A concentration of deep-discount, top-quality companies defines the investment strategy for Rui Cardoso, vice-president at Beutel Goodman Investment Counsel in Toronto.
“When we find those great businesses, we only buy them when we can have a 50% return over a three-year investment horizon. This is a long-term perspective on value, regardless of what the short-term market sentiment is on the stock,” says Cardoso.
Cardoso and co-portfolio manager Glenn Fortin, together with a five-member team, manage the gold-rated U.S. Beutel Goodman American Equity Class F mandate. According to Cardoso, a select portfolio of “25 to 30 gems” sets them apart from their peers.
“Our hurdle stakes in terms of what qualifies for any Beutel portfolio, are very high. If we get most of those names right, and we can limit the downside on the ones we get wrong, then we’re going to protect capital in down markets, which is one of our core focuses,” Cardoso explains.
He defines ‘value’ as companies that can generate high, sustainable free cash flow over time, including high returns, a very strong competitive advantage, and strong management teams, among other qualities.
Research by the team, who spend most of their time as analysts, follows a multi-tier investment approach. The first step is sharing their best gem ideas among the group. If everyone on the team gives the “the thumbs up,” then an additional group of analysts do a full research report on the stock. Following this extensive research, if the stock hasn’t moved and it still offers a possibility of a 50% return in the future, the report is reviewed again and presented to the investment committee for approval.
Sector exposure in the predominantly large-cap fund is a result of a bottom-up approach. To meet the stock criteria, the fund will typically be underweight or have zero exposure in sectors where the businesses tend to have poor balance sheets, or the returns on their valuations are too high. As a result, the fund tends to be underweight sectors like real estate and utilities because the balance sheets have too much leverage and are viewed as too risky in a concentrated portfolio. “Even in materials and energy,” says Cardoso, “where the quality of the businesses tends to be not as high and there are balance sheet potential issues as well.”
Macro views are not part of the research process. “We don’t try to make any kind of call on things we can’t control. Increased complexity leads to bigger mistakes,” he says. The strict investment discipline is credited for the double-digit performance for over a decade. “There’s a natural kind of recycling within the process,” says Cardoso, “where we’re trading out of stocks that have worked and getting expensive and moving to quality businesses that are quite cheap. If you’re a long-term investor, we think the strategy will do well.”
Currently, the managers are not seeing as many new opportunities as last year, following the market rally in the first quarter of this year. Despite fewer opportunities, “we still have very deep discounts for each stock in the portfolio, and that gives us a lot of comfort on the downside as well. We’re still very confident on how well the portfolio will do, regardless of how the end market does.”
An example that illustrates the strategy is the fund’s top holding, Verizon Communications Inc (VZ), the biggest wireless player in the U.S. It was weak when the fund bought into it thanks to, “a very bloody kind of price war between the four players, Verizon, AT&T, Sprint and T-Mobile.” He backed Verizon because, in his view, the firm with the best balance sheet in a price war wins out in the end. “And not only does Verizon have the best balance sheet, they also have the best sustainable free cash flow given their dominant position,” adds Cardoso. In the meantime, the investment managers are happy to wait until the competitive situation changes and collect the approximately 4.5% dividend from the stock.
Another favoured holding is a mature biotechnology company, Amgen Inc (AMGN), that Cardoso believes is trading at a deep discount to intrinsic value, as competition increased in the sector. “We take a long-term perspective,” he says, “and look at the drugs currently launching and in the pipeline in differentiated areas of very high medical needs.” Those areas include cardiology, oncology, osteoporosis, and migraine treatment. As well, “they invest in their business, they generate high returns, and the balance sheets are very clean. We’re happy to collect a 3% dividend there and wait for the market to recognize the stock.”
Amdocs Ltd. (DOX), a leading billing provider in the telecommunications industry, has a “very big banner customer base, and they generate fantastic free cash flows,” Cardoso says. It’s very challenging to replace a billing software provider, so the customers are locked in for long periods of time. In addition, the company is favoured for its very stable business, great returns, great balance sheet and excellent management team.
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