HIP’s investment philosophy is to invest in quality companies identified by a three-stage investment process which filters out non-compliant companies. The investment portfolio comprises low capital intensive growth companies.

The first or primary stage filters for investment grade companies are:

• Historical sales growth
• Return on equity
• Interest cover

The first filter tests whether a company is growing. Only those companies with sales that have been growing faster than the Australian economy (as measured by Nominal Gross Domestic Product) are accepted.

The second filter tests whether a company’s management has been successful in obtaining excellent returns on equity. Only companies showing an annual return on equity of 15% or greater are considered. To put this another way, if an investor can get a return of 5% on government bonds that are relatively risk free, one of the core beliefs of HIP is that 15% is the minimum that an investor in a company should receive for the extra risk of owning equity. This represents an equity premium of 10%.

The third filter tests for security of clients’ funds. Only those companies whose pre-tax profits cover their annual interest bill on their borrowings by four times or greater are considered. That is, company profits have to drop by more than 75% before they are going to have trouble servicing their debt.

When these three filters are applied together to all the Australian listed companies, only 80 to 100 companies remain for investment consideration. The common traits these companies share are that they are growth orientated with a strong business franchise, and in particular, appear to have a sustainable competitive advantage.

A sustainable competitive advantage is like having a moat around a company’s business. It protects a business from competitors and new entrants to its market. Companies with a sustainable competitive advantage usually have workforces that are incentivised for business success. The company’s suppliers are not usually in a dominant bargaining position, so the company has access to well priced and consistent inputs.

Finally, before buying a particular stock the investment team considers, “Would we buy all of this business if we had the money?” That is, HIP buys shares in the business as a business owner, not as a trader of shares.

• If there is a major change in management and insufficient continuity of management to be associated with the track record.
• If there is a major takeover or merger.
• If the company loses its sustainable competitive advantage.
• If the market valuation of the company exceeds certain thresholds.
• If a company’s cash flow deteriorates to a point where it no longer is four times the interest paid and the reasons therefore are not acceptable.

Using this philosophy, the day to day management of HIP’s investment portfolio is undertaken by Hyperion Asset Management Limited. A full description of Hyperion Asset Management, its team and performance track record can be found at www.hyperionam.com.au.