Best company: the candidates

Company name: Chr Hansen

Reason chosen: Long shelf life

Chosen by: Sam Cosh, fund manager, European Assets Trust

Great companies have the ability to generate high returns on capital and to compound those returns for a long time. Preferably, their cash generation should be consistent and growing. I know of no company that fits this description better than what I believe is the highest quality company in Europe – Chr Hansen (OMX:CHR) (that’s its offical name, though everyone still thinks of it as ‘Christian Hansen’). The company produces cultures and enzymes for the dairy industry and natural colours. Not only do these help determine the taste, nutritional value, health benefits and end-product shelf life, they also improve the manufacturing process for cheese and yoghurt producers.

To consistently deliver high profits, a company needs to be able to protect itself from competitors. This is called a moat and Hansen has one of the widest. It operates in a global oligopoly of which it is the market leader, giving it cost advantages through scale. The barriers to entry are high, partly due to the oligopolistic structure of the industry, but also because of the technical complexity of manufacturing enzymes and natural colours in scale. This translates into a high value product with high gross margins, and market-leading levels of profitability.

The company also offers superb growth opportunities for a number of reasons. First, there is strong underlying growth from the key product areas it sells into. For example, the dairy industry is growing as emerging markets become richer and move towards western diets in which dairy foods play a larger role. Second, the industrialisation of the food industry provides another leg of growth as modern dairy processing requires a more systematic approach to application of cultures and enzymes. The natural-colour division benefits from the switch from synthetic to natural ingredients by the food and beverage industry. Finally, greater innovation in the food industry pushes growth further as Hansen helps customers develop their products. This means it achieves strong growth on a sustainable basis that is driven by trends which have permanence and are not temporary or cyclical.

The final key ingredient for a quality company, or the key reason why a company can remain high quality, is to have an aligned management team that makes sensible decisions. Of particular note for us is that the company is disciplined when allocating capital. We like the Chr Hansen management because they understand what they’re good at and will not expand out of their core product areas with value-destructive acquisitions. We believe this is a management team that we can trust to keep the company delivering good growth, strong profit margins and cash-flow generation, all key characteristics that mark it out as an exceptional business.

Company name: ExxonMobil

Reason chosen: Setting the standard

Chosen by: Matthew Allan

Mention ExxonMobil (NYSE:XOM) and often the first thing that springs to mind is the Exxon Valdez oil spill off the coast of Alaska in 1989. While it’s true that event forever altered the company’s image and approach to safety – its corporate motto is now Nobody Gets Hurt – some things haven’t changed.

ExxonMobil remains the dominant energy company in the world despite seeing 18 American presidents come and go since being carved out of John D. Rockefeller’s former monopoly, Standard Oil. Today, ExxonMobil brings in more money annually than the GDP of most countries; its credit rating surpasses that of the US government; and only computer maker Apple has a larger market capitalisation. Royal Dutch Shell, arguably ExxonMobil’s biggest competitor, is valued at around half as much.

Investors place a premium on ExxonMobil shares because, quite simply, Exxon is better at making money than its competitors. It has long produced the highest average returns on capital employed (ROCE) of any major oil company. Even when looking at just the past two years, which haven’t been great by Exxon’s standards, its remarkable average ROCE of 21 per cent handily outstrips Shell’s 11 per cent. Looked at another way, despite Shell selling slightly higher dollar values of oil and gas than Exxon last year, Exxon’s profits of $32.6bn were nearly double Shell’s profits of $16.4bn.

The secret of ExxonMobil’s success is discussed in great detail by Steve Coll in his 2012 book, Private Empire: ExxonMobil and American Power. But, generally speaking, it comes down to the company’s strict top-down management style, which focuses on long-term investment discipline, best-in-class engineering and an ability to adapt to changes in the energy market – including a willingness to do business wherever the most profitable supplies of hydrocarbons are located. “We don’t run this company on emotions,” Lee ‘Iron Ass’ Raymond, Exxon’s all-powerful CEO from 1993 to 2005 once declared; all that mattered was “the relentless pursuit of efficiency”.

True, some investors complain the company has lost its way since the current boss, Rex Tillerson, took over in 2006. Last year, Mr Tillerson admitted his timing was off by a year or two when he decided to buy American shale gas producer XTO Energy for a whopping $41bn (£24bn) in 2009. He noted the deal was predicated on a 30- to 40-year outlook that sees natural gas growing in importance as part of the global energy mix. “While we anticipated at the time of the merger that it would be non-accretive in the near-term, because we expected that natural gas prices had not yet bottomed out, they stayed low much longer than we expected”, Mr Tillerson acknowledged.

Although gas prices have since recovered somewhat, the downturn has coincided with a period of massive up-front investments in long-lead projects that have temporarily suppressed profits.

Shares in ExxonMobil have nevertheless risen – alongside many US equities – to an all-time high at around $100 a share. That puts them on a relatively pricey 14 times estimated earnings for 2014, against an average of 11 for major multinational oil groups. Its 2.8 per cent dividend yield also compares unfavourably with a peer group average of around 3.4 per cent. The average earnings multiple for the past 10 years is roughly 11, so we would suggest buying the shares between $80 and $85 – a realistic price given that’s in line with the 52-week low.

Company name: HSBC

Reason chosen: Global and local

Chosen by: John Adams

Banks are not popular, but some are just better at what they do than others. And HSBC (HSBA) – now the world’s second largest bank by assets – is arguably the best.

Established in 1865 to finance trade between China and Europe, the Hong Kong and Shanghai Bank spent the next century or so developing a footprint in Asia. In fact, its spread to other parts of the world is relatively recent and it lacked a significant presence in either America or Europe until the 1980s. The US business only really began to take shape after the acquisition of a majority stake in Marine Midland Bank in 1980; while it wasn’t until 1987 that the group began building a serious foothold in Europe, through a 15 per cent stake UK clearer Midland Bank. It took full control of Midland in 1992 and the group’s headquarters moved to London in the same year.

Taking on Midland would have been a challenge. Not only was it falling behind in the UK after struggling with an especially inefficient branch network, but the bank’s overseas adventures had taken their toll. Specifically, it entered into a disastrous deal with Crocker National Bank of California in which Midland invested money but failed to gain full management control. Crocker went on a lending spree, which generated heavy losses, while its Latin American loans went bad after the Mexican debt crisis in 1982. Arguably, Midland never recovered. But by mid-1999, when the Midland branches were rebranded with HSBC’s logo, Midland had been seamlessly absorbed. Crucially, Midland provided HSBC with a big UK presence and a springboard into Europe which, when added to North American expansion, marked the birth of a truly global strategy.

It’s this global thinking that makes HSBC so successful. By developing a strong local presence in the core economies of Asia, America and Europe the bank has an impressive measure of natural risk diversification and counter-cyclicality. Few other lenders look so well diversified. What’s more, its focus on emerging economies – Asia in particular, but also Latin America – has given the lender a long-term growth profile that most western banks will never match. Indeed, from end-December 1992 (the year it bought Midland) to end-December 2013 HSBC’s pre-tax profit rose from £1.7bn to £13.5bn, while the loan book grew from £91bn to £645bn.

Sure, HSBC couldn’t completely side-step the financial crisis. Most significantly, its US sub-prime operation, formerly Household International, suffered a painful credit-quality problem. In 2009 some 60 per cent of HSBC’s bad debt charge related to this business yet less than a quarter of lending was in North America. But, compared with most lenders, HSBC sailed through the most severe financial crisis since the Wall Street Crash – even avoiding any kind of state bail-out – to emerge in relatively rude health.

Today its operating metrics are amongst the best in the sector. It’s Basel III-basis core tier-1 capital ratio (comparing equity to assets, weighted for risk) stands at nearly 11 per cent - making it one of the world’s best capitalised lenders.And robust cash flows, helped by disposals and cost-cutting, support fat dividends: the shares yield nearly 5 per cent on 2014’ likely dividend. Yet at 625p they also trade on about 1.3 times forecast tangible book value, leaving them rated more cheaply than those of Lloyds (LLOY), which doesn’t pay dividends and still has legacy issues to tackle. That’s undeservedly cheap for such a robust global bank with superior long-term growth prospects.

Company name: Illumina

Reason chosen: It's all about genomes

Chosen by: James Anderson, fund manager, Scottish Mortgage Investment Trust

We believe the world is at a really important juncture in the approach to healthcare and understanding of disease: specifically, the role that genes play in a vast range of conditions. That’s why one of our favourite Scottish Mortgage holdings is Illumina (NASDAQ:ILMN), which leads the genomic industry in promoting the accessibility of sequencing. This manufacturer and distributor of sequencing machines is pioneering the epidemiology of non-infectious disease. The hope is that by unlocking the language of DNA, doctors will then have specific genetic targets at which to aim their arsenal of treatments.

There are several steps the healthcare industry must take to ensure it can act on the information created by the sequencing industry and the first is to increase accessibility. In January, Illumina announced it had reached the landmark low cost of $1,000 to sequence a whole human genome, courtesy of its HiSeq X Ten machine. This is significant because for the first time sequencing en masse is economically viable. This means the genomics industry now has the opportunity to step into the clinical setting, beyond its traditional role in research and academia.

Healthcare is the largest industry in the world and in the US it absorbs an unsustainable 17 per cent of national output. Providing someone is comfortable with the ethics of knowing his or her susceptibility to a certain type of cancer, genomic sequencing will enable the healthcare industry to become more proactive and maintaining health is much cheaper than fighting sickness. Personalised medicine will also open up the capability for treatments to be designed for someone’s DNA, so side-effects are minimised, costs are reduced and benefits amplified. The potential for a transformation in healthcare is very exciting and from the vantage point of early 2014, Illumina looks to be in an enviable position in the blossoming genomics industry.

As investors, we believe that Illumina remains at the forefront of this transformational and disruptive industry. Our conviction is that Illumina will become the dominant force in this hugely important sector. One of our greatest challenges – and indeed opportunities – as investors is dealing with holdings that have a wide range of outcomes. We are enormously excited about the potential of genomics, while remaining mindful of the philosophical questions that will need to be answered alongside the scientific ones.

As in much of literature, identity is a prominent theme. In Game of Thrones, characters change names, take on disguises or shape-shift into animals; meanwhile, Game of Thrones character Jon Snow is haunted both by his lack of knowledge about who his mother is and his perceived genetic ignorance. This is understandable. The question of why we are, who we are, is fundamental to the human condition. Our heritage has always been entwined with our destiny, but in unlocking the secrets of the genetic code we might be able to steer our future in a more favourable direction.

Company name: Procter & Gamble

Reason chosen: Head and shoulders in front

Chosen by: Simon Thompson

In determining my short list of candidates, I looked at six key areas: the defensive merits of the business; global reach; pricing power; robustness of profit margins; sustainability of operating cash flow; and dividend record over the long-term. Many companies ticked all the boxes, but the one that stands out for me is the world’s largest consumer and personal goods group Procter & Gamble (PG: NYSE), a US corporation with a market value of $217bn (£130bn) and one that has been in business for 176 years.

To give an idea of the scale of the enterprise, P&G sells products in more than 180 countries and generates annual sales in excess of $84bn. Well-known brands include Fairy, Head & Shoulders, Gillette and Olay. And it’s the strength of these brands that gives the company the pricing power and dominant market position to earn eye-catching operating profit margins of around 19 per cent. Cashflow generation is pretty awesome too: cash inflow from operations rose almost 15 per cent to $15bn last fiscal year. This enabled the company’s board to declare an increased dividend for the 57th consecutive year at a cost of $6.5bn. There was still ample cash left over for P&G to buy back a further $6bn of shares, a 50 per cent increase on the prior year.

Not that the consumer goods giant is resting on its laurels. A push into emerging markets has been paying off to reduce the dependence on more mature western economies. And a restructuring programme has led to productivity gains by taking costs out of the business and using multi-billion dollar marketing budgets more efficiently. The aim is to deliver organic sales growth modestly above market rates, generate core EPS growth of high single digits, and maintain that awesome free cash flow generation.

Moreover, as long as P&G can achieve this then shareholders will continue to reap the financial rewards. There shouldn’t be too many complaints on that front from long-term investors: a $100 investment in the shares a decade ago is now worth $200 with dividends reinvested; over 20 years the $100 has risen nine-fold; and over 30 years it has grown 30-fold.

Of course, sitting back and banking the dividends is only one part of generating such healthy long-term rewards. Timing the purchase is the other. So to create a ‘margin of safety’, I would be comfortable waiting for the share price to pull back to around $70. At that level, P&G shares would be priced on a reasonable forward PE ratio of 15, and offer an enticing prospective dividend yield of almost 4 per cent, an entry point well worth locking into.

Company name: Shaftesbury

Reason chosen: The village gardener

Chosen by: Stephen Wilmot

It’s a shame investors can’t buy into the Crown Estate – the historic property portfolio of the royal family, now a national asset – or the Grosvenor or Howard de Walden estates, which have steadily enriched their blue-blooded owners since the dawn of modern London some three centuries ago. In a market of globalising demand and often-irreplaceable supply, these assets embody the otherwise somewhat unreliable investment maxim of Mark Twain: “Buy land, they’re not making it anymore”.

But investors do have an excellent proxy for the aristocratic estates: Shaftesbury (SHB). The £1.9bn public company that owns parts of Soho, China Town and Covent Garden has only been around since 1986, but has grown to resemble its venerable forbearers. That’s because the property crash of the early 1990s convinced then chief executive (now non-executive chairman) Jonathan Lane to focus exclusively on the company’s holdings in China Town, which had proved more resilient. Ever since, Shaftesbury has been gradually piecing together various West End ‘villages’, consisting mainly of shops and restaurants, with some offices and flats above.

The portfolio is hard to beat as a store of value. Because of the simple constraints of location, combined with tight planning and listing rules, supply of property in Soho and Covent Garden is inflexible. Meanwhile, demand for restaurants, shops and flats continues to grow, both with the disposable income of Britons and, increasingly, global tourist wealth.

As a result, rents and values have grown steadily in excess of inflation. This is unusual. Most commercial property devalues in real terms over time, as newer, more efficient stock is built. But Shaftesbury, uniquely, deals in the “antiques of the property world”, as Mr Lane puts it – much of its portfolio dates from the 17th century. This may explain why its rents have only fallen once in recent history: in the 2009 crash, due to the more cyclical demand for its upper-floor offices. Shaftesbury has been gradually converting these into flats to remedy this problem.

Mr Lane has another expression for Shaftesbury’s business model: “urban gardening”. For the company does not just sit on its assets – though they would surely perform well even if it did. Once it has bought enough properties to justify the capital expense, it also boosts rents by ‘weeding’ individual streets. This involves refurbishment work, extensions and reconfigurations, as well as working with Westminster Council to improve the streetscape.

Carnaby Street is Shaftesbury’s most successful scheme in this respect – as anyone who has frequented it on a Saturday will know. Its next project is Berwick Street, Soho’s run-down historic market street. So far the company has only made acquisitions; the regeneration work has yet to begin. The pace of progress is slow, as property rarely comes up for sale. This is a tale of slow-burning, rather than meteoric, growth. The corollary is an irreplaceable market position.

The shares are currently priced at 677p – an 8 per cent premium to the book value of 629p forecast by broker Liberum Capital for the September year-end. With the other London property stocks trading on much bigger premia, and Shaftesbury’s portfolio held at conservative valuations, that rating isn’t demanding for long-term investors. We recommended buying the shares in November and stick with that stance.

Company name: WD-40

Reason chosen: Canned franchise

Chosen by: Philip Ryland

Almost every home in the UK – and, more importantly, in the US, too – has a can of WD-40 (NASDAQ:WDFC) somewhere. Maybe it’s under the kitchen sink; or in the garage or the garden shed. But somewhere there is that familiar blue-and-yellow can waiting for when it’s needed.

And those needs are numerous. Britons and Americans love WD-40 because it can do so many things. Not just the obvious, such as lubricating locks, keeping garden tools rust-free and stopping moving parts from squeaking. It can also do esoteric jobs, such as removing chewing gum from just about anything, or – if the company’s web site is to be believed – helping free a Boa constrictor from a car’s engine compartment (don’t ask). Such ability and versatility in a product makes it a must-have and creates brand loyalty. You don’t go into a DIY store and ask ‘Where’s the solvent remover?’; you say, ‘Where’s the WD-40?’

Proof of the brand’s strength is the company’s financial record. WD-40 was launched in 1953 and it took 14 years before it chalked up $1m-worth of annual sales. That was in 1967 and in the 46 years since then sales growth has compounded at almost 14 per cent a year, to bring $369m (£224m) of revenue in 2012-13.

Sure, in recent years the company has been helped by contributions from similar specialist products (WD-40 made its first diversification via the acquisition of 3-IN-ONE oil from the corporate forerunner of Reckitt Benckiser in 1995), but WD-40 and its branded derivates continue to dominate. And they bring wonderful financial returns. In 2012-13 the group produced a 15.4 per cent operating return on its sales and a 24 per cent return on capital employed, which fed through to a 22 per cent return on equity.

Returns in that ball park have been normal for the past 20 years. Yet the company has no patents or secret formulae to protect its products. It does nothing that would be beyond the likes of Exxon-Mobil, BP or Dupont. Even so, giants like those stay away because WD-40’s greatest strength is that the franchise is not worth the effort of attacking.

In order to compete, a rival would have to spend huge amounts on distribution and marketing, and price its product below WD-40. But the price differential would be meaningless to consumers. After all, a can of WD-40 costs £5.98, so a 10 per cent discount for a me-too product will hardly tempt shoppers. It would, however, make it all the harder for the competitor to make money, especially as its fixed-costs would be spread over a sales base that grows painfully slowly (after all, loyal customers can go many years before they buy a new can of WD-40). True, the effort could make serious in-roads into WD-40’s profits. But because WD-40 spreads its own fixed costs over far more sales than its theoretical rival, it would always be in a position to make the struggle even nastier for the newcomer.

So for those with the financial strength to hurt WD-40, the prize is not worth the struggle; while those for whom the rewards would be meaningful lack the muscle.

That investors appreciate the strength of the franchise is reflected in a rating that is 28 times 2012-13’s earnings and almost eight times book value (see table). True, the rating has come off the top – it hit a 10-year high of 33 times historic earnings earlier this year – but it has much further to fall before the shares are clearly worth buying. The average earnings multiple for the past 10 years is 21 times. Pay that and you are looking to buy at about $54.

Philip Ryland

The elegant side-step by Nick Train

The greatest company is what I shall call the VanrockBC & General UK Tracker open-ended investment company (Oeic).

I say this because the question – what is the world’s best company – requires one to make an important distinction between 'favourite' and, indisputably, 'greatest'. We all have favourites, both for the short and long term, but the idea of 'favourite' brings with it personal, emotional bias, yet here we’re asked to identify something objective and most specific – absolutely the best. For instance, my favourite company must be Young’s (YNGA), the London pub company, whose shares have been and probably will continue to be a terrific investment. But Young’s is my favourite because my father bought me my first pint at the Coach and Horses in Barnes, not because it is the greatest company in the UK.

To qualify as primus inter pares our notional company must, surely, have permanently exceptional qualities. It must look likely never ever to lose its competitive edge or never be run by self-serving or irrational management. Such paragons do not and, actually, cannot exist, because it is virtually the job of financial markets to ensure that well-funded start-ups snap at the heels of excessively-profitable incumbents. They also do not exist because the most casual acquaintance with economic history confirms that the damagingly unexpected is just around the corner. Greatness is – always and necessarily – temporary and, therefore, not truly great.

So, this is why I cop out and, asked to pick just one great company, instead go for a representative low-cost tracker OEIC. My choice gives me access to all of the assets, cash flows and ingenuity of the UK’s quoted corporate sector. Of course, the tracker comprises the good, the bad and the ugly, but it will automatically cleanse itself over time as weaklings drop out. And, looking back over past decades, few investors would have been disappointed to earn the return delivered by the index.

Nick Train co-founded Lindsell Train Limited in 2000. He is the portfolio manager for UK equity portfolios and jointly manages Global portfolios. Nick has over 30 years experience in investment management. Before founding Lindsell Train he was head of Global Equities at M&G Investment Management.