Panning for gold

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Typical analytic screens have limited ability to find outstanding companies worth investing in, says Aylon Ben-Shlomo, principal and client portfolio manager with Los Angeles-based Aristotle Capital.

Screens are often backward-looking and lack predictive power, he said. And those that are forward-looking are usually based on consensus — a sign of overexposure in the market.

Ben-Shlomo said using standard screens is akin to searching through a bargain bin that has already been picked over by all the customers.

“What are we likely to find there? Probably not an attractive purchase. More likely than not, a very low-priced good that’s low priced for a reason,” he said.

His process is centred on identifying large-cap businesses with sustainable competitive advantages, and then learning everything he can about how they operate in given market conditions.

When he and his team invest, they do so for the long haul — often seven years or more, rather than the typical three to five years.

“We seek to understand businesses, not predict stock prices,” he explained. “What makes a management team special? What makes the business model unique? What makes the cash flows and returns sustainable? That requires a lot of work.”

One of his favourite areas of study is the value chain, which spans a company’s first supplier to the end user. That’s because the value chain is an excellent harbinger of risks, opportunities, market shifts, potential disruptions and changing consumer preferences.

“Knowing how profit pools may or may not be shifting from a supplier to a customer, a competitor [or] a potential disruptor helps us understand who’s ultimately delivering a good or service that is valued and will continue to be,” he said. “We want to understand the value chain so we can better understand where businesses are going, rather than try and predict stock prices in the short run.”

For example, he cites recent developments in the commercial truck rental industry as a reason for closing out his position with Wisconsin-based Oshkosh Corp. The manufacturer of work trucks like cement mixers, garbage trucks and fire engines faces new headwinds from a recent trend toward truck leasing rather than ownership.

“That’s one area where we’ve been able to see potential changes going on and understand how that could be potentially negative for Oshkosh and positive for other companies,” he said.

Another example involves Apple Corp., which recently returned as a customer to San Diego, Calif.-based Qualcomm, the provider of baseband or modem chips.

“That created a very large stamp of approval in our eyes of Qualcomm’s business model [and] their technology leadership — particularly in 5G [cellular networks] — and provided us with greater conviction to invest in Qualcomm in July of last year,” he said. “Since then, 5G adoption has been quite strong, and they’ve been able to sign deals with virtually all the large phone manufacturers in the world, setting the company up quite well for the next three to five years.”

Ben-Shlomo said dramatic shifts in market dynamics — the catalysts many investors seek — are only valuable when companies can control them.

“We don’t want to invest based on some macroeconomic or secular factor. Those are great if we can identify them, but it won’t help us identify which business to own,” he said. “Moreover, we want to invest based on things that are not based on hope or not based on something that’s outside of the business’ control.”

For example, he recently invested in Crown Castle, a REIT headquartered in Houston, Tex. The catalyst in this case was the rapid adoption of 5G, which requires more cell tower “touch points” than previous standards. Crown Castle has infrastructure in place in desirable locations, and has already signed lucrative tenancy deals with companies such as New York-based Verizon and DISH Network Corporation of Englewood, Col.

“The pathway to profitability for Crown Castle is quite strong,” Ben-Shlomo said. “As Crown Castle’s tenancy ratios increase, we expect to see margin and cash flow and return on invested capital improvements.”

He described his investment process as a three-legged stool, relying on quality and valuation as well as catalysts.

“The bottom line for us is having a disciplined and repeatable process that we can execute consistently over time,” he said. “So, when we see a good business or an attractive valuation with compelling catalysts, we act. If we don’t, we wait.”


This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.

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