5-Star Buys for Quality, Growth and Value
06/10/2016 10:00 am EST
The Jensen Quality Growth Fund has earned a coveted 5-star rating from Morningstar; here we talk with co-portfolio manager Allen Bond to understand his time-tested quality growth and value strategy and review a trio of his favorite current investment ideas.
Steve Halpern: Our guest today is Allen Bond, co-portfolio manager of the top performing Jensen Quality Growth Fund (JENSX). How are you doing today, Allen?
Allen Bond: I’m great. Thank you for having me on.
Steve Halpern: Now could Jensen Quality Growth Fund, which has earned the highest five-star rating from Morningstar, focuses on what you broadly call all-weather companies, could you explain what you mean by this?
Allen Bond: Sure. So we manage about $6 billion in large caps in what we call a quality growth strategy.
That strategy focuses on what we think are value-creating businesses that have competitive advantages, consistently generate free cash flow, and have good attractive long-term opportunities for growth.
We’re also valuation sensitive, so we will only buy at a price that we see as a discount to our estimate of full value, and within the strategy we invest in about 25- to-30 companies. Our goal for the long-term is to generate superior risk-adjusted returns.
Steve Halpern: Now one metric that you emphasize is return on equity. Could you explain how you use this measure to narrow down the broader universe of stocks into this more constant created group of names that end up in the portfolio?
Allen Bond: Sure. So the return on equity screen is the first part of our investment processing, probably the most distinctive part of our strategy. So simply put, we will only invest in companies that have generated a minimum of 15% return on equity for at least 10 consecutive years.
That’s obviously a very selective screen. Right now it creates an investable universe for us of about 220 companies, but we believe it’s highly aligned with our philosophy.
That return on equity screen is very good at identifying companies that have competitive advantages, that have resilient business models, and companies that generate consistent free cash flow.
Steve Halpern: So could you just briefly go through some of the factors that help you go from that larger group of 220 down to the elite group that you end of buying in your 25-to-30 top names.
Allen Bond: Sure. So we have a four-step investment process. The first step is the return on equity screen that we talked about.
Between that first screen and the final portfolio, we looked at a variety of other quantitative factors, return on invested capital, bAllence and strength, margin strength, marketing consistency, all things that we think can help us zero in on the most attractive, the highest quality names in our universe.
We also do internal due diligence here and proprietary. We do it all in-house, that really focuses on making sure we understand those competitive advantages, and assessing strategy and the durability of competitive advantages, and then we create a portfolio that I said is about 25-to-30 companies.
It’s a conviction-weighted portfolio, so that the highest weight in the portfolio is going to be a business really excited about a stock that we think is attractively valued and in one that we think is relatively stable.
Steve Halpern: So, let’s look at some of the stocks that make it into that elite list and one where you like the prospects is Becton Dickinson (BDX), as a diversified global healthcare company. What’s the attraction here for you?
Allen Bond: Sure. So Becton Dickinson is the world’s leading producer of needles and syringes and they dominate the global market for that business, and we think scale in that needles and syringes business is really the key competitive advantage for Becton Dickinson.
For example, they produce more than 29,000,000,000 syringes and needles per year. It’s very much a scale business and their scale gives them a very good cost structure advantage.
We also think growth prospects are very good. The company’s developing technology to make needles safer and more efficient to use and also as healthcare infrastructure builds out throughout the world, Becton Dickinson benefits from that as a major of very basic and necessary medical supplies.
The big picture with Becton, we see very stable business. More than 80% of their revenues are somewhat recurring in nature. They consistently generate a lot of free cash flow and they consistently produce high returns on equity and on capital.
Steve Halpern: now you’re also a fan of Microsoft (MSFT), in part due to its strong free cash flow. What’s your outlook for this tech company?
Allen Bond: Sure. So we think cash flow is something that we always need to keep in mind as investors when we look at companies, and Microsoft is a great example of this.
Obviously, its a very well-known global technology company with key franchises that include the Windows Operating System, the Office Productivity Suite, and then a cloud platform called Azure.
When we think about Microsoft, we see network effect and high customer switching costs among enterprise customers as really the company’s key competitive advantage, but there is a little bit of a short-term noise around the stock that’s making the picture a little cloudy right now.
The company is in the middle of a transition to more of a cloud delivery model for their business, and they’re also in the process of exiting some of the legacy mobile phone businesses that they acquired with Nokia.
We think this transition could be lumpy in the short term, but ultimately will create a very consistent and powerful long-term growth model and it comes back to cash flow.
Despite all of this noise, the company continues to post very high return on equity and consistently produces a lot of free cash flow. We think this is a great business for the long term.
Steve Halpern: Now also in the tech sector, you highlight Cognizant Technology Solutions (CTSH), an IT consulting firm. What’s the idea behind this company?
Allen Bond: Right. So, Cognizant, is a little bit less well known than the other two companies we talked about. They’re a global IT consulting and outsourcing firm.
They serve a wide variety of businesses around the world via what we think is a unique business model in that they combine onsite client service professionals with remotely based technical teams that are primarily based in India.
The big picture with Cognizant, we think the company has a very good platform, agnostic way to invest in what we see as a secular trend of companies using technology to make their businesses more efficient, and we think Cognizant is very well positioned.
We think that flexible business model allows them to very nimbly execute, do so with a very attractive cost structure and really effectively serve an increasingly global customer base.
Steve Halpern: Again, our guest is Allen Bond of the top performing Jensen Quality Growth Fund. Thank you so much for your time today.
By Allen Bond, Co-Portfolio Manager of The Jensen Quality Growth Fund