A Focus on All-Weather Stocks
04/04/2014 10:00 am EST
Rob McIver, a portfolio manager with Jensen Quality Growth Fund, will only buy a stock that has shown 15% return on equity for ten years; here, he explains his strategy and highlights some stocks that have made the grade.
Steve Halpern: Joining us today is Rob McIver, a portfolio manager with Jensen Quality Growth Fund. How are you doing, Rob?
Rob McIver: Good, thank you, Steven. Good to be with you.
Steve Halpern: Thank you for joining us. At the Jensen Quality Growth Fund (US:JENSX), you focus on what you call all-weather companies. In fact, you only consider stocks for your portfolio when the company has achieved 15% return on equity for ten consecutive years. Could you explain this investment process and why return on equity is such an important factor?
Rob McIver: Absolutely. I should say that the 15% return on equity every year for ten years is a demanding hurdle and it’s meant to be so.
Fewer than 200 companies achieve that high business level of profitability and it’s there, really, because we at Jensen believe that one of the true motivators of success in investing is that you have to remain in the market rather than timing the market.
With companies that have an all-weather business model, our strategy aims to provide shareholders with good market returns, but with much lower volatility than the border market over an entire economic and stock market cycle.
Of course, we can only do that if the companies in which we’re invested don’t struggle when times become more challenging, and I should say, Steven, that while 15% return on equity is our minimum level of profitability, today, the average return on equity for our companies exceeds 29%. They are tremendously profitable.
Steve Halpern: So, these are all-weather companies that, in both good times and bad, you feel comfortable that they’ll be able to maintain their outlook?
Rob McIver: Yes, we do. This is, let’s say a very high quality pool of companies in which we’re looking to invest. We believe that, over the long-term, the market will award shareholders for the business value that these companies are creating every day.
In our opinion, this can only be achieved if a company has durable competitive advantages and uses those advantages to reinvest organically for future growth, through merges and acquisitions and, in the shorter-term, reward shareholders with the payment of dividends and share buybacks.
Steve Halpern: Now you’ve also noted that you focus on stocks where there is a durable competitive advantage, growing cash flow, and you also look for shareholder friendly management. Could you expand on those factors a little?
Rob McIver: Absolutely. Shareholder friendly management is very important for investors because, ultimately, the management teams running these businesses are the ultimate insiders and stewards of our shareholder’s money.
We’re looking for quality elements in their business models, where the shareholder returns are greater than their cost of capital, but we’re also looking for that growth aspect and using cash flow to grow the future foundation for success going forward.
Now, as I say, the cash flow we’re looking for is typically reinvested organically through small acquisitions. As our companies are large, they tend to be market leaders and, of course, there are shorter-term rewards in terms of dividends and share buybacks.
Steve Halpern: Now, you look at the 15% return on an equity to consider a stock to buy, but once you already own that company, if it falls below that level would that be part of the criteria you use in determining when to sell?|pagebreak|
Rob McIver: That’s correct. Our sale discipline mirrors, very much, our buy discipline and we are very disciplined in that connection. There are three reasons that will sell a company from a Jensen Quality Growth Fund.
The first is if its market value exceeds our estimate of the company’s full value. You can lose a lot of money as a shareholder by buying a great company by overpaying.
Secondly, if a company’s return on equity falls below 15% then that’s an automatic sell for us at Jensen. That happens rarely, but in 2008 one of our smaller companies had a year-end ROE of 14.8% and that was not 15%, so it was sold.
Thirdly, which is typically a reason we’ll make a change within the portfolio, is that there’s a better idea—where we’re looking for more compelling business models that offer the opportunity to upgrade the portfolio.
Steve Halpern: Now, you mentioned that about 200 companies meet these qualifications, but then you look at those companies and only about 30 make the final cut, in terms of what you add to your portfolio. Could you tell us about a few stocks that have made the grade on your very strict approach?
Rob McIver: Absolutely, and we understand that 28 and 30 companies is quite few, but we’re very concentrated. As we build the portfolio one company at a time, we really believe that the durable competitor advantages and the breadth and depth of the company’s business models offers a lot more diversification than would at first appear.
For example, one of our top holdings in the Jensen Quality Growth Fund is Becton, Dickinson & Company (BDX), which is a global medical device company that specializes in the design and manufacture of needles and syringes.
Its had 80% company sales come from products that are disposable in nature and more than 50% of the company’s sales are generated outside the United States.
We believe that Becton’s primary competitive advantage is scale. It produces over 29 billion syringes a year. That accounts for about 70% of the global market share for needles and syringes. It’s a tremendously successful business model and we really like the annuity-like stream of earnings that that company produces.
Steve Halpern: Would you be kind enough to share another name or two?
Rob McIver: Certainly. Another company that did very well for us last year and is one that we’ve held in the portfolio for over ten years is 3M Company (MMM), which has sales over $30 billion a year and is a diversified manufacturer.
In fact, it sells over 55,000 products in over 200 countries. Again, the international scale of the business really reaps great rewards for shareholders. Over 65% of 3M’s business sales are assigned to the United States.
And what we’re noticing here particularly is that the company is allocating cash and capital to the faster growing higher margin businesses, particularly in the emerging markets that are spending a lot of money on building out infrastructure.
3M last year increased its dividend by 35% and you’ll be interested to know that that is the 97th consecutive year that 3M has actually paid a dividend without interruption.
Steve Halpern: I really appreciate you taking the time today. Thank you for joining us.
Rob McIver: A pleasure, Steven. Thank you for having me.