The Four Things Matt Sweeney Looks for in a Stock

During their recent episode, Taylor, Carlisle, and Matt Sweeney discussed The Four Things Matt Sweeney Looks for in a Stock. Here’s an excerpt from the episode:

[Matt] Yeah. I mean, I start with a couple of main questions. And the first one is just, is it a good business?
And it’s totally possible to make money in the market by owning crappy businesses and hoping they get less crappy. And it’s a completely valid strategy. I just know for me in a concentrated portfolio, I sleep better at night, knowing that the business is good in quotes and good can mean a number of different things.

It could be on the quantitative side, like returns on equity or returns on capital. It could also just be the idea of close your eyes and try to envision what the future will look like in five or 10 years and think that the business will be reasonably similar. I don’t do a lot of things that are very tech forward and you have to kind of predict how the world is going to evolve around the business.

So, you know, a lot of, I like, for example, a lot of like services businesses and things like just to pick one out of the portfolio, like fire prevention. I don’t care how the world changes. We’re still going to need to prevent fires.

And like, there’s not a tonne of brainpower that needs to go into that statement. Fire is bad. I feel very strongly about that.

So, you know, stuff like that could be a good business on just like, you know, a sentence that my kindergartner can understand. Like fire is bad. That makes it a good business.

It’s more deep than that, but that’s just like the place to start. And then the next question is just understanding who we’re partnering with. And I typically look for some combination of either a management team that owns a lot of stock, a board of directors that owns a lot of stock, or maybe it’s an activist investor that’s recently got involved, but I want someone with skin in the game.

Someone that’s going to be there to, you know, keep an eye on the business at a closer level than I will ever be able to do as an outside minority investor. And again, that’s the sleep while at night. Then the next piece is kind of understanding how a business performs through a cycle.

And that could be the macro cycle. It could also be an industry specific cycle, but want to recognise that nothing goes smoothly forever. You know, there’s going to be a time when the business hits a bump in the road, whether that’s their own doing or something external to what they’re doing, but you feel better about them being able to survive that period cleanly.

So that could be a rock solid balance sheet. It could be recession resistant or recession proof cash flows. It could be a history of being acquisitive during downturns.

It could be, you know, buying back stock, but just a view on how they’re likely to behave when things get difficult, because those difficult periods are always around the corner. We just don’t know how far away that corner is. And then the last one that I spend a lot of time on is understanding why something is cheap.

And you know, why, why am I so lucky to find this opportunity in the market with the general idea that most of the time the market is efficient and you could find these sort of wrinkles or repeatable repeatable setups that indicate that something might be cheap. And the way I think about it, mostly we touched on a little bit brief or a little bit earlier with the idea that so much of the market is dominated by quant funds and what are the things that could kind of trick the quant funds. And at a very, very high level, all the quant funds in the world only have two sets of inputs, right?

And one of those is trailing financials and the other one is forward financials. So by going small cap where there’s maybe less sell side coverage, you can maybe even reduce or remove the impact of those forward financials if there’s no forward inputs to feed into the quant model. And then two is just like what is going on that might hide the actual potential of the business through the gap financials.

And it could be anything like, you know, a recent acquisition. It could be an off balance sheet asset. It could be recent divestiture.

It could be actually recently I’ve had a lot of success with, you know, unknown legal outcomes. I hope there’s some sort of pending litigation, for example, some sort of regulatory review, but all these things that just don’t show up in the numbers, but very clearly are going to have an impact on the future earnings power of a business. And if you could kind of find an opportunity where you have a good business led by good people, that business does well through cycles.

But right now there’s some sort of temporary problem or it doesn’t have to be a problem. It could be an optical issue with the gap financials or something like that, but something to just indicate that what you see on the page and in front of you with a quantitative screener does not tell the whole truth. And then the job is figuring out what is the whole truth and how predictable is it?

And will that whole truth be surfaced over a reasonable investment timeline? For me, that’s typically three to five years. And then what is the market likely to do when it sees the normalised earnings power of the business a couple of years out?