Profits For The Long Run

Over on one of The Motley Fool's dedicated discussion boards for income-oriented investors, readers have been mulling over a just-published White Paper from American investment firm GMO.

And, in an investment world still dominated by fancy algorithms, derivatives and goodness only knows what other forms of complex financial engineering, the paper delivers a refreshing message.

Namely, that buying shares in decent, profitable businesses is a good way of minimising risk, and thereby maximising overall investing returns over the long run.

Let's hear it direct from the authors, Chuck Joyce and Kimball Mayer:

"Put simply, profitability is the ultimate source of investment returns. [And] contrary to popular belief, profitability can be forecasted, and superior profitability persists. Investors systematically undervalue the unexciting stability of [such] quality stocks, except during times of financial crisis. Rather than being beholden to some black box model... we would argue that a fundamental focus on profitability remains the best way to minimize the true risk with which investors should be concerned."

Mis-priced value

Better still, argue the authors, the market tends to mis-price such companies, seeing them as dull dividend machines, when it should be valuing them as dull, safe dividend machines.

Put another way, when looking at companies such as British American Tobacco (LSE: BATS), GlaxoSmithKline (LSE: GSK), SSE (LSE: SSE) and Diageo (LSE: DGE), the market is looking at the incoming stream, but placing insufficient value on its dependability.

Screening for superiority

Now, how to find such businesses? And more particularly, how to find such businesses outside the realms of 'the usual suspects' -- in among the FTSE 250 and below, for instance?

For clearly, businesses with superior and sustainable profitability must be found outside the FTSE 100 (UKX), which is where many income investors on our High Yield boards have traditionally focused.

And, sure enough, the ensuing debate on the discussion board focused a lot on how to screen for such businesses. Read it -- it's fascinating stuff. I'd never even heard of a Piotrosky F screen, for instance.

FTSE, 42%; Woodford, 347%

Such as über-income investor Neil Woodford, for instance. For when it comes to sniffing out businesses with a long run potential for pumping out sustainable profits, there are few better.

And, as it happens, he's the subject of a recent special free Motley Fool report: "8 Shares Held By Britain's Super Investor". It's packed with data and insights, but the figure I keep returning to is this statistic: over the 15 years to 31 December 2011, on a dividend re-invested basis, the FTSE All-Share delivered a 42% return. Mr Woodford's High Income fund, meanwhile, gained 347% -- that's quite a difference.

Let's just dwell on those numbers for a moment. FTSE All-Share: 42% over 15 years. Mr Woodford: 347%. That's quite a margin -- and a seeming endorsement of just what the GMO authors were saying. But will the eight Woodford picks profiled in the report repeat that performance? Why not take a look, and judge for yourself? It's free.

Sage perspective

Warren Buffett, of course, is another investor with an eye for such businesses. If his well-known "economic moat" isn't another way of saying "businesses with high long-run sustainable profitability" then I don't know what is.

And recently, as you're probably aware, he's been buying into a British business that meets this description -- one, moreover, with a share price that's currently beaten down by adverse sentiment.