Investing for the long term: 'Future Quality' companies

Firstly, we look at value creation models within firms. We assess the level of excess cash return on invested capital earned by firms and the sustainability of those returns into the future by looking at the importance of a firm’s competitive advantage period.

Secondly, we analyse past stock market returns to highlight that it is not merely the level of excess cash return on invested capital earned by a company that drives shareholder returns. Rather, the market rewards companies that can allocate capital to improve cash returns on investment and maintain their competitive advantage.

Finally, we assess the role of growth and its impact on shareholder returns for businesses with high, medium and low cash return on invested capital structures.

Drawing on this academic research, we explain in detail what we mean by ‘Future Quality’ and why we believe it leads to long-term outperformance. If an investor can anticipate a meaningful positive change in excess return (cash return on invested capital less cost of capital), identify firms that have a longer competitive advantage period than the market anticipates and can reinvest those excess returns into the business (growth), they should generate shareholder returns above the market. These are the characteristics of a ‘Future Quality’ company.

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