Silver Linings: Companies with a Playbook for Tough Times

We seek businesses with the financial flexibility to stay on the offensive, in good times and bad

A common general impression is that small-cap companies are of lower quality. It’s a well-founded assumption if you look at the Russell 2000 Growth Index. Fifty percent of those businesses are not generating free cash flow (FCF). The index tends to be highly levered, and the return on invested capital (ROIC) is lower.1

If you look at Polen Capital’s portfolio, you’d see something different. We have a cash flow return on invested capital that’s two times that of the index, and our companies are in a net cash position.2 So, we think that while the index overall is lower quality, we’ve been able to create this extremely high-quality portfolio that is meant to weather any storm.

One of the biggest advantages of the companies we invest in is the strength of their balance sheets and cash flow generation. We only seek to invest in companies that are able to self-fund their own growth, and we do that in good times and bad. This gives them optionality – to reinvest in their businesses, buy back their shares, and position the business for better returns and long-term outcomes.

Financial flexibility allows our companies to remain on the offensive. In difficult times, our companies are often widening their moats. They’re furthering their competitive advantages and planting the seeds for future growth.

–  Whitney Young Crawford, Portfolio Manager, Director of Research & Analyst, Small Company Growth

For example, RH is a holding in two of our strategies.3 Over the past year, CEO Gary Friedman has been very intentional about strengthening the balance sheet. The company has been buying back shares, and they’re not standing still. We’re in the middle of the second year of sales decline, yet the company continues to open new galleries in the U.S., and they just launched their first international property in England. We think that when the luxury home furnishing market returns, the company is very well positioned for success.

Another advantage our companies have is the ability to take advantage of strategic opportunities, and a big one right now is acquisitions. There are a lot of companies in our portfolio that have the cash and have been waiting for the right opportunity to do deals, which can really accelerate the long-term potential for those businesses.

Many companies will be impacted by an economic downturn, and very few are entirely immune. The key for us is finding businesses that can emerge from that environment even stronger, and we believe our investment horizon supports that. For most businesses, when times get tough, their focus shifts to the short term – to preserving their profits and cash and raising capital. In contrast, the companies we invest in don’t need to do that. They can continue to invest for future growth, widen their moats, and plant seeds for the long term.

Important Disclosures

1Bloomberg as of June 30, 2023

2Polen U.S. Small Company Growth portfolio characteristics as of June 30, 2023

3RH is a holding in Polen’s U.S. Small Company Growth and U.S. SMID Company Growth strategies as of June 30, 2023.

This information is provided for illustrative purposes only. Opinions and views expressed constitute the judgment of Polen Capital as of August 2023 and may involve a number of assumptions and estimates which are not guaranteed and are subject to change without notice or update. Although the information and any opinions or views given have been obtained from or based on sources believed to be reliable, no warranty or representation is made as to their correctness, completeness or accuracy. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice, including any forward-looking estimates or statements which are based on certain expectations and assumptions. The views and strategies described may not be suitable for all clients. This video does not identify all the risks (direct or indirect) or other considerations which might be material to you when entering any financial transaction.

The information in this video has been prepared without taking into account individual objectives, financial situations or needs. It should not be relied upon as a substitute for financial or other specialist advice. This video is provided for informational purposes only and may not be reproduced in any form or transmitted to any person without authorization from Polen Capital Management.

The volatility and other material characteristics of the indices referenced may be materially different from the performance achieved by an individual investor. In addition, an investor’s holdings may be materially different from those within the index. Indices are unmanaged and one cannot invest directly in an index. The Russell 2000® Growth Index is a market capitalization weighted index that measures the performance of the small-cap growth segment of the U.S. equity universe. It includes Russell 2000® Index companies with higher price/book ratios and higher forecasted growth values. The index is maintained by the FTSE Russell, a subsidiary of the London Stock Exchange Group.

RH is a holding in Polen’s U.S. Small Company Growth and U.S. SMID Company Growth strategies as of June 30, 2023. Portfolio information is shown as of June 30, 2023 and should not be construed as a recommendation to purchase, hold or sell any particular security. There is no assurance that any securities discussed herein will remain in the composite or that the securities sold will not be repurchased. The securities discussed do not represent the composite’s entire portfolio. Actual holdings will vary depending on the size of the account, cash flows, and restrictions. It should not be assumed that any of the securities, transactions or holdings discussed will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. A complete list of our past specific recommendations for the last year is available upon request. 

Past performance does not guarantee future results and profitable results cannot be guaranteed.