Billionaire Bill Ackman is one of the most-quoted investors in the financial press. With a net worth of about $3.6 billion, according to Forbes, when Ackman speaks, many people listen.
He often makes headlines due to his short-selling of big-name stocks, which paints him as an aggressive contrarian. But his fundamental investing advice is actually closer in nature to that of Warren Buffett, another well-known billionaire investor who’s generally seen as a bit more conservative in nature.
Here are the investing “commandments” that Bill Ackman has said are the secret to his success, along with a look at how he implements them and whether or not they may apply to your own investment portfolio.
An Investment Must Be a Simple, Predictable, Free Cash-Flow Generative, Dominant Business
One of the many reasons why investors aren’t able to keep up with the market averages is that they’re often looking for some type of edge. “Boring” companies with regular, predictable cash flow aren’t necessarily glamorous or exciting, so more speculative companies with exciting names or products often draw investment dollars.
However, according to expert, billionaire investors like Ackman — and like Buffett, for that matter — the companies you should actually be focusing on are those dominant, established businesses that generate prodigious cash flow. When you take out the emotion from investing, this principle actually seems as obvious as it should be. What other type of company would you want to own except one that dominates its industry, is understandable by everyone, and continually generates large amounts of cash flow? Yet many investors still tend to overlook them.
An Investment Should Have a High Return on Capital, a Strong Balance Sheet and Limited Need for Outside Funding
According to Ackman’s philosophy, the best investments are essentially self-supporting. Businesses that generate a high return on capital can use their own money for expansion or growth. This protects them from relying on debt or outside capital, which can dilute profits or increase interest expenses. It also validates the business model of the company, as it is able to generate profits based on demand for its products.
An Investment Should Have Limited Exposure to Uncontrollable Risks, Excellent Management and Good Governance
All businesses have risks, but Ackman focuses on those with limited exposure to extrinsic variables that it can’t control. He also chooses companies with managers who understand how to run their businesses in an appropriate way.
Of course, as a billionaire investor, Ackman is able to lean on companies and influence them to act in ways that maximize their profitability. But if a company already has an excellent management team, it makes Ackman’s job that much easier.
How Do Ackman’s Investment ‘Commandments’ Translate Into Portfolio Construction?
Ackman’s desire to find consistent, reliable, easy-to-understand businesses serves another important purpose in terms of his portfolio construction. When a business is easy to analyze, it makes it easier to find a fair value for it. In turn, this suggests when a company is undervalued or overvalued.
For an investment manager like Ackman, this is the essence of his entire business: finding undervalued companies and buying them at a good price. If Ackman can easily pick apart a company’s financials and see that it should trade at $80 per share but is currently at just $50, for example, that means it’s likely a good time to buy — assuming the company passes all of Ackman’s other screens, such as having a good management team, not relying on outside capital and so on.
How Can You Apply Ackman’s ‘Commandments’ to Your Own Investments?
You don’t have to be a billionaire to use some of Ackman’s financial advice for your own portfolio. Of course, you won’t have the financial leverage that Ackman has to influence how companies do business. But you can follow his strategy of investing in easy-to-understand, cash-generating businesses that are well-run and predictable.
More than anything, these “commandments” will help protect you from making big mistakes with speculative, fly-by-night companies that may just as easily go bankrupt as double in value. By sticking with reliable, dominant businesses, you’ll rarely put yourself in the position where you’re risking your entire bankroll. Rather, you’ll more likely be setting yourself up for consistent, long-term gains.
One caveat to keep in mind is that although Bill Ackman is an individual, he doesn’t do all of this work himself. Ackman is the head of a hedge fund, Pershing Investment Capital, meaning he has a team of analysts and investment managers that crunch numbers for him and assist him in finding the right investments. In other words, while the basic principles Ackman espouses are simple to understand, you’ll still have to do your own legwork to implement them into your portfolio.
This doesn’t mean they are out of reach of everyday investors, though. On the contrary, by understanding Ackman’s “commandments,” you’re likely to become a better investor. By paying closer attention to the financials and valuations of companies, your investment results are likely to improve, even without a team.
More From GOBankingRates