The rub on growth stock investing is that over the long term it always loses to a value style. Tell that to Dan Davidowitz and David Polen, co-managers of the Polen Growth Fund. The mutual fund, which opened in September 2010 and has a 1.25 percent expense ratio, is run in an identical style to Polen Capital Management’s privately managed accounts for high-net worth investors. Those accounts have delivered a 10.2 percent annualized return over the last 15 years, well ahead of the S&P 500’s 5.7 percent and the Russell 1000 Value’s 6.5 percent. An edited transcript of Lewis Braham's discussion of the fund’s strategy with Davidowitz follows.
Q: If you look at the historical stats, value investing has beaten growth. How do you explain your record?
A: The answer is in the labels. We believe we’re growth investors, but the legacy at Polen Capital comes out of the Ben Graham and Warren Buffett value school of investing.
One of the things key to what we do is margin of safety, a Ben Graham teaching. The way that's been used by most value investors is to say, "I think this company is worth x, and I’m going to try to buy it at a big discount to x." The way we think about it is different. The margin of safety is in the competitive advantage of a business and its growth prospects. If you can find a huge competitive advantage to a growth business, that’s the margin of safety. As long as you don’t pay too much, you can get an exceptional return. Instead of expecting a valuation gap to close, we let earnings growth drive performance.
Q: What kind of criteria do you use for finding companies?
A: We invest in very high-quality companies, typically 18 or 19 stocks, and have an average holding period north of four years. We ask, "Is this a business that is so wonderful and has such great prospects that we would want to buy the whole company if we could?" In 23-plus years, we’ve owned less than 100 companies.
A company has to have an exceptionally strong balance sheet, with a ton of cash and virtually no debt. It has to be able to generate free cash flow far in excess of what it needs to run the business. And it has to have very high returns on capital that are sustainable -- at least 20 percent. That hurdle is important because very few companies can sustain returns that high, and if you are doing that, it means you're likely doing something that keeps competition away. We also want strong revenue growth and stable or expanding margins. And companies should have a market cap over $4 billion.
Q: Your largest holding is Apple?
A: It’s about 9 percent of our portfolio. We purchased it in early 2009 at about $90 for 10 times free cash flow. We were tracking it a few years before that. We knew we liked the business, but until the iPhone debuted we weren’t sure of the sustainability of Apple’s growth. The iPhone turned Apple from a "sell a device once and hope they come back" business to a repeat business with a recurring revenue stream. That ecosystem of repeat customers started with iTunes earlier on but accelerated tremendously with iPhone’s App Store.
There are still a tremendous [number] of growth opportunities. Apple, just by maintaining its 8 percent market share of handsets, could see a four to fivefold increase in the iPhone business. The iPad is also a tremendous new category Apple is dominating. We believe the tablet market could be quite a bit larger than the PC market.
Q: One company you added to in the first quarter was CH Robinson Worldwide. Why?
A: CH Robinson is a truckless trucking company. They are a broker for mostly domestic North American truck freight. They match up people who need to ship something by truck with small truckers.
Robinson provides an advantage to the company shipping and to the trucker that neither could get on their own. It offers a lower price to the customer because Robinson provides a tremendous amount of volume to these truckers. More people are outsourcing their trucking needs because CH Robinson is very flexible and easy to work with. Yet it doesn’t own the trucks, so its business model isn’t capital intensive. It’s growing a little slower than it has in the past, but we think that will prove temporary. We bought more at $67 a share.
Q; You also bought more of FactSet Research Systems. What’s the story there?
A. FactSet is one of our newer companies we began adding last year. It provides software and services to professional investors like me. FactSet’s legacy was software for analyzing equities. They branched out into fixed income and a bunch of contiguous areas to broaden out the number of people they could license the software to.
FactSet is the No. 3 securities data provider behind Bloomberg and Thomson Reuters. They’ve been No. 3 for a long time but have been closing the gap over the last 30 years at a steady pace. It’s an extremely profitable business with very stable growth and high recurring revenues. The retention rate of clients is always north of 90 percent. It’s 5 percent of our portfolio.