In the profile sheet of our Fundamental Growth strategy we describe it as:
A high-quality equity portfolio of well-managed, fast-growing companies with strong balance sheets. The portfolio employs a disciplined, proprietary and research-driven investment process.
While managing custom balanced portfolios for investors in our Private Client Group remains our largest offering, Fundamental Growth is our flagship all-equity strategy. This post describes what we mean by the description above: how do we identify and manage the best companies for Fundamental Growth?
Quantitative Factors
We utilize five quantitative factors to characterize how well a company might fit in Fundamental Growth: revenue growth, revenue variability, operating cash flow margin, debt burden, and return on assets. Our emphasis on revenue growth speaks for itself, but low revenue variability is a key factor in determining whether a company is still in its rapid growth phase. Companies with high operating cash flow as a percentage of revenue (cash flow margin) are generating enough cash that they require relatively lower or no debt to finance future growth. Finally, return on assets gives us a sense of how well the company uses its existing assets to generate profit.
These factors are not a screen: we never just buy or sell a company’s stock based on its score. But because the factors relate to fundamental characteristics, they help us gauge whether a company is worth understanding better and likely accomplishing what we seek.
Qualitative Measures
If a company looks interesting along quantitative lines, we then want to better understand its qualitative appeal. A prospective Fundamental Growth company should exemplify two or more of the following characteristics:
- Management: does the management team understand their industry, their competitive position within the industry, and have they demonstrated a track record of generating profit growth in that context?
- Operating Catalyst: is the company currently pursuing a strategy which can reasonably lead to faster sales growth, lower expenses, or both?
- Barriers to Entry: can many entrepreneurs expect to replicate the company’s business model, or are there manufacturing requirements, intellectual property protections, or first-mover advantages which secure the company’s position for the near future?
- Secular Tailwind: does the company compete in an industry which is expected to grow rapidly due to innovation and new market penetration?
Valuation
If a company looks attractive along quantitative and qualitative lines, we then ask whether the stock is priced attractively. The two most important features of a sound valuation framework are whether it is relevant to the industry, and useful in the context of the current capital market environment. For example, the price to sales ratio would typically be more useful than price to book value when assessing an information technology stock. Additionally, a stock’s price to earnings ratio may describe the opportunity better during certain phases of the business cycle than discounting future cash flows.
Investment Decisions
If a company displays sound quantitative and qualitative factors and its stock is a good value, it may immediately become a Fundamental Growth stock. Many times, companies will be attractive but their stock price is too high relative to the value we expect to receive. In these circumstances, the stock may go into our bullpen for future consideration.
On the other hand, current Fundamental Growth holdings which weaken along quantitative and qualitative lines or appreciate to a point where the stock price is too high would likely be sold.
Ideal Investors
Fundamental Growth stocks are those of companies which are still well within the growth stage of their corporate lifecycle. The prices of these stocks can sometimes be volatile, but their business prospects over many years are exceptional. We believe long-term investors with a tolerance for some volatility will be well-suited for an investment in the Fundamental Growth strategy.
Our minimum investment in Fundamental Growth is $250,000. If you know investors who would be interested to learn more about this or other Peloton strategies, we welcome your referrals.
Disclosures
Past performance is no guarantee of future results. Investing involves risk, including possible loss of principal. Diversification may not protect against market risk or loss of principal. The opinions expressed above should be construed as neither investment advice nor a solicitation to buy or sell securities. Actual investor results may vary.
Not FDIC Insured – No Bank Guarantee – May Lose Value