Investing in U.S. innovation

Invesco's Ashley Misquitta cites fair values and powerful macro drivers.

Sonita Horvitch 3 September, 2014 | 6:00PM

Ashley Misquitta, portfolio manager at Invesco Canada Ltd., says that after the huge rally in the U.S. equity market since the 2008 global financial crisis, valuations are generally fair.

"We have to work harder to find high-quality companies trading at reasonable valuations than we did in the aftermath of this crisis," he says. "But there are opportunities that meet our criteria in a number of sectors," says Misquitta, who together with veteran portfolio manager Jim Young manage Trimark U.S. Companies and Trimark U.S. Companies Class.

In stock selection, this duo emphasizes companies with a sustainable competitive edge and that look to innovation to both drive and maintain that edge. "Our target companies," says Misquitta, "are industry leaders that typically enjoy good profit margins, produce a high return on capital and generate substantial free cash flow, which they can reinvest in the business or return to shareholders or both."

The case for investing in the U.S. equity market remains, says Misquitta. In the shorter term, the U.S. economy "is on a recovery path, albeit at a slower pace than some would like." Also, he says, the political logjam in Washington could be eased with the upcoming November elections, which could see a Republican majority in the Senate.

The longer-term macro drivers of the United States are "powerful," says Misquitta. "They are far more favourable than those in most developed countries." The United States has a cheaper and more abundant source of energy than many western European countries, he says. "This is thanks to its application of innovative exploration technologies to its shale oil and natural-gas deposits." Cheap natural gas, he says, is helping to fuel the early stages of a manufacturing renaissance in the U.S. Midwest.

Also, U.S. demographics are superior to those of most developed economies as is "reflected in the growing U.S. work-age population." Another plus, Misquitta says, is its extensive and efficient agricultural base.

Finally, he says, the United States continues to be a leading engine of product and service innovation globally in such key fields as technology, health care and financial services.

At the end of July, Trimark U.S. Companies had 30.8% in technology, 16.2% in consumer-discretionary stocks, 14% in financials and 13.3% in health care. "The fund, which usually has between 40 and 50 holdings, had 49 names at the end of July," says Misquitta. "We stay with our investments for some time."

 
Ashley Misquitta

In technology, a long-time holding is the consumer-electronics giant Apple Inc. AAPL. This was the biggest weighting in the fund at the end of July. "Apple's hallmark is its ongoing innovation in all aspects of its business -- hardware, software and services, including its high-margin iTunes and app stores." Investors, he says, underestimate the extent to which Apple's customer base is sticky. "Its ecosystem works together."

Apple is a huge cash-flow generator, says Misquitta, and is returning some of that cash to shareholders. The stock trades at some 16 times earnings-per-share estimates for Apple's current fiscal year to the end of September and 14.5 times EPS estimates for fiscal 2015. (Apple's seven-for-one stock split went into effect in early June.)

A more recent technology addition to the portfolio is Skyworks Solutions Inc. SWKS, which was also among the fund's top-10 holdings at the end of July. "Skyworks has a structural competitive advantage due to its proprietary technology, supported by its commitment to research and development."

This global company is an "innovative producer of high-performance analog semiconductors, which have a wide range of applications and attract high margins," says Misquitta. For example, its products are used in the automotive business and in the wireless-communications industry, he says.

Skyworks has good growth potential both within its existing customer base and from the wider use of its products, he adds. The stock trades at 17.5 times EPS estimates for its fiscal year ended September 2014 and 14.1 times EPS estimates for fiscal 2015.

A global information-technology consulting company that Misquitta says has a "durable competitive edge" is Cognizant Technology Solutions Corp. CTSH, a current holding. "Importantly, the company has scale, competency and a long-standing client list, which are all-important assets in this business," he says. It invests heavily in developing human capital and is good at attracting talent, he adds.

Cognizant is profitable, "generating operating margins in the high teens." In all, he says, it is a successful business that is, at times, inappropriately valued by the market either on the low or the high side. "This provides us with the opportunity to change our weighting in the stock from time-to-time." (The stock was listed in 1998.)

Apple Inc. Cognizant Technology Solutions Corp. Skyworks Solutions Inc.
Aug. 31 close $102.50 $45.73 $56.66
52-week high/low $103.74-$63.89 $54.00-$36.58 $57.18-$23.27
Market cap $618.5 billion $27.9 billion $10.7 billion
Total % return 1Y* 49.9 24.8 124.3
Total % return 3Y* 24.6 13.0 40.2
Total % return 5Y* 34.64 21.3 37.4
*As of Aug. 31, 2014. All figures in U.S. dollars
Source: Morningstar

In health care, Misquitta says that Gilead Sciences, Inc. GILD is an example of company that is using research and technology to deliver more efficient treatments with reduced side effects. This global biopharmaceutical company makes drugs addressing such key diseases as HIV and cancer, he says. "A big driver of Gilead is its drug Sovaldi for the treatment of chronic Hepatitis C." This drug, he says, "is most effective and it has a large and growing market."

Misquitta and Young have reduced the fund's holding in Celgene Corp. CELG. This is a biotechnology company that specializes in cancer. "We still like the business; it was a matter of the stock's valuation," says Misquitta.

In the U.S. financial-services sector, this U.S. equity team's focus is on "major traditional banks that withstood the global financial-services crisis through their disciplined lending practices and the protection of their balance sheets."

Two top-10 holdings in the fund at the end of July were Wells Fargo & Co. WFC and PNC Financial Services Group Inc. PNC. Wells Fargo used its strength during the financial crisis to acquire troubled Wachovia Corp. at a good price, says Misquitta.

PNC, he notes, has a substantial stake in the global investment-management company BlackRock Inc. BLK. PNC, says Misquitta, is a "leader in adapting mobile technology to online banking and is reconfiguring its branches in the light of the changes under way in the industry." This bank, says Misquitta, has also used its strong balance sheet to acquire other banks that were having difficulties. For example, in the fall of 2008, PNC purchased a weaker player, National City Corp., he says.

"Both Wells Fargo and PNC have a strong acquisition track record and could participate in the expected further consolidation in the U.S. financial sector, as the lesser players grapple with the tougher regulatory regime in place."

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Sonita Horvitch

Sonita Horvitch