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How to use the 5-10-15 rule to successfully filter companies

Written by David Thornton, originally published on

Livewire Marketson 7 March, 2022
  6 min read

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Investing shouldn't be a free-wheeling endeavour. Just the opposite, in fact. Sound investing should have a consistent structure to it. Among other things, it helps take emotion out of the equation.

Intermede Investment Partners employ a "5-10-15" rule when investing.

"Five refers to a minimum 5% a year revenue growth, on average, annually. 10% is the annual EPS growth that we're looking for. And 15% is the ROE minimum threshold," explains Intermede CEO Barry Dargan.

In addition to the 5-10-15 rule, in this wire Dargan will also explain what other things he looks for in a so-called "moat". And while we're on the topic of companies with big moats, we delve into the "network affects" that set big tech companies apart.

 

You can watch the video below or read an edited transcript. This interview took place on 23rd February 2022.

 

  • The 5-10-15 rule to investing


    Barry Dargan
    : Five refers to a minimum 5% a year revenue growth, on average, annually. 10% is the annual EPS growth that we're looking for. And 15% is the ROE minimum threshold. So companies in our portfolio must be capable of delivering on these kind of metrics on an annual average basis. And, of course, since that's the universe we're looking for we also screen for this and so we know roughly what the universe of companies that have delivered on these kind of metrics are, over the last 10 years plus.

    It's a very elite group of companies. It's really the top 5% in the universe of companies that are out there, so we're really playing in this very elite group of great companies that we want to aim for the portfolio.
     

    What makes a good moat?


    Dargan:
    Finding out what it is about a company that is setting it apart is very important for us. So we're looking for a sustainable competitive advantage. And that means a company that has this moat, as you say, that makes it very difficult to compete with and so allows it to maintain its pricing power, maintain its margins and the margins don't get competed down by competition coming in. What sort of things are we looking for? These days network effects is a very important facet, or can be a facet, of this. So the social media companies have this but you can find it in other sectors. So a company like Mastercard, for instance, or CME these are companies that each incremental user actually adds to their network and can be done at very low incremental costs. So network effects are very important.

    We like companies with global dominant scale, so something like a Nestlé, which is the largest food company in the world and completely dominates certain categories that are growth categories, like coffee, or waters, or pet foods. It does incredibly well in those areas.

    And, again, can pass on pricing simply because the brands are so powerful. Yeah, there's companies that have first-mover advantage that makes them very difficult to compete with because they're always further down the innovation curve than any competitors that come in. We like companies that, for example, are B2B businesses that are ... When they sell into your business it's very, very difficult to ever get them out again because they become part of the DNA of your business and you rely on them to operate. So, again, we find companies like that incredibly powerful business models that make them, again, very difficult to compete with. So those are the sort of moats that we are looking for.
     

    Is the network power of large tech companies shrinking market competition?


    Dargan: That is part of the power of network style companies, that once they've established their network it's very, very difficult to compete with them because to replicate that you'd have to pursued everybody who's currently on their network to come over to your new network. And while you're persuading them to do that you've got to carry the cost of running your business with very little revenues. So it does make them very, very difficult to compete with. That said there is a history of innovation in markets and disruptors come along with something better. And we're always on the lookout for that, so can't be complacent. You can't say that a company that you own will have its advantage in perpetuity because something ... In technology things change fast and new innovation will come along. So we're always looking out for that, but at the moment certainly some of these companies do look like they're in a very, very strong position.

    I think the thing that we probably perhaps worry about most with these companies is regulation because, as you pointed out, they're in such a strong position and they're almost de facto monopolies in the areas that they operate in. And are making huge profits, and great cash flows, which is all great from a shareholder point of view but society then starts to worry about this and governments start to get involved. So we're also looking out for this and making sure that these companies are not going to fall foul of regulation, which could dent the investment thesis for us. So there are always things to be concerned about and to be looking into.

Important information

The information in this communication is provided by Barry Dargan, an authorised representative of MLC Asset Management Pty Limited ACN 106 427 472, AFSL 308953 (‘MLCAM’). MLCAM is the distributor for units in the Intermede Global Equities Fund (‘Fund’) issued by responsible entity, Antares Capital Partners Ltd ABN 85 066 081 114, AFSL 234483 (‘ACP’). Barry is not the holder of an Australian Financial Services (‘AFS’) licence, or an employee of MLCAM or in partnership or joint venture with MLCAM. This communication is not an offer, invitation or recommendation to buy, hold or dispose, any assets, undertakings, securities or any other financial products in any jurisdiction or to otherwise participate in any investment opportunity. The communication is of a general nature only and is not advice, it has been prepared without taking into account of the objectives, financial situation or needs of any person.  Before making an investment decision, you should consider your objectives, financial situation and needs. Before making any decision about the Fund, you should consider its Product Disclosure Statement (‘PDS’) which is available from mlcam.com.au/igef or by calling 1300 738 355. Opinions are subject to change and the accuracy of the information in this communication is not guaranteed.  Past performance is not a reliable indicator of future performance. Whilst formulated on reasonable basis, any projection in this communication may be affected by inaccurate assumptions or may not take into account known or unknown risks and uncertainties.  The actual results achieved may differ materially from the projection.