Mid-cap U.S. manager looks beyond the quarterly earnings

TD fund's Brian Berghuis focuses on the long-term potential of a business.

Diana Cawfield 25 January, 2018 | 6:00PM

Brian Berghuis credits the strong track record of TD U.S. Mid-Cap Growth to looking beyond the numbers. "I spend probably 90% of my time on the qualitative aspect, "meaning how we perceive the quality of the management," says Berghuis, a vice-president and portfolio manager at Baltimore-based T. Rowe Price. "We're investing in companies where business models are proven. You don't get to several hundred stores in the United States if the business model doesn't work."

Assessing management is the first step in the stock-selection process for the $1.5-billion fund, which has a 4-star Morningstar Rating in the U.S. Small/Mid Cap Equity category.

The next step is looking for companies that have a competitive advantage. That could be low operating costs, a well-known brand, or anything else that might lead to higher return on capital over the long run. The fund's average holding period for a company is about three years, says Berghuis, "but we have lots of companies that we've owned for a decade or more."

Thirdly, the team turns its attention to quantitative criteria such as cash flows and balance-sheet strength. "I think balance sheets are pretty much ignored most of the time by most investors," says Berghuis, who has been the lead portfolio manager of the firm's U.S. mid-cap growth strategy since 1992.

A fourth step, also quantitative in nature, involves risk assessment. Berghuis says some growth managers just look for growth for growth's sake, "but sometimes growth can be too expensive." So the managers need to pay attention to valuations. "When we feel it's gotten way ahead of itself," says Berghuis, "or if stocks are really frothy, we'll pare a company back, or we'll sell it."

Then, for most companies, the team produces estimates of what the company should trade at in a couple of years and whether that estimate is attractive in terms of potential capital appreciation.

Illustrating the investment process is Casey's General Stores Inc. (CASY), which operates self-service gasoline stations combined with retail stores. "They're well-designed convenience stores," says Berghuis, "almost a restaurant within a convenience store, serving pizza and sandwiches." The business model focuses on servicing very small towns with populations of less than 10,000 and spans approximately 2,000 locations. "The company could be many times the size in 20 years," says Berghuis, "replicating their current concept."

Among the top holdings in the fund is  Textron Inc. (TXT). "It's a fairly diversified industrial company," says Berghuis, "and a world leader in helicopter manufacturing," Their business-jets division is an area of growth and the managers see opportunity in their production of planes for military personnel. Berghuis thinks the development of a new plane, the Scorpion, "will have significant applications for military personnel and that's just gaining traction. It could be a huge incremental move for them in 2020, 2021 and 2023."

For robust growth opportunities, "I'm going to put technology and health care in the same category," says Berghuis. "They're really the same, without getting into the underlying trends. The U.S. is a leader in health-care technology companies and there are lots of medium-sized companies that have very exciting technologies, biotech certainly, and the same goes for the technology area."

A favoured health-care holding is  The Cooper Companies Inc. (COO), a medical-device company that specializes in contact lenses. "Cooper probably has the best technology in multi-focal lenses," says Berghuis, "and this area is growing much more quickly with the populations in Western countries aging." In addition, "this is a nicely growing company, sales are running about 10% a year and its earnings are about 15% fairly consistently."

Berghuis's keen interest in mid-cap stocks began early on in his career. "I ran some studies on mid-caps going back to the 1920s, and what we found was that mid-caps outperformed large caps decade by decade. So we said, here we have data that indicates this is a good investment class over about a 70-year period."

To date, Berghuis and his group have met with more than 10,000 management teams. They draw on insights and ideas from a team of 50 domestic analysts.

The benchmark for the TD mandate, which normally holds about 130 positions, is the Russell Mid-Cap Growth Index. The index currently defines mid-caps as US$30 billion in size at the high end. Berghuis says he prefers to buy companies in the low-to-middle range of mid-caps because he and his colleagues like to buy and own companies for years.

The focus on the long-term potential of a business is the "real key advantage to what we do," says Berghuis. "We have had the courage to stick to the process and not chase the latest events. That philosophy has got us through some really tough times, the bear market in 2002, the U.S. financial crisis," and many others. You have lots of potential growth if the concepts are proven."

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Casey's General Stores Inc171.99 USD1.16
Textron Inc45.36 USD2.25
The Cooper Companies Inc335.01 USD-0.11

About Author

Diana Cawfield

Diana Cawfield  Diana Cawfield is an award-winning writer who has been a regular Morningstar contributor since 2000. Her numerous publication credits include the Toronto StarAdvisor's Edge and Chatelaine, as well as the Canadian Securities Institute's online educational services.