Getting solid, above average growth over the long term is a painstaking process, but it's well worth the effort, observes George Fraise of Sustainable Growth Advisers.
Gregg Early: I am here with George Fraise, Co-founder of Sustainable Growth Advisers and Fund Manager of SGA Global Growth Fund (SGAGX). George, you have a different approach to growth stocks than many of your competitors. Could you describe a little bit what it is that makes your growth stock search unique?
George Fraise: Sure. We are big believers that growth investing done well offers tremendous opportunities for excess returns over time. There's a lot of empirical data that points to that.
And doing it well is perhaps even more important in difficult market environments, similar to the ones we've all experienced in the last five years, when individuals are frankly struggling to offset their plan retirement liabilities or institutions are struggling to meet the 7% to 9% return assumptions built into their plans.
We believe that the key to generating higher returns while incurring a lower level of risk is to invest only in the most predictable, the most sustainable, high-quality, strong growth companies. For us, quality and growth go hand in hand, and we won't compromise on either.
In other words, if you don't invest in high-quality companies, we believe that you have too high a risk of capital destruction, and if you don't invest in strong growth companies, you simply can't get the compounding that's necessary over time.
A lot of managers will focus on either one of those parts. We believe that it's very important to find those few companies that have the combination of high quality and strong growth.
Gregg Early: It does seem somewhat mutually exclusive to be able to get strong growth out of a high-quality company. Usually you don't think of those two things going hand in glove.
George Fraise: You're right, you don't. Which is why we have a process which is geared at identifying the few companies on a durable basis that have the characteristics that lead to that combination. We require five characteristics in all the companies that we invest in:
- The first is a high degree of pricing power. We're looking for the price setters, not the price takers.
- The second is a high degree of repeat revenues. We want companies whose products and services are used frequently and need to be replaced regularly.
- The third is what we call global opportunity, which is long runways of growth which give you the conviction to be able to stay with an investment a long period of time. On average, we invest in companies for three to five years.
- The fourth is financial strength. We look for companies that generate a lot of free cash flow, because they can then return that cash to shareholders in the form of higher dividends or share repurchases.
- Finally, the fifth characteristic that we mandate is good management teams, managements that are good stewards of shareholder capital.
Gregg Early: Do you find any sectors sticking out over others using your criteria?
George Fraise: We've found over a long period of time that most sectors have a few companies that embody the characteristics that we look for.
It is a selective process though, I will tell you. In our history, for example, we only have on our buy list 60 to 70 companies today, and we have 25 to 30 in the portfolio.