Conventional wisdom would suggest that in a softening property market, any company exposed to property would suffer operationally. While that might be true for developers and builders, it might not be true for REA Group (REA). Indeed our investment thesis for REA, since first buying its shares below $50, has been built around the idea that it will benefit if and when the property market boom matures and/or weakens.
Our investment philosophy won’t produce the top performing fund results every week, every month, or even every year, but in the long run it will do just fine. Our first fund, for example, which is approaching its seventh anniversary, has never produced a negative return in a year since inception. If we are going to try to continue that track record, we have to do two things; first we have to buy quality at reasonable prices and second, we have to be able to hold cash when a dearth of opportunities exists.
In terms of defining quality, we have a very specific definition. A company needs to be able to generate a high rate of return on equity or invested capital, and it has to be able to generate high returns on incremental capital too. In order to achieve such a feat sustainably the company must be able to demonstrate a competitive advantage. Competitive advantages come in many forms but the most valuable competitive advantage is the ability to raise prices even in the face of excess supply, and without a detrimental impact on unit sales volume. REA has been able to demonstrate this, and at the right price, it certainly ticks the necessary investment criteria.