The Stock Investing Process
- What kind of growth do you expect?
The stocks in your portfolio are picked because we believe their underlying corporate top-line growth can be at least 7%, and often substantially higher. In addition to letting top-line growth guide our portfolio management, we look for earnings improvement much greater than this over our three-year minimum time horizon.
- Do you have price targets in your portfolio management strategies?
If you had identified Microsoft, Intel, Wal-Mart, or any other great company early in its growth phase, how would you feel if you had sold after earning a double, only to see it morph into an icon of American business? Would you have known everything about how its opportunities were to unfold over the years to come? Our best investment management ideas are those that “work” for the initial three-year time horizon Gaineswood establishes, and growth accelerates for many years beyond, transforming an entity for the better. At any one instance in time, our “target” for a given holding is statistically defined within a rigorous matrix of growth and value. Depending upon the growth a company is capable of experiencing, we set aggressive stock investing objectives, often 2x to 3x over three years for most of our ideas. Rather than delve deeply into the mechanics of this portfolio management process, some commentary on the qualitative aspects of this exercise are in order.
Price targets are one-dimensional and static tools that block one from capturing outstanding investment management returns over time. Sudden appreciation or a reduction in our out-year earnings projection may cause us to sell. But given the very high hurdle we hope to clear during our three-year perspective, such a change would need to be considerable.
Just like piloting an airplane flying over the horizon, the maximal view of our portfolio management strategy continues to evolve, resetting expectations for our three-year out earnings horizon, so time is a second dimension. We view quality as a third dimension in the stock investing process: We reap a “discovery” discount when we buy a stock for you, yet because we expect quality and growth to surface over time, we anticipate receiving a premium for our shares upon selling for you.
Much of the growth camp of securities analysis is populated by momentum buyers and trend followers that are fairly insensitive to valuation, and it is this subset of the market that must buy your most successful long-term portfolio investments. Retail buyers may exacerbate this tendency, as was seen during the bubble. At some point in the equation, the psychology of “animal spirits” becomes an essential component of our stock investing selling discipline, which we address with multi-year technical analysis. Another is attention to fundamentals of stock investing, for any weakening of a growth trend once a stock is over-extended can be ruinous. While we are price sensitive as buyers, we are less so as sellers. If your account is taxable, we will strongly consider the burden of capital gains taxation.
One last word: Price targeting is a favorite mantra of large integrated broker-dealers, whose aim is frequent turnover. We would prefer not to buy a stock at $53 with a target of $62, but the trading departments of these firms would love us to do so. They would also tell us to sell whenever a stock took a dip on unfavorable news flow. We believe this stock investing practice is deceptive: It sounds logical, but it winds up being a strategy of watering the weeds and cutting the flowers. Instead, our investment management philosophy makes us invest in persistent growth. Most of Wall Street belongs to the church of price targets, and scorns those who question its reason for being. We think to achieve exceptional performance in investment management one must take a stand apart from the crowd. If we heed the calling of the sweet-sounding siren of price targets, then we are doomed to mediocrity in stock investing and blocked from making long-term investments. Instead, we are engaged in an odyssey towards building significant wealth in your account. And if it were an odyssey without labors, every money management professional could and would seek to complete it.
- How do you measure value?
Through our fundamental analysis of investment management, we make a detailed assessment of probable growth and earnings through our customary three-year investment perspective, and sometimes beyond. From this we compare how a stock ranks in terms of a matrix of growth and valuation quintiles. Although there are several possible favorable combinations within this matrix of stock investing, we usually favor firms that trade at or below reasonable value that could experience above average earnings growth.
While we think of this as a “GARP” (Growth-at-a-Reasonable-Price) strategy, we believe it differs markedly from that of most other practitioners of this portfolio management discipline. From our deep experience within the institutional money management industry, we empirically notice that nearly all within it would choose to define GARP stock investing as the selection of stocks that have experienced above average growth in recent years, but which trade at a market price-earnings multiple or less. Implicit in such a declaration is that a portfolio management professional requires indisputable evidence of solid earnings growth historically, but a stock that is not reflective of the same, particularly when consensus estimates of next-year earnings serve as the input.
In our observation, this condition of stock investing too often arises when a subset of shareholders has chosen to aggressively sell a security, knocking its valuation down below past statistical zones, but the majority of its owners stand pat because there has yet to be a material decrease in expectations for earnings forecast within one year. To a chartist, such a stock would be “rolling over” itself – an early warning of problems ahead. Indeed, we find such application of GARP can maximize risk through casting a net in troubled waters.
Our approach culls from pools of stocks that may have experienced such difficulties one or more years ago, creating a “basing” chart trading pattern during which time fundamental questions about financial performance have been largely resolved. If during such moments of lessened attention to corporate growth and valuation, Gaineswood’s investment management professionals can discern catalysts of multi-year growth and high return on capital employed (and back these up with extensive analysis of a corporation’s end-markets and competitors), your account would likely own a stock with low expectations but large potential for positive portfolio management performance. In so doing, we believe you are likely to own securities that are reasonably valued and washed of the honey that lures other investors into a hive of money management risk.
- What happens when you meet with a company’s management?
Our experience tells us that in such situations, Wall Street analysts tend to cluster their line of questioning around a small set of recently newsworthy issues. Often these relate to microscopic analysis of something that brought forth deviance – positive or negative - from expectations in the most recent quarter. Dominant in the psychology of securities analysis is the incontestable notion that hitting or missing quarterly earnings triggers the motion of stocks. Indeed it does, and we know many high profile portfolio management experts who swear quarterly channel canvassing, accounting monitoring services, or the anticipation of corporate events enables them to outperform the market in stock investing. These lines of inquiry might be productive if one has a short-term orientation (and we do not).
However, in our belief the missing element is that most money management professionals are not consistently deft at predicting earnings surprises that are profitable trades, because if this were easy, the consensus would always be correct in the first place and there would be more than a handful of “great” managers. All too often in investment management, stock-pickers claiming to have an analytical edge proven by performance may just be riding the crest of a recent multi-year trend: hedging since the bubble’s peak, chasing growth in the 1990’s, or worse: survivorship bias. In reality, regulation FD makes discussion of any topical item a blind alley, since executives are only permitted to reiterate broadly disseminated disclosures generally contained in earnings conference calls and financial press releases.
Our company interviews are very fundamental and designed to draw out what excites management strategically over the long haul, thus revealing situations conducive to persistent growth, the defining characteristic of our portfolio management style. We seek to understand penetration, growth, and adjacency of the markets for a firm’s goods or services and the history of, and potential for, competitive shifts. Usually what springs from this inquiry is a vigorous discussion of business strategy, grounded upon detailed knowledge of the importance of individual components of business segments. While others try to generate performance by being event-driven, we prefer to seek out circumstances for stock investing where we suspect a major long-term positive development is inevitable.
- How do you react to negative fundamental developments?
Mirroring life, few if any companies considered for stock investing have no setbacks or twists to their progress, for they compete in a jungle filled with similarly profit-driven rivals, each capable of survivorship built upon individual victories. Quarterly expectations-driven portfolio management professionals can get shaken out of positions at the slightest provocation. We find that confidence in a firm’s long-term direction backed up by detailed industry detective work prepares us for unexpected developments useful for effective portfolio management. Any unforeseen setback must be taken seriously to ensure a smart stock investing approach. If our long-term view of investment management is sufficiently threatened, we unquestionably will sell or compromise by reducing your exposure. If it is not, we oftentimes simply refrain from adding upon weakness for several quarters or a year or more, in keeping with our preference for based-out trading patterns. What we find is that when we patiently remain close to the ground in these stock investing situations, we can witness boredom and washed-out trading that swamps an emergent kernel of positive fundamental energy. While inevitably sometimes we may throw good money after bad, we find such hunting grounds can be especially prolific for your wealth management.
- How are analysts involved in the portfolio selection process?
We rely heavily upon the six analysts and two senior investment professionals of our affiliate, GARP Research & Securities Co., which publishes research consumed by prominent institutional money management experts. Since our founding in 1995, we have built an investment management team of analysts internally that has experienced minimal turnover. Over time each has become more specialized and added sector-specific knowledge. We have a mixture ranging from young, self-taught industry followers to a doctorate holder with decades of life sciences industry experience. Gaineswood’s decision making is the purview of our founder, and analysts are free to form their own opinions in reports they write, as required by FINRA regulations. Deviation of opinion may occur, particularly since Gaineswood’s concentrated portfolio by design holds considerably fewer positions than are covered by our research affiliate. However, Gaineswood’s money management philosophy has been articulated in extensive detail and is hallowed by our investment management team, to the point that the positions in your account generally represent determination and conviction by both our founder and each analyst responsible for having developed specific stock investing ideas.
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