Earnings Growth from a Valuation Perspective
HSBC Opportunity Fund
Rayman Bovell, John Montgomery
Author: Ticker Magazine
Last Update: Nov 14, 2:53 PM EST
|While stock prices ultimately follow earnings patterns, that does not necessarily happen in a straightforward way. Rayman Bovell and John Montgomery explain how the HSBC Opportunity Fund invests in companies with underappreciated earnings growth and reasonable valuations. A key differentiator of the fund is its Investment Committee structure, which supports the decision-making process with the help of a fundamental research approach.
“We believe that paying a reasonable price for growth offers the best opportunity for outperformance over the long term.”
Q: What is the history of the Fund?
HSBC Opportunity Fund was launched in September, 1996. Since 2003, Westfield Capital Management Company, L.P. has been the sub-advisor of the Fund, following the same investment philosophy with the same investment team. We believe one advantage of the Fund has been the consistency, since 2003, of the philosophy, the team, the stock selection and valuation process.
Q: What core beliefs guide your investment philosophy?
The Fund employs a growth at a reasonable price (GARP) investment style favoring investments in companies with underappreciated earnings growth trading at reasonable valuations based on our belief that stock prices ultimately follow earnings growth, and fundamental research best identifies inefficiencies and investment opportunities.
Q: What are the main differentiators of the Fund?
We believe the key factors that differentiate the Fund from others in the marketplace are the in-depth research Westfield’s Investment Committee members perform across the market capitalization spectrum, the valuation discipline the Committee employs, and the depth of investment experience. Bottom-up growth equity firms traditionally place a premium on the quality of their research. However, Westfield’s Committee structure allows for contributions from each member.
The 16-member Committee is a vocal group of talented analysts. Each investment decision is carefully considered and evaluated by the Committee before investment decisions are implemented. The fact that our Committee members are following stocks that span the capitalization spectrum magnifies this advantage. Mid-cap companies coexist and compete with small- and large-cap companies, and our Committee members are at an advantage because they understand market dynamics across the small, mid, and large cap areas of the market, and the relationships between the companies within each capitalization range.
As the Committee strives for consistent outperformance, the group’s dynamic not only serves as a system of checks and balances, but also encourages teamwork and the sharing of information. Our investment process has been successful in a variety of market environments, and we feel our constant review of where we can improve our process will allow us to continue to add value for our clients going forward.
Finally, we believe our employee ownership structure aligns our interests with those of our clients and allows us to attract and retain top investment talent, ensuring the long-term stability of our business and investment model.
Q: How would you describe your investment process?
We are a team of bottom-up oriented stock-picking investment professionals. In the beginning of the process, the analysts develop their ideas and financial modeling to come up with unique and independent financial prospects. Then they vet and develop the idea within the sector with their sector peers. By the time we consider an investment, it has been fully developed by the individual analyst, vetted, tested and further developed with their sector peers. The next step is a formal presentation to the investment committee, which gathers on a weekly basis or more frequently, when time-sensitive issues need to be accommodated.
Because we manage the portfolio as a collective unit, each of us can focus on his or her particular area of expertise. We value the unique perspective of each team member and the continuity of coverage within sectors. For example, over time our technology analysts have developed a deep knowledge of their sector, a network of contacts and valued insight that continues to improve.
At the same time, we believe that it would be very difficult to manage the portfolios without a top-down or a macro view. We certainly have a view on the direction of rates, the prospect for inflation and the economic activity that provides insight into our investment decision-making.
We also value our process of interacting with management teams. In the second quarter of 2018, our analysts had over 400 meetings with management teams. In the course of a year, these meetings can number more than 1,000.
The process of developing investment ideas differs by analyst and sector at the beginning, but it ends in the same way. We require a standard recommendation template to be followed, this way investments can be evaluated relative to each other and across sectors.
Q: How are both the team and the Investment Committee structured?
We have structured our Investment Committee along sector lines. We have four broad sectors and we staff them relative to the investable universe in growth stocks within those sectors. The sectors are technology, healthcare, a collective sector of energy, materials and industrials, as well as a sector consisting of consumer, business services and financials.
These groups are headed by our senior analysts, who provide direction to the other members of the teams. Each member covers specific industries and stocks in the Russell 3000® Growth Index. As much as we look for individual ideas, we make sure that we are always aware of the investable alternatives and that the investments are done purposely. Our analysts are judged by investment performance versus the investable universe of stocks under their coverage.
Q: What is your definition of growth? Would you describe your investable universe?
We look for identifiable earnings growth that we can model. The earnings growth has to be real, within the control of the company, and not necessarily predicated on any cyclicality. We may be interested in cyclically oriented growth only as a complement to a core of organic growth.
As a domestic growth manager covering the small- to mid-cap space, we start with the broad definition of growth of the Russell 2500™ Growth Index. We look for growth stocks with a market cap below $6 billion and we consider the investable universe to be within the market cap range of the Russell Index.
However, we can also own stocks outside of that universe and, as a result, we may own stocks that the Russell Index might not consider growth stocks. As an example, Energy is an area that we are currently overweight and are finding interesting growth opportunities but there are few Energy companies defined as growth stocks within the Russell Index. In our view, this affords us the opportunity to find other interesting secular and cyclical growth stories.
Q: How do you find ideas and what type of growth do you look for?
Westfield’s investment professionals seek to identify companies with broad market opportunities, accelerating earnings growth, and quality balance sheets. Superior company management, disciplined capital allocation, strong returns on invested capital trends, solid financial controls and accounting, unit volume growth, cash flow sufficient to fund growth and unique market position or pricing power are all criteria on which we place a premium. As a ‘growth at a reasonable price’ manager, Westfield’s view is that companies with high foreseen earnings potential can be purchased at a reasonable valuation. Companies that are trading at excessive valuations, in our opinion, will be excluded from purchase.
As research specialists, all fundamental factors are important, and in specific industries some may be more important than others. However, earnings growth is the most integral to our stock selection process. If there is one common theme to all of our holdings, it is that our forward earnings estimates (growth rates and projected EPS) are higher than Street consensus. Depending on the industry and market cycle dynamics, we may use a variety of metrics when valuing stocks, including but not limited to P/E, P/E to growth, EV/EBITDA, P/B and Discounted Cash Flow. These are viewed on absolute, relative, and historic levels.