Smead Value: Contrarian Growth
09/29/2016 8:00 am EST
Bill Smead, chief investment manager of Smead Capital Management, is a contrarian growth investor who told me in mid-August that the increasingly wide spread of P/Es in the market had him the most excited in years about potentially finding stocks he can hold for years (or even decades) in his fund, notes Mark Salzinger, editor of The No-Load Fund Investor.
We agree that now would be a good time to consider his fund, Smead Value (SMVLX), as many of its holdings are cheaper than theyâ€™ve been in years.
He wants only those stocks with seemingly insurmountable competitive advantages and the profits and cash-generation that go with them, but his team will buy only when their valuations are low.
This limits the portfolio to just more than two dozen stocks onto which they are willing to hold for the long haul. Portfolio turnover was recently 20% annually.
Smead and the fundâ€™s two co-managers start with five mandatory characteristics in their search. The first is that the company must meet an economic need, as opposed to an intangible sort of concept that may evaporate as time goes by.
The second is a wide competitive moat, something about the company that renders it relatively immune to current competitors, or even to the infinite number of entrepreneurs who might come up with an idea that could drive the existing company into obsolescence.
The third is high free-cash flow, the amount of cash the business generates in excess of its needs to fund current operations.
Fourth is a long history of profitability, while fifth is an attractive valuation. The company must sell at a discount to where it has traded over the past five or 10 years on either a P/E or price/free-cash flow basis.
In addition to these five characteristics, Smead et al. seek companies with strong enough balance sheets to fund their growth internally, without accessing the capital markets.
While expansion funded by debt may be relatively easy with interest rates currently so low, companies who need no debt will be at a much greater advantage if borrowing costs begin to rise.
Despite being just flat so far in 2016, Smead Value has a five-year annualized gain through Aug. 31, 2016, of 17.0%, vs. 14.7% for the S&P 500.
By Mark Salzinger, Editor of The No-Load Fund Investor