Here for the stayers, not the players

December 06, 2021 12:00

Livewire Markets

For a 10-15 portfolio, it pays to be disciplined on the screening process. But how do you know which stocks to include? For Claremont Global, screening those companies depends not only on real-time growth but a proven history of returns to find that competitive advantage.

Longevity is a key theme in Bob Desmond’s management process, with the average age of included companies over 80 years old.

“We're not looking for the Johnny-come-latelys or the new hot thing. We're looking for the durable businesses.”

In this video, Bob Desmond highlights the value of investing with conviction and why a realistic long-term outlook is better for your portfolio in the long run.

Edited transcript

How do you deal with downgrades, given your concentrated portfolio style?

There's a difference between a really bad downgrade and a miss. It's unrealistic to expect companies to hit their numbers every single quarter.

I guess where we come from is where we see there's been a material change to the thesis and the competitive advantage, we just exit a business straight away.

And the rule we tend to have is if you've got a downgrade and the stock price has gone against you quite materially — 10 to 15% let's say — and you're not willing to buy more of that position, you actually have very low conviction, so you shouldn't be there at all.

There's a lot of good businesses in the world, and just because you're in the portfolio, it doesn't mean you have an advantage. Mentally, we are all wired to this incumbency bias.

A stock that's in the portfolio, naturally you try to defend it. A stock that's out of the portfolio, naturally, psychologically, you're always looking for something that's wrong.

We try as much as possible to guard against those biases. So, we'll normally just cut something if we're not prepared to add.

How do you approach filtering through your investible universe?

Let's say there's 70,000 companies that fulfil our criteria globally. We screen at $3 billion market cap. So that gets us quite quickly down to 11,000 stocks or something like that.

We then screen on return on capital, which is ultimately our definition of a good business. So over 10 years, an average of over 8%, and over 10 years on return on tangible capital, ie, stripping out goodwill intangibles, an average of over 15%. That will really narrow down the universe.

We then screen out bad balance sheets, roughly two and a half times debt to EBITDA. We will be a little bit lenient where the company's got a history of running a good balance sheet and has gone a little bit above that to make a strategic acquisition, and they've committed to getting that debt down quite quickly.

We then screen out what we call excess growth: businesses that have grown faster than the natural growth of that business, ie, through issuing a whole heap of shares, doing a lot of acquisitions or putting a lot of debt on the balance sheet.

Then we just screen out all sorts of industries that basically are leveraged, complicated, commoditised or regulated. We just strip those out. Quite quickly we get down to a useful working list of about 100, 120 stocks.

Now, if you think of the portfolio, the average age and heritage of the companies we own is over 80 years old. The oldest is over 160 years old, and the youngest is Alphabet, I think, from 1999.

These businesses have been around a long time. We're not looking for the Johnny-come-latelys or the new hot thing.

We're looking for the durable businesses, and obviously by their nature, we don't normally come across something really new that we haven't looked at.

In your opinion, which of your holdings excites you the most?

I'm going to be boring again and say Alphabet.

If you look at the growth the company is delivering, there's still a big opportunity in digital. YouTube is still a hugely unmonetised asset. Cloud — they're very strong — catching up to Amazon and Microsoft.

I think the last time I looked, Alphabet have nearly $150 billion in cash. What are they going to do with that cash? Are they going to return that to us, the shareholders?

They have started doing buybacks. I think they'll probably, as they mature further, accelerate those buybacks.

Then I just look at the valuation for that sort of growth. At the last result, you've got high 30s revenue growth in their three core divisions.

And if you strip out the cash and the loss-making businesses, you're still only paying 24 times. That's a sizable discount to where the NASDAQ is today.

So that's probably the one that we've consistently run a very big position in the portfolio, and we still are today because the earnings keep coming through.

Would you ever look at companies that don't have 10 or more years of operating history?

Possibly, possibly. I think it's unlikely, but there have been situations in my career where, let's take Visa — when Visa was spun out from the banks. I think it was 2006, 2007.

It didn't have that long a listed history, but you knew the business is 50 years old and you could see that it was absolutely integral to the way we run our lives.

Another one was Mead Johnson, when it was spun out of Bristol-Myers. You could see that this is a business that's been around a long time.

Sure, we haven't got a listed history, but it was Zoetis that was spun out of Pfizer.

I think there are instances where — like for Google — I was very slow. Google listed, 2003 maybe. I think I only started getting interested in it in 2009. So I was a bit slow there.

We're not going to be right at the forefront. We want a company to get to a reasonably steady state.

We're unlikely to be buying that business when it's growing at 50% or 100 percent and on 100 times earnings. We're happy to miss that first bit until the industry settles down and we can see who the winners and losers are going to be.

Does that mean you pay close attention to spinoff and demerger opportunities?

Very little, very few. But you do get those unique situations once in a while. Like I was saying — Visa, Zoetis, and Mead Johnson are three I can think of.

Something like Accenture even, which fortunately, just in time, came out of Anderson consulting before they went wheels up.

But we're not looking at it for the spinoff, we're looking at it for the business and going, this is a business that's really good and we want to own it.

High conviction investing

Claremont Global is a high conviction portfolio of value-creating businesses at reasonable prices. Stay up to date with all our latest insights but clicking follow, or visit our website for more information.