Concentrating on the US – Q&A with Polen Capital Management’s Dan Davidowitz

16th May 2013

Florida-based investment manager firm, Polen Capital Management, has launched the Polen Focus US Growth Fund as a Dublin Ucits fund. Managed by CIO Dan Davidowitz and Damon Ficklin, the pair follow a concentrated large cap US equity growth strategy.

Polen’s investment philosophy is based on the principal that earnings growth is the primary driver of long-term stock price appreciation. The firm overall manages $5.1bn of investments as the end of March 2013.

Mindful Money talks to Dan Davidowitz about the fund and the US market.

1)     Can you talk me through your investment process?

“We own about 20 to 25 very high quality US companies. We expect good earnings growth and tend to be focused on the very long term so our average holding time is about five years. In the 25 years or so that we have been doing this we have only owned about 100 companies in total. We tend to think and act as if we are the owners of the entire businesses, even though of course we are not. We are focused on doing this one thing very well. We start with a fairly large universe of companies. There are about 1,000 companies we look at on a cursory basis. We shrink that down to those we feel have the odds stacked in their favour. This typically means they have a lot of cash and little debt so they can generate free cash flow far in excess of what they need to run their businesses and have high returns on equity at 20 per or higher. We feel that is an indicator of competitive advantage. We look for companies which have true growth behind them and that are not wholly dependent on the economy. Those are the key criteria.

“Not that many companies actually meet our criteria. Of the thousand that we start with, only about two or three hundred do. Less than half can sustain those great metrics. We are left with a very small universe of a 100 to 125 companies. We spend the vast majority of our time studying those companies and their competitors to see is anything likely to change. Then we think what are the 20 best companies we can own that will grow the entire portfolio’s earnings at a mid-teens rate. This is fast. The S&P is at about 6%. We are talking between two and two and half times that pace. That is going to drive the investment return. We are real buy and hold investors. It is not going to be buying and selling activity that generates the investment return. It is going to be from the companies doing the hard work as they grow. It is quite different from our peers, the concentration and the long holding periods married together, that is different.”

2)     Does the concentrated nature of the fund bring more volatility during market downturns?

“We tend to outperform when the markets go down which seems counter-intuitive but because we focus on only the highest quality businesses with the best balance sheets and competitive advantages, they do tend to go down quite a bit less.

3)     How did you do through the tech bubble and the credit crisis?

“During the tech bubble, my predecessor David Polen said these valuations are ridiculous and moved to consumer staples like Hershey, Anheuser Busch, McDonalds, from the tech firms. That protected our capital. In 2001/2002, our portfolio was down about 14 to 15% and the S&P was down 50% so we protected a tremendous amount of capital. In 2003, we trailed the market on the bounce but we had protected so much. The next few years were tough years. We stuck with super high quality stocks but not everything in the market at that time, was super high quality. Coming to the 2008 downturn, when everything went down our portfolio did as well but we outperformed by about 10 percentage points. It was a higher quality portfolio. Correlations were close to one but we outperformed. It happened so ferociously, we were looking around and realised that all the companies that we study are available at really good prices we have to look at our portfolio. Do we want to own the 20 that we currently own? We looked at our universe again and realised we can buy Apple at $90 a share and Amazon at $55. We shifted five or six out and five or six in. For us that was a lot. When the market rebounded. We outperformed again. We learned a little lesson from 2003.

4)     What is your view of earnings and valuations in the market at the moment?

“You have to be conscious of what is going on in the market place. We are not trying to buy cheap stocks. We are buying companies that are appropriately valued where we think that the intrinsic value will growth with the earnings growth. In the US, we have seen a very large ‘up-valuation’ in high dividend yielding, big blue chip companies. They are pulling up the whole market, because of their relative size – companies like Coca-Cola, Pfizer, AT&T are slow growing but pay a pretty nice dividend. We are seeing a big multiple expansion though they came from a low base so some of this was warranted. There is momentum but it is definitely not driven by the companies themselves but by investors. Our portfolio has not seen the same thing. The dividends are low for our growth companies and we have actually seen a little bit of multiple compression. The market rally has been driven by a group of high dividend yielding companies also a bunch of turn round companies. That is also an area were we don[‘t invest, though it is something we have to be aware of. We like Coca Cola, but if they are only going to grow seven, eight or nine per cent, that will give you a market-like return.”

5)     Concentrated funds tend to be riskier. How does your fund rate for risk?

“Concentration is risky if you do not invest in high quality companies. You can have share prices that move in fairly large increments but if the intrinsic value is moving in the right direction, and the balance sheet is healthy we are in a pretty good spot. We have never had a major capital impairment. We only invest in the best firms. We have some volatility, but we are looking at earnings in five years’ time. We have seen some stocks go down on an earnings report, but the rationality comes back at some point. One firm we own, Cognizant Technologies an IT and outsourcing firm had a modest reduction in revenue growth from 23 to 20%. The stock dropped 20% not from a high level. We bought more on the decline though we do not do a whole lot of that.  The market tends to overreact. There could be volatility but it is a lot less than the S&P 500.”

25 thoughts on “Concentrating on the US – Q&A with Polen Capital Management’s Dan Davidowitz”

  1. forbin says:

    Hello Shaun,

    of course not

    but house prices are a fact of the shortage of houses versus demand. Classix econ babble would have us believe this will mean a increase in the mount of houses

    ‘fraid not

    its the economics of shortages at play. and has been so for 30 year or more , except we’ve imported more population as well

    also we can’t all live in the South East with out it being turned into Hong Kong or Singapore . You can see they “solved” that problem by building flats and high rises ….. so the British will have to come to terms with loving them !

    throw away planning permission = Brazillian slums

    tarmac the Green Belt = you’ll be back in 10 years for more ( also all this will actually result in is the Land banks of the big majors increasing and ergo their profits – build more ? sure a little more , don’t want supply and deamnd operating unfavourably for them do they? )

    reduce demand = major economic recessoin – naw , not gonna happen , not by choice anyways


    1. therrawbuzzin says:

      HS2 is the answer.
      It raises the area of shortage.

      1. forbin says:

        sort of, I think its there to allow MPs to buy further from London,

        any help for anyone else is just a co-incidence 😉

        good job they can get popcorn cheaper in London …


        1. Anonymous says:

          Hi Forbin

          You may enjoy this from Yes Minister which is on your theme…

          “We got to Oxford in little over an hour. The M40 is a very good road. So is the M4, come to think of it. I found myself wondering why we’ve got two really good roads to Oxford before we got any to Southampton, or Dover or Felixstowe or any of the ports.

          Bernard explained that nearly all of our Permanent Secretaries were at Oxford. And most Oxford Colleges give you a good dinner.

          This seemed incredible – and yet it has the ring of truth about it. ‘But did the Cabinet let them get away with this?’ I asked.

          ‘Oh no,’ Bernard explained. ‘They put their foot down. They said there’d be no motorway to take civil servants to dinners in Oxford unless there was a motorway to take Cabinet Ministers hunting in the Shires. That’s why when the Ml was built in the fifties it stopped in the middle of Leicestershire.’

          There seemed one flaw in this argument. I pointed out that the M11 has only just been completed. ‘Don’t Cambridge colleges give you a good dinner?’

          ‘Of course,’ said Bernard, ‘but it’s years and years since the Department of Transport had a Permanent Secretary from Cambridge.'”

          The wittiest satire always has a list an edge of truth I think!

      2. Anonymous says:

        How many commuters can HS2 help ?
        Assume commuters arrive between 7 and 10am.
        I guess a train every 3 minutes. (20 per hour)

        Ergo we have maximum 60 commuter trains into London in morning and similar number returning. The existing 8 to 9 trains run full, but 7 am trains are less than half full.

        Even if we allow 2000 passengers per train, that is 120,000 people. The IEA estimate £80 Billion cost. So I calculate the track cost per passenger at over 66,000 each. Add in cost of trains, staff and electricity.

        So I predict unaffordable rail tickets – ordinary workers will be priced out of HS2 commuting.
        Farnborough – Waterloo 35 miles, was £300 per month. Birmingham – Euston 120 miles – maybe £1000 per month
        Manchester – Euston ????

  2. dutch says:

    ‘The media and the blogosphere continues to buzz about the risks building
    in the UK residential housing sector. Just look at this housing price
    index – we are way above the pre-recession peak. Compare it to home
    prices in Spain to see this massive divergence (see chart). It’s a bubble and it’s about to burst…Hogwash’

    Sober Look says no,but I can’t see what’s going to sustain the UK market higher if it’s not wages/increased bank lending.
    Isn’t the increased popn decreasing salaries?
    Isn’t the incresing popn relying on the gment to sustain growth with unsustainable deficit spending and monetary easing?
    I really enjoy sober look but he/she/they seem wide of the mark on this one

    1. Anonymous says:

      Hi Dutch

      I think that whoever wrote this has little or no experience or exposure to the UK. If they did then neither of the points below would have been made.

      “Furthermore, there is little evidence of any material speculative investing activity in resi property markets that we saw in the US prior to the crisis. And most importantly there is no evidence of aggressive mortgage lending.”

      Buy 2 let is back and are were signs of higher loans to value again

      Or why have both George Osborne and Mark Carney responded at Mansion House tonight?

      1. Noo 2 Economics says:

        If you saw the Florida housing market 10 years ago you would understand the comment. A friend has been a realtor (Estate Agent) in Miami since 1995 and the “speculation” we have seen here is dwarfed by what happened in Florida and elsewhere. They do things on a much much bigger scale, so our “speculative property price increases” are small beer to America.

  3. David says:

    When we bought our first house back in 1978 the Halifax BS would only lend max. of 2.5 x my earnings plus 2 x wifes and you had to have a min 10% deposit and be interrogated before they agreed to anything. There was plenty housing choice. Today less choice of stock but easier access to funds/debt. On reflection we had it easy by comparison (no student debts either).

    1. Eric says:

      Absolutely David. Me too in ’76. The pre-approval inquisition by the Leeds Permanent was scary. I think the interest rate was higher than today too – but it was the only debt I had!

    2. Anonymous says:

      Hi David and welcome to my part of the blogosphere

      Those were very different days indeed and in a way the macroprudential policies are an attempt to turn back the clock to then. The catch is that the world has changed as you point out with the reference to student debt. Some students are claiming they were told that student debt would not count as regards mortgage affordability and I think that everyone can guess what happened next (MMR)!

  4. Anonymous says:

    Ireland and Spain construction was done speculatively by developers using finance.

    To match construction with demand, a mutual type structure could be used. Competing projects could offer property off plan, and the planning go ahead to build made dependent on a project achieving 70% (or similar) sales.
    Benefits include
    – competition motives good design, specification
    – competition promotes affordability
    – 70% sales will finance construction, lessening risky property loans and reducing bank risk from real estate bust

    1. Anonymous says:

      Hi ExpatInBG

      That’s an interesting idea are there any such mutual structures around? I do not want to scotch the idea that building some more house might help what I was trying to scotch was that it was like a magic wand. After all if it was that easy they would have been built into the rallying house prices would they not?

      Perhaps Paul C’s ecohouses will start to see some more UK demand…

      1. Anonymous says:

        Original idea, I don’t know of any examples.

        A big problem in London is developer entry. Only big well financed players can build. Planners cannot be held democratically accountable. My idea puts decision of which projects are best in buyers hands, and lessens the possibility of planning bribes. Supply restrictions = higher prices.

        With creative thinking and politicians willing to ignore vested interests, lobbyists to act in public interest – great achievements are possible.

        Initial Bulgarian sales were to real buyers wanting a property to use, who had the funds available. Strong sales bought in big marketing outfits and big money developers who built in Spain. Some agents promoted “flipping” – buy now and resell next year at a profit when it’s built. This ponzi scheme was bound to end in tears.

        Getting accreditted buyers signed up reduces much risk and cost. Cost savings can be passed back to buyers. Self financing affordable apartments is much better than shared ownership scams for essential workers or govt liability from help to buy.

  5. Pavlaki says:

    You maybe give to much credit to Osbournes ability to influence the timing of a rise in the housing market! It needs confidence, more job security, rising rents and availability of loans before housing takes off. I suppose the government have achieved the first three but loans are harder to come by, even allowing for help to buy.

  6. Anonymous says:

    Hi Anteos and thank you.

    This movement of powers from elected politicians to unelected Quangos has been a clear trend over the last decade or two has it not? So when it goes wrong the politicians concerned can sing along with Shaggy.

    “It wasn’t me. It wasn’t me”

    If we exclude the Governor can anybody name a member of the Financial Policy Committee without googling it? I can but as I worked with her it is not quite fair.

    It returns me to my suggestion that the Bank of England MPC should be elected and now so should the Financial Policy Committee.

  7. anteos says:

    There was ZIRP, SMI (temporary) being rolled over year upon year, HTB and HTB 2. Quite a lot of gment policies to underwrite housing.

  8. Pavlaki says:

    My daughter an husband have just gone through the help to buy scheme and an application for a mortgage via a bank. The criteria were very strict indeed and the amount loaned a very low multiple compared to the past. I really don’t think HTB. Is pumping the market and indeed the market locally (gloucestershire) is only growing fast at he top end . Houses costing around 250k are increasing only slightly, 500k a bit faster but at the 850k and over level they are increasing dramatically – and being snapped up. The UK housing market is very un balanced and calming measures need to avoid throwing the baby out with the bath water.

  9. Mike says:

    What’s the baby here? Surely *all* housing becoming cheaper is the ideal scenario?

  10. Pavlaki says:

    There has been talk of taking away help to buy but that only helps those at the bottom of the mortgage ladder who struggle to afford a house. It is not where the bubble is.

  11. Mike says:

    I couldn’t disagree more. Struggling FTBs are exactly the people who would benefit most from FTB-type properties becoming cheaper. HtB is working against that, both directly by loosening credit taps and more importantly by sending a clear message to speculators that the Government will do anything necessary to maintain housing inflation, including throwing the entire productive economy under a bus.

    Housing is a necessity. Cheaper housing is always a good thing. It’s not something to be grudgingly accepted only in extraordinary circumstances.

  12. Pavlaki says:

    I just don’t see much of an increase at the bottom of the market so I would argue that it isn’t being inflated by HTB. Cheaper housing for first time buyers would be nice but prices around here didn’t drop much even after 2007. If that didn’t effect them then I don’t see the removal of HTB making any impact. But it will hurt those trying to buy their first property. The bubble higher up the ladder needs air letting out of it which will slow the whole market.

  13. Eric says:

    Hi Shaun, If Quangos were ever to be elected, which I doubt because the whole point of “independence” is that they are not elected, then would “they” let you stand for the MPC?

    I guess none of us here need Google to answer that.
    But don’t let that deter you from haranguing “them”!
    Great stuff.

    And nope; can’t name any of ’em; probably because the FPC haven’t done much (yet) to generated media heat.
    No excuse, I know.

  14. therrawbuzzin says:

    A time when the counterfactual may actually be appropriate: if you enforce stricter criteria on potential buyers, to ensure that they can actually afford their mortgages, without HTB underpinning the prices, you get a decline in demand at the bottom, lowering prices, preventing people who have to sell to buy, from moving upwards.

  15. Mike says:

    If it’s preventing significant numbers of second-time buyers from moving up then that feeds through to a fall in demand for STB properties, lowering prices there too. And so on. Everyone still wins.

    If you’re afraid that STBs may get outbid by wealthier FTBs – so what? The national assumption that those who already own property should be favoured over those who don’t is exactly what got us into the current fustercluck. There’s a legitimate need to prevent both FTBs and STBs from being outbid by speculators, but I suspect falling prices would work wonders there too.

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