The Importance of Being Picky
by Graham Summers
October 31, 2006
Yesterday, I gave you a brief description of the “Kings of Private Equity,” American Capital Strategies (ACAS).
Today, I’ll show you how ACAS has beaten every major index as well as most every mutual fund in existence over the last decade. In the last 10 years, ACAS has shown investors an average annual return of 22%. It’s paid out over $21 in dividends. And its current yield is 8%.
How did ACAS do this?
The analysts at American Capital Strategies have learned the art of being picky.
Since 1997, ACAS has invested over $10 billion in 229 privately held companies. I know it doesn’t sound like ACAS is being too picky by investing in some 20 companies a year... But only 1.4% of ACAS’s potential deals reach closing. Tom McHale, ACAS’s senior vice president of finance, walked me through a given American Capital deal last week.
It’s a multistep process that starts with American Capital’s principals (think investment talent scouts) meeting several times with a potential buyout target’s management. Having researched the company’s historical performance, operations, and management, the principals issue a 50-page report to American Capital’s Investment Committee.
After this, a team of three to four of American Capital’s 53 accountants combs through the company’s finances and issues a report of its own.
American Capital also employs an Operations Team, comprised of seven ex-CEO/presidents, four ex-CEOs, and four supply-chain management specialists. These guys look over the company’s operations and issue yet another report.
American Capital will then hire industry specialists and other third-party consultants to investigate management’s background, issue psychological assessments, and offer a legal review of the deal.
Having looked over all of this material, the Investment Committee decides whether or not the company meets American Capital’s standards.
And even then, the Investment Committee has to report to American Capital’s directors, who can veto the deal at any time. Only if the deal passes muster is it closed.
Like I said, ACAS is picky... only 1.4% of prospective deals reach closure.
These guys are the kings of private-equity deals. They produce Warren Buffett-like returns and pay an 8% dividend.
I like American Capital’s approach so much that I added the company to the Inside Strategist portfolio in July 2006. We’re already up 26%, and the stock just hit a new 52-week high. I don’t plan on selling this stock... ever.
It pays to be picky.
Good investing,
Graham
