High-quality companies that deliver expected returns are the apple of Dana Love’s eye and the centre of a sustainable growth strategy for the silver-medalist Dynamic Blue Chip Equity mandate.
“At the heart at what we’re trying to do is to acquire companies that have immense compounding power,” says Love, vice-president and senior portfolio manager at 1832 Asset Management L.P., based in Toronto.
By compounding over longer time horizons, it increases the tax efficiency of the portfolio and decreases the transaction costs, adds Love.
A carefully selected global portfolio of approximately 30 best-in-class businesses is characteristic of the fund. A team of five members led by Love uses active management and multiple research tools to scout out the best ideas.
Think like an owner
The first hurdle that a potential investment must clear is from an entrepreneurial perspective, with the team asking, would we ourselves want to go into this line of business? Some of the stock criteria include an industry structure that is attractive, the ability to deploy capital to grow the business, some kind of competitive advantage in order for that business to remain healthy and sustainable in the long run, along with other underlying economics.
Focus on fundamentals – and culture
If a company makes it past the first hurdle, in-depth numerical, quantitative tools assess the business. The process looks at companies in terms of profit margins, sales growth, the history of capital allocation, cash flow, and the financial leverage or debt of the balance sheet, among other factors. But the team also includes the softer, qualitative, on-the-ground elements of companies to assess the corporate culture and “figure out what makes that business tick,” says Love.
At the right price
Then finally, if the investment is deemed a good company and makes it over the first two hurdles, the price component is assessed. Additional number crunching is done to determine, with a reasonable level of confidence or comfort, whether or not the current price in the public market is attractive to make an investment.
“But I do want to distinguish,” says Love, “that having price sensitivity and taking valuation in consideration as being different from traditional, sort of deep-value approaches.” Companies are favoured when they are attractively valued, on a case-by-case basis, depending on the growth opportunities they offer.
During the research process, the macro environment is taken into account but does not drive investment decisions. As well, the asset allocation, geographic and sector weightings are a result of stock opportunities, not by taking into account where the company’s headquarters or stock exchanges are located. Rather, the focus is on where the business operations are located and where the earnings power comes from.
Diversified by earnings power
“An example,” says Love, “is Techtronic Industries Co. Ltd. (00669)” an industrial company, among the top five holdings. According to Love, anyone who walks into a Home Depot (HD) store is probably very familiar with Techtronic power tools that it manufactures, such as the Milwaukee or Dirt Devil brands and some of the best-selling products. “Techtronic is listed in Hong Kong, and the controlling shareholder is a German individual who founded the company, but about 80% of its business operations are sourced from the United States.”
A favoured, long-term holding is Topdanmark (TQ71), an insurance company based in Denmark that only operates in Denmark. “It’s an oligopolistic industry structure,” says Love, “with a very commanding share of insurance in the small country. The geography is small enough that it doesn’t attract a lot of competition from the larger international insurance companies.” Love has been mostly invested in the company for most of his career that spans over 20 years. “Topdanmark is one of the most efficient, well-run insurance companies on the planet, very highly profitable, with lost-cost ratios and competition is healthy. It’s compounded at about an 18% rate of return going back to the year 2000, a phenomenal success for sure.”
Another “compounding machine” and long-term holding is Nestle SA (NESN), based in Switzerland. “Nestle remains,” says Love, “the dominant food and beverage company in the world and over many decades has always maintained its competitive position. It’s one of those companies, if we buy it, and buy it at the right price, it’s a great business.” According to Love, Nestle has a strong and unique corporate culture, which has value. “It is truly a multi-national company, with only about 2% of its sales coming from its domestic home market.”
Looking at today’s market, “it’s a bit of a head-scratcher,” says Love, with world markets hitting all-time record highs in the face of the coronavirus, trade tensions and tariffs, among other global concerns.
In positioning the fund with judicious risk measures, Love is finding valuations very elevated across the board to varying degrees. “Because we look at individual opportunities of the company, and I would say thankfully,” says Love, “we’re able to find ideas that we think are likely to do quite well at the company-specific level. But in aggregate, going forward, all investors should temper their expectations for future returns. This isn’t a forecast on my part, but I think rates of return from almost all assets, and that would include global assets, are going to be lower than they have been over the last 10 years for the next 10 years.”
