The Illuminator – May 2024

The Illuminator – May 2024

The Illuminator has outperformed the UK All-Share index on a six-month and one-year basis. Although the Illuminator has lagged in recent months and over a three-year basis, the portfolio continues to demonstrate its ability to generate robust returns. We remain confident in the fundamental law that companies that generate returns in excess of their cost of capital will deliver positive returns for shareholders over time. Proving this, the Illuminator has significantly outperformed the UK All-Share since inception by 1,319%.

Written by

Neil Shah

We have explored the inner workings of the Illuminator to review the fund’s top 10 holdings, which read like a ‘who’s who’ of Britain’s brightest companies.

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What makes a company shine? The 10 key criteria of The Illuminator:

1. High-quality product or service

These two factors are unavoidably interlinked and have a foundation in basic classic economics. Differentiated products and services, which are often highly specialised or value added, help provide defensible (and often first-mover) advantages that are typically seen in terms of dominant market share. Tangible examples include the existence of patents, advantages in low-cost production, superior distribution or IT. More intangible examples could include human capital, customer service and branding. We do not (as yet) have an objective mechanism for capturing this and rely on our more subjective analysis and experience. Against this background, for each company that appears in our screen, we feel it integral to meet management face to face and subsequently maintain an ongoing dialogue.

2. Superior management

While somewhat subjective, assessing management quality is as important to us as the fundamentals of a business. We use total shareholder return as a mechanism for capturing this. For companies that we add to our portfolio, we look to meet with management and expect to see evidence of a well-defined business plan with clear targets; we also look for focused businesses. In addition, we expect management teams to be pioneering, with a clear vision, the ability to anticipate change, adapt and – above all – act in the interest of shareholders.

3. Larger than average compound earning

High earnings growth over a business cycle should be the logical companion of high-quality products/services and superior management teams. We acknowledge that in an environment where flexibility over pricing and margins has its limitations, demand (for products/services) must be sustainable for earnings growth to be generated.

4. Consistency and predictability

Economic cycles happen and can cause significant variations in a company’s operational performance. Our contention, therefore, is that if there are recurring patterns of demand for a company’s products/services, it should be less at risk to changes in the economy and its earnings, correspondingly, should be more predictable. Investors will also likely recognise consistency and predictability by attributing a higher multiple (of earnings, etc) to that business. We measure this factor in terms of a standard deviation, where the closer the figure is to zero, the better a company’s earnings consistency.

5. Projected annual growth in earnings

While track record is important, we feel future earnings potential also matters. We rank companies by forecast earnings growth for the next three years. We use consensus estimates and look to roll forward our three-year time horizon regularly. Longer-term growth is, in our view, indicative of a company’s ability to grow above the rate of the economy and have sufficient pricing power to offset inflation. Against this background, investors should be willing to reward a higher projected growth rate via higher multiples.

6. Balance sheet strength

We expect companies to be in a position to finance their own growth: over the course of an economic cycle, we look at overall financial leverage. Robust balance sheets can help reduce earnings volatility and write-downs.

7. High profitability

Expansion and delivery on growth and profitability strategies are shown by improving levels of capital return. Moreover, companies with high levels of returns on capital should be in a stronger

position to return capital to shareholders. Investors also tend to reward improving capital return levels in the form of higher multiples.

8. Free cash flow generation

Well-managed businesses typically have strong free cash flow-generating abilities, a function of the fact that they tend to be less capital-intensive in nature and/or produce high capital investment returns relative to their assets. Shareholders are often the beneficiaries of management’s ability to generate free cash flow and are typically rewarded via dividend payments and/or share buybacks. As with return on capital, there are a number of ways in which free cash flow generation can be defined.

9. International competitiveness

This factor is not applicable to all companies in our universe, but our contention is that globally leading companies with sustainable competitive advantages and/or differentiated propositions (as in our first quality characteristic) have the ability to develop via geographical expansion, resulting in market share gains. Global competitive decisions may also have a greater influence.

10. Valuation: Reasonable purchase price

We believe in investing in growth at the right price: high-quality companies with above-average growth prospects, good financial discipline and an attractive valuation typically generate above-average returns. We recognise that investors should be willing to pay more for higher quality, but context is everything. We assess ‘reasonable’ purchase price using forward earnings and EBITDA multiples, and assess ‘reasonability’ in an absolute, sector-relative and market-relative context.


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