The digital advertising group S4 Capital (LSE: SFOR) is the latest enterprise of Sir Martin Sorrell, who built WPP essentially from scratch. The S4 Capital share price has been on fire, more than doubling in the past year.
I continue to see upside. I am considering adding more S4 Capital to my portfolio even though it is close to its all-time high. I think the company is attractive, and reflects some of Warren Buffett’s investing advice.
Warren Buffett on investing in ad agencies
In an interview available online, Sorrell discussed S4 Capital’s approach to growth as well as his own career. One of the parts that immediately jumped out at me was when he was discussing Buffett’s thoughts on investing in advertising agencies.
When ad agencies like WPP were out of fashion, Buffett wanted to buy into them. Indeed, that attraction persisted for decades. Sorrell has revealed that in 2012, Buffett discussed making an offer for WPP.
One of the reasons Buffett liked advertising agencies back then was because he saw them as “a royalty on the growth of globalisation”. In other words, as globalisation grew, advertising would follow. Owning shares in a leading ad agency could be a straightforward way to tap into the financial benefits of globalisation. The long-term share chart of WPP bears out this thesis, in my opinion.
In his recent interview, Sorrell mused whether in a similar way of thinking, “S4 is a royalty on the growth of digital”.
In other words, as digital ad spending grows, it may raise the boats of leading digital ad agencies. That could propel the S4 Capital share price higher.
Going where the growth is
If so, S4 Capital’s strategy of being digital only looks smart. S4 reckons that the digital advertising market will continue to grow in size. So by focussing exclusively on that market, it should be able to ride that trend.
That helps to explain the barnstorming growth projected by S4. It has a target of organically doubling revenues and profits within three years. After a strong first quarter, it raised its organic growth expectations for this year. That all suggests that its existing business is seeing the benefit of a growth in demand for digital advertising.
Add to that the impact of acquisitions, and the growth story becomes even stronger. Set against that, however, is the risk of dilution. The more shares S4 issues to fund acquisitions, the smaller a portion of the business each existing share represents.
S4 Capital share price risks
As well as dilution, a risk of an ad agency like S4 is something Buffett also noted – key assets include the people who come to work each day. If they leave an agency, it can hurt revenue and profit.
In the interview, Sorrell explains why he hopes the structure of S4’s acquisitions will engage key people to stay involved. I also think S4’s digital focus means talent loss is a lower risk than for traditional ad agencies. The company’s use of digital tools means that its key assets don’t all walk out of the office at the end of the working day.
Despite the risks and a steady increase in the S4 Capital share price, I remain bullish on the company.
