An Interview With Tim Guinness, Guinness Asset Management Founder And CIO: Part I

Includes: HFC, TSO, VLO
by: Michael Tsangaris

Tim Guinness is Chief Investment Officer of Guinness Asset Management, which he founded in 2003. He began his career in investment banking at Barings Brothers. Among other senior positions, he was co-founder of Guinness Flight Global Asset Management, which was acquired by Investec Asset Management Ltd, a move discussed in this interview.

Mr Guinness graduated from Cambridge University with an engineering degree and obtained a Master's Degree in Management Science at the Sloan School M.I.T. in the United States. Currently, he serves as Chairman of Brompton Bicycle Company Ltd. which he proudly mentioned prior to the interview in a discussion between us about a shared enthusiasm for cycling.

Michael Tsangaris: Before you went into investment banking did you have any idea of what you wanted to do?

Tim Guinness: Yes, I was attracted by the opportunity to work in the city because I had uncles and cousins on both sides of my family who worked in the city and they seemed quite cheerful about life. So I thought why not give it a go. It's as simple as that.

Michael Tsangaris: You started out in investment banking. Did it then click that with your engineering degree, you'd be best at something engineering-related such as in your current funds?

Tim Guinness: The point is that engineering is very good training for the mind. It's very good intellectual training. I never regarded it as anything else. I was good enough at mathematics which meant I could enjoy my time at university and pass the exams but I never intended to be an engineer. When I left Cambridge I didn't know quite what I was going to do. By the time I left M.I.T., a job in the city seemed pretty attractive. I was taught by Mervin Scholes of the Black-Scholes technique.

Michael Tsangaris: Could you describe one of your learning experiences of your past jobs, perhaps looking at Barings, in terms of say, managing risk or something else you learned before you went off to found the current Guinness fund group?

Tim Guinness: I think the main thing I learned early on is that if you work hard and set about intelligently analyzing both financial opportunities and problems, you can get ahead of the competition. It's amazing to me how many people don't read the report and accounts or read the prospectus of a company they are thinking of investing in. A lot of investors are incredibly superficial.

Michael Tsangaris: Not enough due diligence.

Tim Guinness: Well not enough thoughtfulness. You've got to be intelligent and thoughtful about what you do. As a matter of fact, I have a particular approach to investing which puts a lot of emphasis on reading and analyzing the numbers, report and accounts and the prospectus. Sometimes I'll meet the management but on the whole I'm cautious about that because I think that most of us are quite bad at arriving at good conclusions based just on a couple of hours conversation with a manager; it's very easy to get over impressed by a very eloquent, articulate person but is his judgment any good? It doesn't tell you that. So hard work, by which I mean diligence in reading and analyzing the numbers, is my mantra.

Michael Tsangaris: As you already mentioned, your investment methodology is looking at individual stocks, could you talk me through your investment approach? How do you decide which companies to invest in?

Tim Guinness: There are two things you have to do. You have to try and work out which sector or investment theme looks as if it's the fastest flowing part of the stream to paddle your canoe in. This enables you to prioritize your company analysis by principally looking at companies in that fastest growth area. For example, today, in my world, what are some of the interesting things? The development in horizontal drilling, gas shales - there are going to be some successful companies emerging in that industry, and also in the huge expansion of use of natural gas in China. Second, we have to find good companies? You've got to have a disciplined approach to prioritizing which companies you look at, to identify good companies that are cheap. I've been giving thought on how best to do this for twenty years. Early on I worked out that screening could be a valuable tool for prioritization. And then about twelve years ago I alighted on a screening technique that I thought could be what I was looking for. When I am looking for a cheap U.S. gas company because we think that's an interesting area, we will screen them on four factors - to identify if they might be "good companies" that are "cheap" where "sentiment is improving" and there are some signs that "investors have started buying."

What do we mean by "good"? We look at the numbers, see what their cash flow return on investment is like. If it's above average for the last four or five years and the projections show it continuing to be above average, we give it a higher score in our measure of "good" companies. It might be a good company because it has good management, good technology or it has lucked into the right prospective bit of gas-in place where there are immature gas reserves. At that stage you don't know whether it's cheap. So how do we screen for cheapness? The technique I use uses a pretty sophisticated discounted cash flow model that was developed by a company called Holt. It seeks to put all companies on basically the same footing. The key thing about analyzing the value of a company is to try and treat all companies the same. This particular modeling technique projects cash flow over the next thirty years, and assumes it will mean revert to the average cash flow return on capital over that time. If a company is earning a higher cash flow return on capital it will extrapolate that and fade it slowly. It will look at what the capital expenditure has been in the past and extrapolate that. We run this discounted cash flow modeling program and then look at the share price. If the share price is at a big discount to what the model shows it might be worth, then that's an indicator that it's a company to look at on cheapness as well as quality grounds.

Then as mentioned we screen for companies where sentiment is improving. We want to see improving analyst earnings forecasts. That's a timing indicator - it shows the market is waking up to a company's potential for improved earnings. And then we check this in terms of its share price: we like it to be trending up against its peer group. You might think a company is cheap, and good quality, but if the stock price is actually continuing to underperform, maybe there's something you've missed.

So that's what we do to screen the universe. It'll throw up a few names and then we'll do some old fashioned number crunching, due diligence etc. Roughly, for every thirty companies we look at, we may buy one. That's how we go about it.

I'll give you an example. We noticed about a year ago that U.S. exports of distilled products like diesel and naphtha and gasoline to Latin America had grown very strongly since 2008. They'd filled the hole left by the recession. U.S. refineries were quite badly hit by the 2008-9 recession, their stock prices had all fallen eighty or ninety per cent and you could then buy them on PEs of five or six. Yet here was this odd thing that their business with Latin America was really booming. The more we looked, the more interesting we thought it was. There's a handful of stocks to look at: Valero Energy Corporation (NYSE:VLO), Tesoro Corporation (NYSE:TSO), HollyFrontier Corp (NYSE:HFC) and so on. On the basis of our measure of value and quality, we invested in Valero. We had a top-down idea and then we found a stock that gave us the exposure we wanted and that met our investment criteria.

Continued in part II

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.