How I choose the companies I invest in – a worked example

I’m looking to own the highest-quality businesses I can. These are rarely the fastest-growing – nor, frankly, the most exciting. But they are likely to endure, and usually get stronger over time. 

They’re the type of businesses where you can bury the share certificate, dig it out 10 years later, and see the profits and cash flows are materially higher. Or at least that’s what I hope (the value of shares can also go down). 

But what specifically am I looking for? I’m going to show you – using RELX plc as a worked example. 

Below are my views – you will have to form your own.

RELX – an important cog in the global economy

RELX is one of the world’s leading data experts: it uses technology to turn raw data into critical insights for customers in the Risk, Scientific, Technical & Medical (“STM"), Legal and Exhibitions sectors. 

98 of the top 100 personal lines insurance companies rely on its data to price car insurance policies and assess claims risks. RELX’s data solutions also help lawyers win cases, governments combat fraud and banks comply with anti-money laundering regulations. 

In its STM business, RELX publishes more than 2,700 academic journals, often the foremost publications in their field. Being featured in one of these prestigious journals, like The Lancet, can make a career and is a vital step in getting new research recognised.

RELX’s smaller exhibitions business hosts more than 400 events across 43 different industries. These provide a crucial platform for customers and suppliers to network and transact. 

Revenue by segment

Low-risk business model

What I’m looking for boils down to something simple but rare: companies largely in charge of their own destiny. And I believe RELX fits the bill because of three aspects of its business model:

1. Low economic sensitivity – Aside from its smallest division, Exhibitions, demand for RELX’s services is relatively insensitive to the economy. Academics and lawyers need access to RELX’s solutions whichever way the economic winds blow, while risks like fraud and money laundering must be tackled – it’s mandated by regulation. This sustains demand for RELX’s solutions in good times and bad.
2. Highly predictable revenues – More than half of RELX’s revenue comes from recurring subscriptions sold under long-term contracts, while much of the remainder is linked to repeating transactions. 
3. Exceptional cash generation – Almost every pound of profit RELX generates converts into cash. It gives the business many options, from investing in acquisitions, to returning cash to shareholders through share buybacks and dividends. 

RELX cash conversion

RELX use of cash (£ million)

Strong competitive position

A strong business model counts for nothing if competitors can easily eat your lunch. However, there are several aspects to RELX’s business that help protect it from competition, in my opinion. 

Having the best data sets is what really counts in these industries. The difference between 99.1% accurate data that covers 90% of the population, and 99.8% accurate data covering the whole population, is night and day. It can translate into millions of revenue and profit lost or made. For instance, if a bank is looking for a system to digitally verify the identity of its customers, it stands to reason it would go with whichever provider has the best data sets. It wouldn’t scrimp to save a few pounds.

RELX has some of the broadest and deepest data sets in its industries. Some of its data is proprietary and not easily replicated. But having the best data is just one part of the equation. 

Data must be processed, analysed and interpreted – a costly, time-consuming and complex task. RELX employs 10,000 technologists who use advanced algorithms to turn data into critical insights. That’s hard for competitors to replicate, even if they had the raw data.

Because RELX’s data-driven insights tend to get used every day, they become deeply embedded in customer workflows. It makes switching away from its solutions costly, risky and disruptive. 

Combine this with RELX’s brand strength, long-term customer relationships, multi-year contracts, reputation, global scale and innovation – well, put it this way, I wouldn’t want to compete with it.

Attractive culture

The risk with a business like this is it rests on its laurels – success can breed complacency and stifle innovation, sowing the seeds of decline. I see no evidence of this at RELX. In fact, for its size, I think it’s remarkably adaptable and innovative. 

The big change RELX has had to navigate has been the transition from print to online. Print publications (like magazines and books) used to account for around two thirds of its business. Today print is less than 10%. 

RELX revenue by type

The transition was achieved through a series of acquisitions and disposals, combined with significant internal investment. It has been a steady but extraordinary transformation, without which the group would be staring into the abyss. Instead, RELX is arguably in the strongest position it has ever been.

Innovation has played a key role, with the group spending heavily on data and analytics. These investments are now contributing strongly to RELX’s growth in all four divisions.

But there is also a conservatism to RELX’s culture, which – I have to say – I like. It’s been run by the same Scandinavian CEO (Erik Engstrom) since 2009. He is understated, has no interest in glamour projects and has invested consistently in the right areas, to bring greater value to customers. 

Why does that matter? Many investors would say it doesn’t. But for me, having an experienced CEO at the helm, who has successfully steered the company through a period of change, without any fanfare, gives me confidence in its future. 

A highly resilient business

Put all this together – a low-risk business model, strong competitive position and attractive culture - and you are left with a highly resilient business, in my opinion. This was borne out during the pandemic.

Covid-19 was just about the worst thing that could happen to RELX’s exhibitions business, turning a profit of £331 million in 2019, into a loss of £164 million in 2020. However, its three other divisions – Legal, Risk and STM – all saw profits grow. As a result, the group’s overall profit fell by less than a fifth.

That’s what resilience is to me. It doesn’t mean bad things won’t happen. But when they do, the company can survive and bounce back stronger.

RELX remained highly profitable and cash generative throughout the pandemic. It didn’t have to ask shareholders for more money and its future was never in doubt. In 2022, profit is expected to significantly exceed pre-pandemic levels.

Growth and valuation?

There are two elephants in the room – growth and valuation.

Both are important, but I always assess resilience – and the factors influencing it (business model, competitive position and culture) – first. 

The reason is simple. If a business isn’t resilient, I don’t care how fast it’s growing, because that growth probably won’t last. Nor do I care about valuation in this scenario, because if the company is wiped out tomorrow, no valuation will save me. 

RELX isn’t the fastest-growing business and perhaps that puts a lot of investors off, because they’re seeking something more exciting. However, steady, predictable growth can be very valuable over time. And RELX has delivered in spades. 

Over the last decade to January 2023, earnings per share have approximately doubled, and the shares have generated a total return of 350% versus 84% for the overall UK stock market. Please remember past performance isn’t a guide to the future. 

RELX vs. L&G UK Index Trust I Acc (%)

Given RELX’s digital transformation, and its investments in data analytics, I consider it a higher-quality business than 10 years ago, with enhanced growth prospects. In this context, the current valuation of c.24x forecast 2022 earnings seems reasonable to me, on a five-to-ten year view. 

My aim is to own 15-20 companies like RELX

I owned RELX in my previous fund and expect to own it in my Quality Shares Portfolio. 

The portfolio will hold 15-20 of the highest-quality businesses I can find, exposed to a range of industries. These companies will have similar qualities to RELX and will be chosen first and foremost for their resilience, business model, competitive position and culture. 

I hope to be able to share further details with you shortly.