Tucker Walsh, Head of Team, Portfolio Manager & Analyst, and Rayna Lesser Hannaway, Portfolio Manager & Analyst, recently sat down with The Motley Fool and discussed how they apply the Polen Capital investment approach to the small- and mid-cap universe and what they believe is unique to small- and mid-cap investing at Polen Capital.
Read the top 5 highlights from the interview below and learn more about Polen Capital and our small- and mid-cap investment capabilities.
1. Polen’s Philosophy Can be a Compelling Approach for Investing in Smaller Companies
Tucker Walsh and Rayna Lesser Hannaway joined Polen Capital in 2017 to launch the Boston-based Small Company Growth Team, which is focused solely on capitalizing on the opportunity set in the small- and mid-cap categories. The Team now includes eight members managing three strategies: Polen U.S. Small Company Growth, Polen U.S. SMID Company Growth, and Polen International Small Company Growth.
Polen’s Small Company Growth strategies employ the same disciplined, timeless approach to investing as all others at Polen Capital.
Rayna indicates that their investment approach is simple—it involves concentration, only investing in high-quality businesses, and having a long-term time horizon. This is Polen Capital’s specialty, and what they believe differentiates the firm is that each of its strategies shares the consistent philosophy that’s been successful at Polen Capital for over 30 years.
2. Their Deeply Collaborative Process and Flywheel Framework is Designed to Uncover the Truth
The Small Company Growth Team searches for several elements in an investment, which fit into what is known as their flywheel. Each company endures a rigorous research process and must meet all five of these flywheel criteria to be considered a candidate for investment.
After first running a quantitative screen to filter the investing universe for companies that have sustainably favorable economics, the Team performs fundamental research on the companies that rise to the top of the screen. The portfolio managers, along with the research analysts, work together in an iterative process to get to the heart of a company.
According to Rayna, they assign three or four people for every company they research to build significant knowledge and expertise on the business. Then, they come together and challenge each other by asking tough questions and working to uncover each other’s biases and blind spots. They seek to ask and answer the right questions to help them make smarter decisions. They believe that one plus one, or in their case, one plus three or four, equals something much greater than any of them could do on our own.
After determining whether a company meets the flywheel, the Team then looks at valuation. According to Tucker, considering valuation at the end of the process is important to explore all a business’s potential upsides and downsides without being anchored on price.
3. Concentration, Patience, and a Long-Term Perspective are Key
Polen’s Small Company Growth strategies typically each hold 25 to 35 companies at any one point in time, which the Team views as key to harnessing the power of high-quality companies and maximizing the returns for their style of investing.
Tucker said, “Truthfully, not many companies meet all parts of our flywheel, so we only invest in the ones that do. We believe that an important part of being able to manage a successful concentrated strategy is by thinking and acting long-term in our perspective, or really thinking like business owners.” Tucker also mentions that it becomes difficult to own more than 35 or so companies and really be able to think like a business owner. So, they focus on buying great companies that can generate cash and reinvest it wisely, which they believe typically creates better results.
Truthfully, not many companies meet all parts of our flywheel, so we only invest in the ones that do.
One company that has met these strict criteria is Alarm.com, a cloud security solution for home and business, owned in both the Polen U.S. Small Company Growth and U.S. SMID Company Growth strategies.
Alarm.com has recently expanded into the commercial space and video, which has created new avenues for growth and provided more repeatability and deeper relationships with customers. The Small Company Growth Team believes that Alarm.com can continue to grow its revenue at an attractive rate by taking advantage of a strong dealer network for installations, capitalizing on recurring revenue via the cloud, and pursuing thoughtful reinvestment opportunities.
4. The Small- and Mid-Cap Categories are Ripe for Disruption and Growth
The widespread adoption of the internet had led to more and more opportunities for small- and mid-cap companies to grow and compete on a grander scale. The Small Company Growth Team searches for companies that they believe can win in the digital age.
Rayna indicates that they believe in investing in fast-growing, disruptive businesses, but they do it with discipline, which includes their belief that profits matter. In their experience, cashflow and profitability enable financial flexibility, which, in turn, helps a company to survive and thrive in any environment.
The Small Company Growth Team wants to own companies that can fund their future growth without relying on outside help or funding. The importance of this financial flexibility is clear to them, especially now during the COVID-19 pandemic.
According to Tucker, maturing business models have allowed some companies to take advantage of a well-positioned product to generate cashflow and reinvest back into the business, which the Small Company Growth Team views as a sustainable path to growth.
One company that they believe has mastered this formula is AppFolio, which provides cloud-based software for property managers and property investment management. AppFolio’s market opportunity includes smaller property managers who often have multiple properties through a product suite that helps them with property management, utilization, payments, and more.
Tucker thinks AppFolio draws a straight line to the customer with their products, and their customer connection is one of the best they have seen. AppFolio has a culture that is organized around making its customers happy. The company has great visibility on its revenue, and it has been effective at reinvesting back into its products. AppFolio reaches out to its customers to find out how it can better serve customer needs, and then it typically reinvests its resources in this area to provide more value.
5. The Team Believes Continuous Learning Leads to Constant Improvement and Sustainable Success
Polen Capital’s culture of continuous learning promotes the building and sharing of knowledge across the firm to constantly improve and achieve better results.
Everyone at the firm wants to get better every single day.
The Small Company Growth Team utilizes continuous learning, which includes a training budget provided by Polen Capital, to develop a symmetry of knowledge with one another to better understand companies, business models, and other important skills and topics.
“Everyone at the firm wants to get better every single day. It’s really invigorating to be surrounded by people with this mindset, and it’s clear to me and to our whole team, from having done this for a while, that you have to continuously learn to sustain success as an investor. We really appreciate that we need to be updating our views appropriately.” Through continuous learning, the Small Company Growth Team seeks to constantly raise the bar.
Please note that this document is a condensed summary of the full interview conducted by The Motley Fool.
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