Many clients know CCM as a fixed income impact investing manager but are less familiar with our equity offerings. Similar to our approach in fixed income, we evaluate equity securities from an impact and financial perspective. In this week’s blog, Tom Lott, portfolio manager, discusses the compounder strategy used for asset acquisition in the firm’s equity portfolios.
The compounder strategy was designed to own best-in-class companies, at attractive valuations. This means owning quality stocks hopefully for long periods of time. With potential increases in capital gains tax rates, a buy and hold approach means we can avoid paying taxes today, and instead use deferred gains which with to generate more gains. In short, this could work out to be an extremely tax efficient strategy.
CCM has developed a proprietary list of equity names we call compounders – those we consider the highest quality stocks. In general, high quality stocks exhibit certain characteristics such as a strong track record of earnings per share (EPS) growth, a solid balance sheet, low capital intensity, high returns on equity/assets, solid free cash flow, organic revenue growth, recession resistance, and strong management teams. We avoid secular decliners and capital-intensive companies, which tend to underperform the market over longer periods of time.
While we have identified a list of roughly 200 names that fit these stringent requirements, we do not necessarily buy them all for our mutual funds. Entry point requires that we attempt to purchase these stocks generally when they trade cheap to their fundamentals and historical trading patterns.
The disadvantage of a compounder strategy is that it generally avoids IPO’s, SPAC’s, and start-up names. “Disruptors” are a popular investing strategy, and we generally will not find many of these fitting into our portfolio. Simply put, we are not managing venture capital/seed capital funds. This means we may “miss” the next Google, but the probability of finding these names is quite low anyway. There are probably hundreds of failed businesses for every Google that comes along. Facebook was the 11th social media product to hit the market, not the first.
Often companies with great track records can experience negative changes. Sometimes, compounders can become non-compounders for a variety of reasons (e.g., low interest rates, management change, government regulation, or via acquisitions). However, with over 25 years of professional investing experience, we constantly monitor each name for changing market dynamics and will sell stocks that no longer fit into our compounding criterion. For more information on our equity strategies and impact and ESG policy across all asset classes, visit www.ccminvests.com.