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Strong and sustainable competitive advantages, good management and conservative financial position are the three characteristics of a good, high-quality company. Everybody agree on that. But a good company is not necessarily a good investment, since the return depends on the price payed, not on the quality of the business, as Graham pointed out. Sometimes, the best investments are those on extraordinary bad companies with low multiples. So, what drives a good investment?

Investment return is about the future. That is, depends on the evolution of the company and the market valuation. In this sense, we can differentiate different elements that change over time and drives the return.

The first two are fundamental-based elements such as revenue per share growth and margins expansion. They depend on the business itself, including the allocation of capital by the management, the efficiency of operations and the capacity to achieve new markets. If margins and valuations multiples remain constant, the only driver for obtaining a good return is that revenue growth per share is positive, which in the end turns into effective or potential dividends growth. The other fundamental driver of positive returns on investment is that margins improve over the years. As well as in the revenue growth case, an expansion of margins becomes a growth in shareholders’ cash flows due to the reduction of outflows, other things remaining equal.

Therefore, the objective of a company to create value should be either growing in sales per share or expanding margins, or preferably, both. There are many different ways to achieve these two objectives, from strengthening the brand to digitalizing operating processes. The key issue, then, is that a good investment is, generally, one in which the management have a plan to obtain at least one of these two objectives in the medium term.

Nevertheless, a company with neither growth prospects nor margin expansion expectations, can be a good investment if valuation multiples are relatively low. That is, if market multiples are expected to increase, whatever the reason, a non-growing company can become a good investment. As an example, if a business gives a non-growing EPS of $10 and trades with a P/E ratio of 10, it can be a good investment if we expect the P/E to improve, let’s say, until 15 times in the following two years. If this occurs, in two years, although EPS would be equal, the share price would have risen from $100 to $150, which implies a 22% annualized return.

So, a good investment is the one that has, at least, one of the following attributes: growth expectations, margins improvement or multiples expansion, remaining the other equal or better. Based on this assumption, the best investment possible is the one that expects an improvement in the three attributes, and this is the key element to find ten-baggers.

Yet, it must be taken into account that, when growth estimations or margin expansions are high, valuation multiples use to be high, so finding companies with the three characteristics is almost impossible. But this is the task of a good stock picker: finding the companies with the best combination of growth, margins improvements and multiples expansions.