Portfolio Manager Q&A: Standing the Test of Time with Quality Companies

Dan Davidowitz speaks with Motley Fool about Polen Capital’s growth investing philosophy & why he feels it continues to deliver results for clients

Dan Davidowitz, Co-Head of the Large Company Growth Team, recently joined Motley Fool to share the time-tested Polen Capital investment philosophy, how it continues to deliver results, and why it’s not just about buying low and selling high. Read the interview highlights below and learn more about Polen Capital’s investment capabilities.

Q: Can you tell us about Polen Capital?
A: We’re a purpose-driven investment firm. What I mean by that is everything we do starts with our clients and doing the right thing for them. Protecting capital is the first and foremost thought in our mind, and then compounding that capital off a higher base.

The Focus Growth strategy, our oldest strategy and the one I lead today, has close to a 32-year track record. We now have three investment teams—the Large Company Growth Team, the Small Company Growth Team, and the Emerging Markets Growth Team. All our teams invest with the same Polen Capital philosophy that was established over 30 years ago. Everything is built around investing with a concentrated, high-quality growth approach.

In my opinion, one of the great things about Polen Capital is that we’ve never changed our investment philosophy since our firm’s founding. I’m very proud of how consistent we are with our research and investing methodology, and you can see this reflected in the consistency of our returns.

Q: What is your stock-picking strategy? What types of businesses do you own in your portfolio?
A: Essentially, we look for companies that we believe are the most financially superior, competitively advantaged businesses that we can find and nothing less. Only a small number of companies fit our investment criteria.

We screen the world for companies that meet five stringent criteria. We call these our guardrails, which are:

  • A cash-rich balance sheet
  • Abundant free cash flow
  • Sustainably high returns on capital
  • Stable or increasing profit margins
  • Real organic revenue growth

Each of these hurdles is intentionally high, and the companies we own must meet all five of these criteria. In the large-cap universe, a little over 10% of the world passes our screen. Our process is really about allowing that quality to rise to the top so we can find the best of those businesses. We think investing in average, inferior, highly cyclical, or highly leveraged companies is where risk is introduced.

Q: How do you think about growth?
A: Typically, the vast majority of the companies we own grow their earnings at a double-digit rate, so 10% or higher. We have some companies growing between 10-11% and others growing at a 30% rate. What’s most important to us is that each company has a massive competitive moat that allows for that compounding of growth to occur without a lot of risks.

We’re not just going after the fastest-growth companies. We also want to own companies that we think have safety-like qualities. We want to protect capital, which for a growth manager, is not very common. We do that by investing across the growth spectrum.

In the Focus Growth portfolio today, we own Dollar General. Dollar General is a 10-11 % grower, but it’s a countercyclical type of business with open growth potential. It’s not the fastest-growing company, but it tends to be very stable through even challenging markets or recessions. You will also see companies like Autodesk and ServiceNow in our portfolio that are very fast-growing businesses.

Q: In looking at the returns for your other strategies, Polen has been able to repeat its success in its newer products. What’s your secret?
A: We have a clearly defined investment philosophy and a repeatable process. The guardrails I mentioned are also essential because they help to keep us out of trouble. They help steer us clear of businesses where there might be significant downside risk. We think companies that have a considerable amount of leverage, cyclicality, or capital intensity are the types of companies with much more variability and potential downside. By eliminating those companies with our guardrails, we believe we put ourselves in a position of success.

Q: One of the oldest investing maxims is to buy low and sell high, but you’ve said your approach is not to buy low and sell high. Can you explain what you mean by that?
A: It means we’re not just looking for bargains—we are looking for great companies. When you set the hurdles as high as we do, you will rarely find a company that feels extremely cheap.

At Polen Capital, we try to find great companies that we believe will compound for a very long time and where the valuation is not fully reflecting that potential. People’s time horizons tend to be quite short in the investing world, and we feel it is not hard to find great businesses at attractive prices.

The Focus Growth strategy’s long-term annualized return of 15%, in the most efficient investment category in the world, U.S. large-cap, has been able to beat the S&P 500 Index by 400-500 basis points per annum over 30 years. That should not be possible. But, it is possible because, in our view, people have a hard time valuing these companies over several years.

We do not spend a lot of time building discounted cash flow models, but many people do. In these models, after five or ten years, the idea is to take the growth rate down to GDP and the margin stop. But we believe that doesn’t happen with great companies. Great companies can compound at over GDP growth rates for decades usually. So, the ”market” has a hard time pricing that.

Essentially, we seek to buy companies at a discount to their intrinsic value. It may not appear that way when you pay 20-30X earnings. But the strength of earnings growth and length of time that a company compounds that growth is how we achieve our results.

Typically, we’re not trying to buy on dips—we’re trying to buy companies where we think the returns will roughly track the earnings growth. So, we do not take the view of buy low, sell high. We ride along with these great compounders for years and years and years.

Important Disclosures
The information provided in these materials should not be construed as a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in the portfolio at the time you receive these materials or that the securities sold have not been repurchased. The securities discussed do not represent the entire portfolio. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable or that any investment recommendations we make in the future will equal the investment performance of the securities discussed herein. Past performance is not indicative of future results, and the investments discussed involve risk of material or total loss.

This document is not intended as a guarantee of profitable outcomes. Any forward-looking statements or estimates are based on certain expectations and assumptions that are susceptible to change in circumstances. Opinions and estimates expressed herein are also based on assumptions that involve known and unknown risks and uncertainties and other factors and are subject to change without notice or update.

Performance figures are presented gross of management fees and have been calculated after the deduction of all transaction costs and commissions, and include the reinvestment of all income. The management fees will reduce returns.

The S&P 500 Index is a widely recognized, unmanaged index of 500 common stocks which are generally representative of the U.S. stock market as a whole.

The indices shown have not been selected to represent an appropriate benchmark with which to compare performance, but rather are disclosed to allow for a comparison of the performance to that of certain well-known and widely recognized indices. The volatility and other material characteristics of the indices referenced may be materially different from the performance achieved. In addition, the firm’s holdings may be materially different from those within the index. Indices are unmanaged, and one cannot invest directly in an index.

Please note that this document is a condensed summary of the full interview conducted by Motley Fool.