In this Q&A, Portfolio Manager Steve Weeple discusses why the Janus Henderson Global Equities Team avoids trying to predict economic and political cycles or market sentiment. Instead they take a disciplined, long-term approach, seeking to invest in a portfolio of high-quality, growing companies that have the resilience to weather unforeseen events.
How would you define a high-quality growth stock and why is it relevant to invest in this type of company at this stage in the economic cycle?
The process of identifying attractive investments for our clients is one that requires patience, discipline and a long-term perspective. We invest our clients’ capital into companies that we believe have the potential to thrive and grow over the long-term, compounding attractive returns over many years. We seek companies with a high degree of resilience – financial and operational – through whatever conditions the economy and capital markets may exhibit.
We remain disciplined in this approach regardless of what ‘stage of the cycle’ we are experiencing. What we know is that we are not going to be able to consistently identify changing market conditions, or cycles, before they happen. Instead, we stay true to our investment philosophy, which we believe can deliver over the long-term regardless. As we think about the kind of companies that are most likely to be able to do that, we believe that gaining a deep understanding of the nature of their growth opportunity, and their operational and financial quality, is paramount.
When we consider how a company is likely to grow over the long-term, we seek to invest in names that are likely to have much more predictable and sustainable growth. We believe that companies operating in end markets that are benefiting from well-entrenched secular trends – often a result of societal, demographic or technological shifts – will be better positioned to grow in a more predictable manner and will be significantly less dependent on any particular stage of an economic cycle. They should also require less support from either fiscal or monetary policy. We look for long-term secular tailwinds that can help grow a company’s addressable markets and drive this powerful opportunity for many years.
However, not every company operating in an attractive and predictably growing market is going to succeed over the long term. Its balance sheet may not be resilient to market cycles and unforeseen events or, for instance, the company may not exhibit the governance standards for success. Companies can fail for many reasons. However, there are a number of fundamental characteristics of ‘quality’ we can look to as key indicators of the likelihood that the companies we invest in will thrive and deliver compelling returns to our investors.
We will only invest in companies that we believe have strong and durable franchises: companies that possess clear competitive advantages and margin structures that demonstrate this. We seek companies with proven leadership teams and governance structures that clearly protect and prioritise minority shareholders, and companies that systematically mitigate the operational risks that come from managing their environmental, social and governance footprint.
When we conduct our analytical due diligence, it is these definitions of growth and quality that we always look for. We believe it is companies that exhibit this fundamental ‘quality’ that are most likely to generate the long-term returns we aim to deliver to our clients.
What would be an example of a key position in the portfolio and your investment rationale?
One of the larger holdings in our Global Equities portfolio is the US-listed real estate investment trust, American Tower. The company is a global provider of wireless communications infrastructure, offering solutions and services to deploy and support wireless networks in 17 countries located across five continents.
American Tower exhibits attractive long-term revenue growth driven by the continuing rise in demand for mobile data services, as shown in the chart below.
Contracted revenue $ in billions
Source: American Tower, Fourth Quarter and Full Year 2018 Earnings update, 27 February 2019.
2019E reflects 2019 outlook midpoints. Assumes 2019 FX rates consistent with year-end 2018 rates for comparability
It also possesses some outstanding qualities, given the crucial role it plays in the propagation of mobile service providers’ networks; the quasi-monopolistic nature of each individual cell-phone tower that it operates; the nature of its pricing power, attractive cash flows and balance sheet; and its management’s successful history of capital allocation.
American Tower operates a business model with highly recurring and long-term client contracts, with clients that only very rarely move away from its service. Coupled with the secular demand that is driving demand for its services – more global consumer demand for e-commerce, e-payments, e-video streaming, e-gaming, e-payments, provides a long-term growth model. The company’s contracts have built-in annual price increases, adding to the highly predictable nature of its long-term revenues and providing a clear demonstration of the company’s franchise and pricing power. The secular and resilient nature of demand for its service can be seen in its financial performance during the financial crisis. In 2009 it was able to grow its property revenues by 8% and cash flows by greater than 10%.
The company has modest spend requirements to maintain its assets, allowing it to use its substantial operational cash flows to both grow the business internationally and pay attractive dividends to its shareholders. It does have a high absolute level of debt at more than $20bn, however, its long-term and more predictable business model means it also has more than $35bn of long-term contracted revenues against those debts. In addition, American Tower, has exhibited a long history of steady and consistent financial success, delivering a compound annual growth rate of operational cash flows of more than 15% over the last 10 years.
Taken in the whole, the attributes we see in American Tower are representative of the type of ‘quality’ we look for in our holdings. While the geopolitical and macro backdrop will undoubtedly lead to bouts of uncertainty and volatility, we avoid trying to predict these and instead seek to find companies such as this to best serve the long-term interests of our investors.
It has grown its dividends per share at greater than 20% over the last five years, clearly valuing the role its ordinary shareholders play in its capital structure. This is a company that, we believe, exhibits both high levels of predictable and attractive growth, and demonstrable financial and operational resilience. We believe this is an investment that will continue to generate strong absolute returns for our clients.
How high are valuations for this type of stock and are there still attractive opportunities in the markets?
Identifying companies that exhibit all of these fundamental characteristics of growth and quality is not a trivial task. We will not compromise on any one of these aspects when we invest, so we cast our net wide as we look for these opportunities. We travel extensively and typically meet more than 250 companies a year searching for ideas, looking across geographies, industry sectors, and market capitalisation sizes. When we also consider whether we can invest in these companies at a valuation that, we believe, will provide a reasonable margin for error and the strongest possibility of generating attractive long-term absolute returns, the challenge becomes that much harder. But we always maintain that strict valuation discipline.
On first glance many of these companies may look ‘expensive’, with nearer-term valuations (price to earnings) typically above that of the overall global equity market. However, it is our view that one of the common failings of investors is to focus too heavily on the near-term, forgetting that companies with growth and quality characteristics are well positioned to keep growing their cash flows for many years to come.
By staying focused on these types of companies we can extend our investment and valuation time horizons. This is why we only invest in these types of companies. Investing in equities – an asset class with no maturity dates or expiry dates – provides the patient investor with the ability to take a long-term perspective and reap the potential rewards. We remove ourselves from the preoccupation of the short term, looking at least five years ahead and, as a result, we continue to find companies with these qualities trading at what we believe are attractive absolute and relative valuations.
There are attractive opportunities in the market, but not an unlimited amount and certainly not in every country or industrial sector or of every size. But for investors like us that are looking to manage a concentrated and benchmark agnostic portfolio for our clients that we intend to hold for the long-term, we certainly remain excited by our portfolio and the holdings within it.