16th May 2013
Florida-based investment manager firm, Polen Capital Management, has launched the Polen Focus US Growth Fund as a Dublin Ucits fund. Managed by CIO Dan Davidowitz and Damon Ficklin, the pair follow a concentrated large cap US equity growth strategy.
Polen’s investment philosophy is based on the principal that earnings growth is the primary driver of long-term stock price appreciation. The firm overall manages $5.1bn of investments as the end of March 2013.
Mindful Money talks to Dan Davidowitz about the fund and the US market.
1) Can you talk me through your investment process?
“We own about 20 to 25 very high quality US companies. We expect good earnings growth and tend to be focused on the very long term so our average holding time is about five years. In the 25 years or so that we have been doing this we have only owned about 100 companies in total. We tend to think and act as if we are the owners of the entire businesses, even though of course we are not. We are focused on doing this one thing very well. We start with a fairly large universe of companies. There are about 1,000 companies we look at on a cursory basis. We shrink that down to those we feel have the odds stacked in their favour. This typically means they have a lot of cash and little debt so they can generate free cash flow far in excess of what they need to run their businesses and have high returns on equity at 20 per or higher. We feel that is an indicator of competitive advantage. We look for companies which have true growth behind them and that are not wholly dependent on the economy. Those are the key criteria.
“Not that many companies actually meet our criteria. Of the thousand that we start with, only about two or three hundred do. Less than half can sustain those great metrics. We are left with a very small universe of a 100 to 125 companies. We spend the vast majority of our time studying those companies and their competitors to see is anything likely to change. Then we think what are the 20 best companies we can own that will grow the entire portfolio’s earnings at a mid-teens rate. This is fast. The S&P is at about 6%. We are talking between two and two and half times that pace. That is going to drive the investment return. We are real buy and hold investors. It is not going to be buying and selling activity that generates the investment return. It is going to be from the companies doing the hard work as they grow. It is quite different from our peers, the concentration and the long holding periods married together, that is different.”
2) Does the concentrated nature of the fund bring more volatility during market downturns?
“We tend to outperform when the markets go down which seems counter-intuitive but because we focus on only the highest quality businesses with the best balance sheets and competitive advantages, they do tend to go down quite a bit less.
3) How did you do through the tech bubble and the credit crisis?
“During the tech bubble, my predecessor David Polen said these valuations are ridiculous and moved to consumer staples like Hershey, Anheuser Busch, McDonalds, from the tech firms. That protected our capital. In 2001/2002, our portfolio was down about 14 to 15% and the S&P was down 50% so we protected a tremendous amount of capital. In 2003, we trailed the market on the bounce but we had protected so much. The next few years were tough years. We stuck with super high quality stocks but not everything in the market at that time, was super high quality. Coming to the 2008 downturn, when everything went down our portfolio did as well but we outperformed by about 10 percentage points. It was a higher quality portfolio. Correlations were close to one but we outperformed. It happened so ferociously, we were looking around and realised that all the companies that we study are available at really good prices we have to look at our portfolio. Do we want to own the 20 that we currently own? We looked at our universe again and realised we can buy Apple at $90 a share and Amazon at $55. We shifted five or six out and five or six in. For us that was a lot. When the market rebounded. We outperformed again. We learned a little lesson from 2003.
4) What is your view of earnings and valuations in the market at the moment?
“You have to be conscious of what is going on in the market place. We are not trying to buy cheap stocks. We are buying companies that are appropriately valued where we think that the intrinsic value will growth with the earnings growth. In the US, we have seen a very large ‘up-valuation’ in high dividend yielding, big blue chip companies. They are pulling up the whole market, because of their relative size – companies like Coca-Cola, Pfizer, AT&T are slow growing but pay a pretty nice dividend. We are seeing a big multiple expansion though they came from a low base so some of this was warranted. There is momentum but it is definitely not driven by the companies themselves but by investors. Our portfolio has not seen the same thing. The dividends are low for our growth companies and we have actually seen a little bit of multiple compression. The market rally has been driven by a group of high dividend yielding companies also a bunch of turn round companies. That is also an area were we don[‘t invest, though it is something we have to be aware of. We like Coca Cola, but if they are only going to grow seven, eight or nine per cent, that will give you a market-like return.”
5) Concentrated funds tend to be riskier. How does your fund rate for risk?
“Concentration is risky if you do not invest in high quality companies. You can have share prices that move in fairly large increments but if the intrinsic value is moving in the right direction, and the balance sheet is healthy we are in a pretty good spot. We have never had a major capital impairment. We only invest in the best firms. We have some volatility, but we are looking at earnings in five years’ time. We have seen some stocks go down on an earnings report, but the rationality comes back at some point. One firm we own, Cognizant Technologies an IT and outsourcing firm had a modest reduction in revenue growth from 23 to 20%. The stock dropped 20% not from a high level. We bought more on the decline though we do not do a whole lot of that. The market tends to overreact. There could be volatility but it is a lot less than the S&P 500.”