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25 Feb 2022
Battle of the brands
The importance of good capital allocation decisions during a recession
At the start of the pandemic, I co-hosted a Zoom presentation with a friend of mine who heads brand strategy for a number of the world’s largest consumer brands. We were speaking to a group of investors about what companies spend money on during a recession.
In the finance industry, we describe a company’s spending as “capital allocation”. Those companies that master it can come out on top, even during the toughest times.
A generally accepted approach to capital allocation
Conventional wisdom suggests that, when consumer spending drops, business spending must drop in turn.
History shows that the parts of a business which are considered ancillary will typically see the largest cuts when times get tough, and it can take years before the impact is felt on the bottom line. After all, it’s much easier for management to let go of a few people in their marketing teams than it is to mothball a factory or tell a pension fund that their dividend isn’t getting paid this year.
This approach could be considered akin to hibernation: waiting out a difficult period to prioritise survival. With the majority of companies choosing this strategy, there is a golden opportunity for those who think differently.
The value of making bolder decisions
The Outsider by William N. Thorndike Jr is a book that is considered a favourite of legendary investor Warren Buffet. It follows the CEOs of 8 companies that have outperformed the S&P 500 Index in the US by a factor of twenty during their tenure. Although they have all in different industries, they have all shown an ability to know which spending taps to turn and when.
I spoke with our media analyst, Simon Lapthorne, and he gave me the most fitting historical example. Have you ever heard of Post’s cornflakes? No? I thought not. But you have heard of Kellogg’s, right?
The story is that Post and Kellogg’s were started in Battle Creek, Michigan, in the early 1900s by CW Post and WK Kellogg. They were the number one and two cereal brands in the US and a similar size to one another.
In the 1930s depression, Post battened down the hatches, cut spending and waited for the good times to return. Kellogg’s, on the other hand, doubled their ad budget, moved aggressively into radio advertising, and heavily pushed its new cereal, Rice Crispies. By the mid-1930s, despite an awful economic backdrop, profits were up more than 30 per cent and they staked their claim as the dominant cereal manufacturer, which continues to this day.
It may not apply to every company, but it certainly bears consideration. The time to advertise to get people into a store is when the store is empty, not when it is full of people.
Turning a crisis into an opportunity
History shows that, during a recession, those companies which are in a strong position already will emerge in a stronger position at the end of it. They can afford to take risks when others are looking to survive.
Baron Rothschild of the famous Rothschild banking family is credited with saying “buy when there is blood on the streets, even if the blood is your own.” It is a virulent expression that has often been regaled by business magnates including Warren Buffet and John Rockefeller. For shareholders, the best companies are those that know how to make the most of a bad situation.
During the pandemic, many companies have been affected and the human toll is unthinkable. Our view is that companies that have prepared well and have sought opportunities to grow will stand in a stronger position in future.
At Investec, we have a bias towards investing in quality growth companies for our clients which we feel are positioned to win market share from weaker competitors. We are long-term investors and believe that owning companies that are best in class will deliver superior long-term performance.
With investment your capital is at risk.