Finding Growth - Powerful Trends for Profit Hunters

May 21, 2014 @ 3:48 pm

By James Hamel, CFA | Portfolio Manager, Artisan Partners Growth Team

James Hamel
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James Hamel

Consuelo Mack: A lot of us consider ourselves to be more value-oriented investors. The question is, why growth?

Jim Hamel: To answer that, I'll first give my team's definition of growth. We believe stocks follow profits. So growth to us is when a profit-accelerating catalyst—internal to the company or external or both—makes a firm grow faster in the near future. We are also focused on the rate of change, not an absolute level of growth.

As to your question: Why growth at all? The answer requires a bit of our world view and a bit of simple math. Our world view says: The world moves forward over time—it is positively biased. So a little bit of growth in a superior business can go a long way to cover up macro environment headwinds. The simple math is compounding of returns. If you expose yourself to the very best businesses with great management teams, you can let them do the work of growing through time.

Consuelo Mack: What do you look for when you evaluate and invest in securities?

Jim Hamel: We look for three characteristics. First, high quality businesses—what we call franchise businesses. Second, attractive valuations. Third, accelerating profit cycles. The first two elements are how we aim to protect against permanent capital impairment during prolonged downturns.

In identifying franchises, we look for those things that set a business apart, that protect them from the forces of competition over time. That can mean dominant or rising market share; proprietary assets—intellectual property, patents, the corner lot; or a defensible brand name—in many cases consumer companies have iconic brand names that resonate with global consumers. We look for one or more of those elements in our hunt for defensible franchises.

Consuelo Mack: And what about valuations?

Jim Hamel: A key distinction—we look for attractive or reasonable valuations, not cheap valuations, because really great businesses rarely sell at extraordinarily cheap valuations.

To establish a range of reasonableness, we look through the lens of a strategic investor or a private equity investor and ask, “What would they be willing to pay to own this entire business today?” Then we recognize in the public equity market that businesses usually trade at a discount to that level. So we are typically comfortable with stocks trading at approximately 60% to 85% of that takeout level.

Consuelo Mack: Tell us more about the concept of being "profit cycle hunters"—what does this mean and why is this so important to what you do?

Jim Hamel: Being profit-cycle hunters is what distinguishes us as more “growthy” investors as opposed to GARP-oriented investors. What that means is that we want to buy great businesses that are well positioned selling at reasonable prices. But beyond that, for us to consider investing, we must understand the growth catalysts and believe the firm is in the very early stages of an emerging profit cycle. Then, should that profit cycle start to play out as we anticipated, we can add capital to that position with confidence. Anticipating profit cycles and being there early is very critical to what we do.

Consuelo Mack: What are some of the key secular trends currently driving your investment strategies?

Jim Hamel: We are not thematic investors. However, as we do our bottom-up research, we occasionally identify strong secular trends that drive many of our investment campaigns. Some examples of strong trends we see now are industrial process innovation, the mobile Internet and the golden age of gas.

Industrial process innovation is what I affectionately call "man versus machine." Recently, wage inflation has limited the ability for manufacturing firms to easily increase profitability just by outsourcing. With labor costs more balanced, we are seeing a couple of interesting developments. First, a degree of manufacturing is “re-shoring” back to the developed markets. But second, to maintain competitiveness, firms globally are managing labor costs by automating with next-generation industrial robots overlaid with software and smart technology.

Consuelo Mack: You also mentioned the "Golden Age of Gas"—can you explain this in more detail?

Jim Hamel: The golden age of natural gas might also be called the "shale revolution"—particularly in North America. It is all due to a technological breakthrough. We have long known that we had these vast shale resources beneath the ground, but exploiting has become increasingly economic over the past 3 and 5 years as hydraulic fracturing and horizontal drilling has become more widespread.

Natural gas production is now at an all-time high in the US and crude oil production is also starting to increase materially. Canada is experiencing something similar. This trend nicely dovetails with the prior one. Taken together, we could be in the early stages of a long sustained period of very high levels of productivity and efficiency for the United States.

Consuelo Mack: How are you viewing growth trends in mobile?

The shift of content consumption to mobile devices has been fairly dramatic. It is even more interesting when you look at advertising dollars, which have hugely lagged this trend. By late 2013, roughly 16% of all of the time spent on the Internet was on a mobile device. Yet, only about 3% of advertising dollars were spent in mobile environments. While mobile advertising is lagging, it is clear where we are going. A select few companies are figuring out how to monetize mobile traffic in a very effective way. In the US, companies like Google and Facebook are starting to monetize well, and in China, we see Baidu and Tencent doing the same.

Please click here to read the new Artisan Partners whitepaper Where we are finding growth-industrial process innovation.


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