This book details the investment philosophy of London-based AKO Capital Management where it started as an internal project to share their body of knowledge with new team members. It presents the concept of quality investing as a sort of third way that isn't growth or value but draws on elements of both.
First, quality investing is defined using a number of "building blocks" that these companies tend to share. Then they run through some "patterns" or common industry set-ups and company attributes that have historically produced quality businesses. And the book finishes by outlining the "pitfalls" or traps that investors fall into and market forces that can make companies falsely project quality.
Here's my attempt to concisely summarize the central idea: Due to a rare combination of several factors (the two most important being the durability of advantage and the runway for reinvestment and growth) there is a class of company that is able to maintain its competitive advantage over an exceedingly long time frame. It is unlikely these companies are ever statistically "cheap," but their premium is warranted because the duration of their competitive advantage will lead to above-market returns for a longer-than-anticipated time.
Quality investing defined
It is first acknowledged that everyone you ask will offer a different definition of quality and that the best definition is some variation of "you know it when you see it." Nonetheless, it is presented as follows:
“In our view, three characteristics indicate quality. These are strong, predictable cash generation; sustainably high returns on capital; and attractive growth opportunities. Each of these financial traits is attractive in its own right, but combined, they are particularly powerful, enabling a virtuous circle of cash generation, which can be reinvested at high rates of return, begetting more cash, which can be reinvested again.”
Critically, the authors call out the industry structure in which a company operates as a key determinant. "even the best-run company in an over-supplied, price-deflationary industry is unlikely to warrant consideration."
Below are the "building blocks" that AKO believes tend to be shared by quality companies and their sub-parts that are each spelled out in detail:
Capital allocation (growth capex, R&D, M&A, dividends and buybacks, working capital)
Return on capital (returns, asset turns, profit margins)
Multiple sources of growth (gaining market share, geographic expansion, pricing mix and volume, market growth)
Good management (discipline, independent, long-term, and tenacious, out of the limelight, candor)
Industry structure (mini monopolies, oligopolies, barriers to entry, obscurity)
Customer benefits (intangible benefits, assurance, convenience, customer types)
Competitive advantage (technology, network effects, distribution)
Other takeaways
A recurring theme that I hadn't considered is the fact that family-owned or controlled businesses are often underappreciated. Truly patient, long-term-focused management that isn't accountable to a shareholder base that is in turn accountable to customers with a short time horizon, is a massive advantage that allows management to allocate capital for the long-term and be more concerned with longevity than near-term returns.
I found the use of case studies in the book to be additive when they can sometimes be an unnecessary distraction. They were often less than a page long and told a short story of a single company that exhibits the trait in question. They also provided insight into some of the specific companies that AKO has owned over the years. Some examples include L’Oréal, Diageo, Assa Abloy, Unilever, H&M, Luxottica, Rolls Royce, Ryanair, Hermés, and others.
Noticeably absent from the list are the fang names or any in the class of high-growth tech that have, as a result of their track record and media attention, become viewed as the only stocks worth owning. As you read the list of "quality" attributes, they seem to include if not favor technology companies. However, I found it insightful to read about applying frameworks I'm familiar with around network effects, barriers to entry, etc. to companies in industries like fashion, chemicals, or cosmetics.
Overall, I found the book to be a concise and compelling dive into a specific investment philosophy. It's not going to provide step-by-step instructions on how to find the next quality company (surprise, no book will). Instead, the book examines business characteristics that AKO believes lead to investments that check all their boxes. I find it useful to train your own pattern matching ability with other people's experience as well.