Jensen: Quality and Value
06/25/2014 10:00 am EST
Portfolio manager Robert Zagunis has a disciplined focus on long-term value and high quality when selecting stocks for his top-ranked Jensen Quality Value Fund. Here, we discuss his strategy along with some favorite stock ideas.
Steven Halpern: Joining us today is Robert Zagunis, co-portfolio manager of the Portland, Oregon-based Jensen Quality Value Fund (JNVSX). How are you doing, Robert?
Robert Zagunis: I’m really good, Steven, thank you.
Steven Halpern: The investment philosophy underlying the Jensen family of funds is based on a long-term perspective and a commitment to high-quality businesses. Could you expand on that for our listeners, please?
Robert Zagunis: Certainly. We think and believe that investing is made a lot better when focusing on fundamentals. They provide you strength in the underlying value that’s in your portfolio and then can create, you know, companies with good financial—and fundamental—strength that provide really good building blocks for portfolios.
We, sort of, see that companies can be categorized into three areas. One: Those that are just streaming without profits. Two: Those that have generally profits and fair cash flow but can’t do anything spectacular. Three: The companies that have this high return on equity that is one of their key tenants tend to have an excess cash, which then allows them to build for the future and provide all the shareholder value creation that we like.
Steven Halpern: Now, the management team at Jensen Quality Value begins with roughly 5,000 stocks and narrows that down to 200 companies. Then they begin another quantitative process that filters this down to 70. Could you explain this process?
Robert Zagunis: Yes. We deal in this limited universe of these companies that have high return on equity, high return on invested capital, and they have to have performed that business result for each year for at least ten years in a row.
It might seem on the surface somewhat restrictive and extreme; however, when companies can do that, they actually exhibit the ability to be predictable, so we focus in on earnings predictability.
We focus in on free cash flow, and what we end up doing in the Value Fund is pushing a very large element of our discipline into valuations.
So, what we end up with are, sort of, the smaller, mid-cap companies in our universe—and recognizing that they’re very strong fundamentally but then are very aggressive on valuation; that’s the basic thrust of how we manage the Jensen Quality Value.
It is a portfolio of great company building blocks, focusing very much on, sort of, the valuation proposition. We want to buy them really cheap, and we tend to capture that profit when they move a lot more aggressively than we do with any other of our disciplines, especially the growth side of our business.
Steven Halpern: Now, in general, there always seems to be an ongoing battle in the market regarding growth versus value stocks. Where in this cycle do you think we stand now?
Robert Zagunis: Well, I think we’re in a transition, clearly. The performance in the markets over the last year or so, especially last year, was really driven by, sort of, cheap valuations. Everything was moving up.|pagebreak|
We ended up with a, sort of, a PE expansion-driven performance and certainly the business performance did not match up with the stock price performance.
So, I believe that we are going through a transition period where now you have earnings driven performance expectations and so, consequently, we do believe that it’s more important to be more focused on the individual holdings.
We see that in our portfolio. You know, you can make a comment about the markets being, maybe, fully priced; however, within that, there’s a range.
There are companies that are overpriced and companies that are underpriced, and so, the opportunities that have shifted away from, you know, just market indexes, if you will, to a more active, more specific approach, which is driven by the fundamental expectations of these individual companies, and they’re not equal, so I think that’s where the opportunity lies.
Steven Halpern: So, looking at some of the individual stocks that stand out in your methodology, I noticed that two stocks you like are in the medical diagnostics area, Laboratory Corp. of America (LH) and Quest Diagnostics (DGX). Could you tell us a little about those?
Robert Zagunis: Right. It’s, both companies obviously have the basic fundamental positioning and history that we require, but when you take both of them together they are really the dominant players in that industry, and, you know, both LabCorp and Quest provide diagnostic testing, information services, and, basically, helping patients manage their health better.
The attraction for us is sort of the commotion of what’s happening in the industry. Testing is very important for health. You clearly have a lot of movement in the healthcare business with Obamacare and how things are going to be handled.
I think both companies—although they’re different in some key ways—both companies are poised to take advantage of higher volume, and they have scale, and they’re large enough, and the biggest players in the industry that they can actually take advantage of volume and win more of the volume that’s out there and be positioned very well.
The attractiveness for both of them also has to do with valuations. Given what is likely to happen with those businesses, we obviously think that the valuation is good, and consequently they’re in our portfolio, as noted.
Steven Halpern: Now, I noticed you also have positions in two companies that would be categorized under shipping and logistics. Could you share your thoughts on United Parcel Service (UPS) and C.H. Robinson Worldwide (CHRW)?
Robert Zagunis: Yeah. Even though they’re in the same general industry segment of logistics and services of those sorts, they’re really quite different companies. UPS, everybody knows about them, you know.
They have these great competitive advantages. They have a worldwide network which is getting stronger all the time, so, as the world economics morph into more of an international requirement, UPS is clearly well positioned. Very high return on equity, great management, you know, great brand.
They have an integrated supply chain and information tracking that really is almost second to none, so we like that company. It is—compared to CH Robinson—an asset heavy company. I mean, they have the planes and the fleets and all those distribution systems, so the volume is critical for them.|pagebreak|
On the flip side, CH Robinson Worldwide is, sort of, an asset-like company, where they’re sort of providing a service for the shippers and the truckers and are intermediaries, and, consequently, they can grow and shrink their staff and workforce depending on what the volume is.
Both companies have a great return on equity. Both companies take advantage of what should be an increasing economic environment in the world, and again, both companies are priced attractively, so that’s why they’re included in our portfolio right now.
Steven Halpern: Now finally, I noticed that S&P Capital IQ recently chose Jensen Quality Value as their focus fund of the month, noting that it was very well positioned to benefit from a shift by investors towards higher quality stocks. Could you comment on that?
Robert Zagunis: Yes. In large part, driven by the fundamentals—and this whole focus on return on invested capital, which is, really, if you boil it all down, is so fundamental and so powerful that it really does drive our decisions to start with.
That is, if you have a cost of equity, cost of capital that’s low and you have a very high return on capital and return on equity, you tend to, and, if the company can do that consistently, you tend to have very strong companies that do things very, very well compared to their competitors.
And that platform, I think, is more important now than in the past for the reasons that I said earlier, is that there’s been this shift going on where you do have to have, sort of, a fundamental strength in the portfolio that is driven by earnings.
If you have that and free cash flow that can then be reinvested by management in a whole variety of different ways to create shareholder value, you end up with, in the Value Fund, a combination of, not only really high quality companies as we define them, but then also a very attractively priced portfolio that gets adjusted on a regular basis to be able to capture the increase in the price of the stocks.
The performance of this stock fund is really pretty remarkable given the quality of the underlying building blocks in the fund.
So, basically, what we’re looking at is earnings, strength in the individual companies and an aggressive management of that portfolio to capture, fairly aggressively, the movement in the price of the stock, which then results in the performance that people can look up.
Steven Halpern: Well, we really appreciate you taking the time today. Thank you for joining us.
Robert Zagunis: My pleasure. Thank you.