5 quality compounders Forager sees potential in (and 1 emerging opportunity)

In a year where the biggest performers have also been the biggest names, it’s easy to forget that less exciting companies can be the long-term bread-and-butter of your portfolio. Better yet, these can help diversify you away from the high level of concentration in the market now.

If you are looking for value too, you may be surprised to realise there’s plenty of opportunity in the market – that’s despite the record-highs of the S&P 500. As Forager Funds Management’s Steve Johnson points out, the share prices of 42% of the companies in the S&P 500 are down this calendar year.

Johnson’s philosophy centres around generating long-term returns from unloved, under-researched and undervalued stocks – with the idea of quality compounders an essential component of long-term returns. In fact, these currently comprise around a third of the international portfolio.

In Forager’s latest annual report, Johnson and the Forager International Shares Fund portfolio managers, Gareth Brown and Harvey Migotti, discuss five quality compounders that have been strong contributors to performance in the last year, along with an emerging company.

What is a quality compounder?

“Quality compounders are companies that consistently achieve earnings growth and generate high returns on invested capital across different economic cycles,” says Johnson.

These are your reliable businesses that can keep the fires burning while you investigate options that may take longer to pay off.

The Australian equivalents of quality compounders would be businesses like CSL, Wisetech or Reece. They have solid pipelines and contracts; they are dominant in their fields of expertise and may or may not be considered ‘exciting’ businesses.

The Forager team typically likes to aim for quality compounders that are not necessarily appreciated for their earnings power by the market.

5 quality compounders with room to move

1) CRH (NYSE: CRH)

CRH is an industrial business that offers building materials solutions globally. It was trading at $82.61/share as of 17 July 2024 and moved to a US listing in September 2023. 

Brown and Migotti believe it is still trading at a 40% discount to North American peers and it has been benefiting from increased US funding for infrastructure.

“CRH has significant pricing power from the very localised nature of heavy quarried materials where expensive transport costs limit the shipping radius,” they say.

2) Installed Building Products (NYSE: IBP)

Another company to benefit from infrastructure and construction demand, Installed Building Products is a market-leading insulation installation and distribution company. As of 17 July 2024, it is priced at $251.22/share.

“The company increased revenue by 5% in 2024, a year where broker estimates suggested the company would struggle to grow at all,” says Brown and Migotti.

The company’s share price has appreciated substantially, meaning Forager has taken the opportunity to reduce its position – though the International portfolio managers are quick to note they would add to the position in any weakness.

3) APi Group (NYSE: APG)

APi Group is a global business services provider of safety and specialty services. It has grown over time from the careful acquisition of smaller competitors. It is one of Forager’s larger holdings and as of 17 July 2024, was priced at $38.37/share.

Brown and Migotti are positive about APi’s ongoing ability to generate healthy cash flow.

“It should continue to do well across various macroeconomic environments given its largely recurring revenue focused on inspection, maintenance and monitoring,” they say, noting that most of APi’s work is regulatory or statutorily driven.

4) Insight Enterprises (NASDAQ: NSIT)

This tech company focuses on business-to-business and information technology for enterprises. As of 17 July 2024, the business is priced at $217.79/share.

“Insight’s move to a solutions integrator has helped shelter the company from a slowdown in the IT hardware market over the past year,” say Brown and Migotti.

They are seeing improving margins from the movement towards software and services.

5) Ferguson (NYSE: FERG)

Ferguson is a multinational distributor of plumbing and heating products. As of 17 July 2024, the company was trading at $216.13/share. 

Ferguson has been active, spending US$1.5 billion in the last 5 years to acquire over 50 companies. The international portfolio managers view this positively, arguing it has added meaningfully to revenue growth and helped consolidate a dominant market position.

“This has resulted in earnings per share compounding at above-market levels for a long period of time – a trend we expect to continue going forward,”they say.

An emerging quality compounder

Brown and Migotti nominate a top contributor to returns in the international portfolio as an emerging quality compounder: Zeta Global (NYSE: ZETA).

Zeta Global is a one-stop shop for data-driven marketing solutions across SMS, email, display ads and social media. According to the fund managers, it has been able to grow 25% annually due to the value of proprietary data. It is currently priced at US$20.17/share, as of 17 July 2024.

“Whilst the share price has appreciated more than 100% over the past year and we have reduced the Fund’s holding, it is still valued at a discount to peers and offers plenty of upside should management continue to execute,” they say.

If you are interested in reading this report and others from Forager, visit their reports page on the website here.