

Low-Price Providers at Scale

One high quality business model favoured by the team are low-price providers backed by scale economies. Companies like Aldi (Private), Costco (NASDAQ: COST), and Interactive Brokers (NASDAQ: IBKR) are examples of businesses leveraging scale economies to offer compelling value propositions, thereby ensuring customer expansion and reducing competitive threats.

Low-price providers offering a compelling customer proposition leads to a continually expanding customer base from word-of-mouth. If it's backed by a company with a significant cost-of-production benefit (typically scale and other execution factors), it significantly reduces disruption risk and competitive threats.

Interactive Brokers, with its low-cost services and infrastructure that supports other broker businesses, illustrates how operational efficiencies can underpin a competitive offering. Interactive Brokers has the lowest-cost-to-serve and best-execution and is increasingly becoming a utility to the broker industry, allowing others to build broker businesses on its infrastructure.

Value Through Customer Wallet Share

Those companies that provide products and services commanding a low share of the customer wallet, distributed by a trusted middleman are another favoured business model among the ECP investment team. These businesses provide essential services at a low relative cost to customers, thereby achieving low churn and pricing power.

Companies like Xero (ASX: XRO), have seen rapid success, due to the quality nature of their business model. Xero charges its small business customers $30 a month, and is recommended by the customer’s accountant, making customers very sticky. It took a technological shift to the Cloud for Xero to unseat MYOB in that market.

When a product is a small fraction of the entire cost of a service in a large market, management can raise the price without anyone caring. When the product is being recommended by a trusted source to an end customer it increases the stickiness and it provides more pricing power. 

Evaluating a business's quality crucially involves examining its capacity to increase prices without surrendering market share to competitors. Echoing Buffett's sentiment, if a management team must resort to prayer every time it considers a 10% price hike, that business is fundamentally flawed.

Capital-Light Compounders

Capital light compounders offer a proven format that can efficiently expand their economic footprint by embracing store rollout models that utilise franchising or reinvest free cash flows from cost-effective operations, ensuring rapid and predictable scaling with minimal financial strain.

Lovisa (ASX: LOV) is an attractive growth story with a global store rollout opportunity. Lovisa’s vertically integrated business model underpins their high gross margins, enabling rapid speed to market. Lovisa is a prime example of a store rollout model where the company strategically opens stores in high-traffic areas of shopping malls, maintaining a compact yet efficient store size of 50-100 square metres with a relatively low build cost.

The product planogram is designed centrally, using the prior week’s sales data, meaning a methodical approach to inventory that allows Lovisa to maximise profitability at the SKU level. Here, this demonstrates the potential of capital-light models to achieve high ROIs through careful, data-driven expansion and management strategies that are replicable in different geographies. 

Unique Physical Infrastructure 

Those companies that leverage hard-to-replicate physical infrastructure at scale have a greater ability to drive best-in-class unit economics over the long-term.

Copart (NASDAQ: CPRT) has distinguished itself by integrating scarce physical infrastructure into its business model, achieving a unique position in the market.  Over the years, the company has strategically acquired land in key locations worldwide to establish its salvage yards, enabling them to create a leading online auction platform for salvage vehicles.

By capitalising on its extensive network of yards, Copart’s superior unit economics are a function of the accumulation of these salvage yards over time. Competitors will find great difficulty in being able to replicate the network footprint to effectively compete with Copart, meaning they would struggle to deliver the same unit economics.

Quality Investing for Long-Term Success

Focusing solely on quantitative measures can lead investors to overlook the sustainable returns a business can offer. It's the qualitative characteristics—those that contribute to a business's unique competitive advantage—that ensure longevity and shape the return profile of quality franchises.

As investors, our goal is to build a portfolio of companies that not only exhibit strong current performance metrics but also possess the qualitative attributes necessary for sustainable success. By adhering to quality principles, such as our ‘Pillars of Quality Franchises’ framework, investors are able to balance quantitative analysis with qualitative insights.

For those investors that seek to achieve enduring returns, identifying the highest quality investments are indeed those robust enough to thrive, no matter who is at the helm. Even a ham sandwich.

The article has been prepared by ECP Asset Management Pty Ltd (ECP). ECP is a funds management firm based in Sydney, Australia. For further information, visit This material has been prepared for informational purposes only and is not intended to provide and should not be relied on for financial advice. ECP and the author own shares in Interactive Brokers LLC, Xero Limited, Lovisa Pty Ltd and Copart Inc. ABN 26 158 827 582, AFSL 421704, CAR 44198.

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