- Managed in-house by Mawer since 1992
- Provides investment in common shares of U.S. companies across all capitalizations
- Creation of a broadly diversified portfolio of wealth-creating companies, with excellent management teams, bought at a discount to their intrinsic value
- Portfolios hold between 30 and 60 companies across at least 7 of 10 (GIC) industry sectors
- "Quality at the right price" investment style
Better than market rates of return with lower than market levels of financial risk over economic cycles. The S&P 500 index is used as a benchmark for both returns and standard deviation.
Our stock selection process has four main steps: idea generation to identify buy candidates, intensively analyzing those candidates to determine buy/sell recommendations, constructing portfolios of buy-rated stocks and monitoring and reviewing our portfolios and investment universe. This process is then continually repeated in a systematic manner.
1. Idea Generation
We generate ideas from several sources including in-house analysis, broker-dealers, industry contacts and our entire portfolio management team. For external research and idea generation we benefit from the excellent relationships we have developed over the years with a number of brokerage firms. We conduct interviews with major dealers on an ongoing basis.
Another part of idea generation is our screening process. Our objective is to quickly reduce the number of companies we are going to look at, primarily by eliminating those companies in which we are unlikely to invest. We look at two main elements to do this: a company's track record of creating wealth and its valuation.
We assess a company's track record of creating wealth by looking at its historical rates of return on capital. Companies create wealth only when their returns on capital exceed their costs of capital. We have the ability to screen most companies by using off-the-shelf software, which gives us a record of historical Return on Equity (ROE). At this stage we can also adjust the data in order to estimate historical returns on total invested capital, rather than just ROE, and we can manually assess companies that are not included in these databases. We are looking for companies with sufficiently high, and preferably increasing, rates of return on capital. We typically eliminate those companies with poor records of creating value, where return on capital is deteriorating rapidly or where return on capital is being maintained by non-operating sources.
Our simple valuation screens look at traditional valuation parameters such as Price/Book (P/B) and Price/Earnings (P/E) ratios. We also consider other ratios such as Total Enterprise Value/Earnings Before Interest Taxes Depreciation & Amortization (TEV/EBITDA). Given their limitations, we do not have specific cut off points for these ratios, but we do use them to rank wealth-creating companies' attractiveness. Other screens we can quickly use to restrict our investment universe include market capitalization, market float, debt levels, etc. By far, however, we are most concerned with a company's ability to create wealth and its valuation.
Companies that make it through this step are considered buy candidates.
2. Intensive Analysis
Although screening has the advantage of being reasonably quick and easy, it has many limitations. Using historical data, for example, says little about a company's ability to create wealth going forward. Simple ROE ratios may also cover up critical weaknesses or accounting choices. P/E and P/B ratios make implicit assumptions that are seldom true. Finally, it is not enough to know that a company creates wealth. One must determine how much one should pay for a share of the company.
Our intensive analysis involves a thorough assessment of the industry in which the company operates and its position within it. Critical sources of information include the company's filings, independent media sources (industry journals, trade magazines, business magazines, newspapers), analyst research and our own interviews with management, suppliers and customers, whenever possible. We use formal questionnaires and summary sheets to guide us through this step and ensure consistency in our process. Throughout this step we are trying to determine if the companies we are investigating have sustainable competitive advantages since we believe this is ultimately what drives high returns on capital.
We convert this industry and company knowledge into a formal discounted cash flow projection for the company. We use five years of explicit forecast data and a ten-year implicit fade to terminal value in order to estimate cash flows and assess whether the company can generate an acceptable return on capital. We apply a discount rate to these cash flows in order to estimate intrinsic value in current day dollars. And finally, we use "Monte Carlo" simulation to perform sensitivity analysis on these results, producing a "fair value range" of intrinsic value.
We spend about 75% of our time in the intensive analysis stage of our stock selection process. For us, this is the key step not only in identifying attractive investment opportunities but also in controlling risk. That is, we believe that risk is best controlled by thoroughly investigating investment opportunities and only committing capital when valuations are attractive.
Companies that make it through our initial screens, that are wealth-creating, and that trade at attractive valuations, earn buy recommendations.
3. Portfolio Construction
Next, we combine the most attractive of our buy-rated stocks into actual portfolios. The weight that each individual security receives is largely based on a confidence level derived from the attractiveness of a company's wealth creation, discount to intrinsic value, management, and improving fundamentals. We also ensure that each portfolio has adequate diversification and the makeup of each portfolio properly reflects our economic outlook. Our objectives are to further control risk and to emphasize those stocks believed to be at the right parts of their cycles.
We diversify our portfolios by restricting single security and industry weights. In practice, this means we seldom have positions with a weight of more than 6%. We also typically limit our single industry exposure to 20% of the portfolio. We note, however, that these are guidelines, rather than rigidly defined limits.
While we are fundamentally a bottom-up investment manager, we do consider the macroeconomic environment. We use decision-tree analysis to derive expected 12-month return forecasts for major groups within our stock universe. This is part of a firm-wide exercise to assign probabilities to potential outcomes such as strong economic growth, recession, etc., in order to identify major asset classes and industry groups for emphasis and de-emphasis in our portfolios.
4. Monitor and Review
Finally, we continually monitor and review our portfolios and our investment universe to evaluate whether circumstances have changed; for example, whether a company no longer creates wealth, whether its valuation is no longer attractive, or whether better opportunities have arisen.
Grayson Witcher, CFA, Portfolio Manager
Need More Information?
If you wish to receive detailed information about our U.S. Equity management, please e-mail us at Mawer Information .