American billionaire Bill Ackman is a super-investor whose decisions are closely followed by thousands of investors.
Ackman has built a very successful hedge fund management company – Pershing Square Capital Management – which generated a 17.1% annualized return over the last 18 years.
He has comfortably outperformed the S&P 500, which raises the question of how he picks companies to invest in.
Pershing Square stands out for only investing in a few companies rather than having a large, diversified portfolio.
The firm’s biggest holdings include Lowes Companies, Chipotle Mexican Grill, Hilton Worldwide, Restaurant Brands International, and Canadian Pacific Railway.
Commenting on their investment strategy, he said they look for high-quality businesses that are simple, predictable, free cashflow generative, and dominant in their sector.
They must also have a high capital return, limited exposure to extrinsic risks, strong balance sheets, and an excellent management team with good governance.
These are businesses that billionaire investor Warren Buffet would describe as having an economic moat.
In simple terms, the business can maintain its competitive advantage over its competitors to protect its long-term profits and market share.
Bill Ackman’s checklist for investing
Ackman described a checklist they go through before investing in a new company, which focuses on the cash the business will generate over its lifetime.
- Predictable cash flow – The business must have a predictable cash flow to calculate what it is worth. If you don’t know what it is worth, you cannot invest in it.
- Trading at a discount – After you know what the business is worth, you check whether it is trading at a discount. If there is a big gap between its value and where it is trading, it is worth a look.
- Find out why it is trading at a discount – You must determine why the business trades below its value.
- Can the problems be solved – After you understand why a company trades at a discount, you need to ask if the problems can be solved. Can changes be made to narrow the valuation discrepancy?
If it is possible to change things to solve problems at a company, narrow the trading discount, and contribute to growing the value, Ackman will invest in a company.