Investment process - The analytical process

The starting point for assessing a potential investment, whether long or short, is to analyse the business and financial components of a company. There are a number of distinct characteristics, good and bad, that Cartesian looks for.

Cartesian favours companies with the following characteristics:

Growth:	Sustainable in the long term. May come from organic development or be supplemented by sensible acquisitions. If possible, should be supported by a historic pattern of sales volume and profit margin progression.
Market position:	Secure position based on supply barriers and/or excess demand, providing some pricing power.
Free cashflow:	Sufficient to fund a combination of organic growth, acquisition activity, sustainable dividends and share buybacks.
Financial strength:	Robust under a range of market and economic conditions. Likely to reflect asset backing and sensible levels of gearing.
Restructuring:	Potential for strategic change leading to value release through divestment or demerger.
Corporate activity:	Background transactions involving private equity or trade buyers at premium valuations.
Recovery:	‘Below-normal’ trading performance with catalyst for change either through management or market environment.

Cartesian avoids or shorts companies with the following characteristics:

Aggressive accounting:	In spite of the implementation of International Financial Reporting Standards, there is still scope for companies to manipulate their earnings and financial position, for example through accelerated revenue recognition, cost deferrals or off balance sheet liabilities. Cartesian is alert to this and unexpected changes in accounting policies.
Low earnings quality:	Cartesian likes to see a close relationship between reported profit, cash generated and tax paid. Poor conversion of profit into cash, low effective tax rates or cash tax paid to the Inland Revenue, are all warning signals of low earnings quality. The team also looks for recurring exceptional costs, which may indicate underlying trading difficulties. They are also suspicious of profit margins that significantly exceed a company’s historic record, or that of its peer group, and which may be unsustainable.
Financial weakness:	Symptoms include heavy on and off balance sheet debt levels, overdependence on short-term facilities, large working capital requirements and significant pension or lease commitments. This could lead to excessive dependency on the support of capital markets. Cartesian also monitors rating agencies and debt market activity to identify distress potential.