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Investing in Persistent High Achievers
Guinness Atkinson Dividend Builder Fund
Interview with: Matthew Page

Author: Ticker Magazine
Last Update: Nov 02, 10:34 AM EDT
Established companies generating returns that exceed their cost of capital tend to have anchored business models in a stable customer base, efficient management, and strong balance sheets. Moreover, these businesses are likely to maintain their market dominance and share some of the excess cash flow with investors. Matthew Page, portfolio manager of the Guinness Atkinson Dividend Builder Fund, maintains a concentrated portfolio by investing in companies that share such characteristics.

ďIt was our belief that companies that consistently generated returns on capital above their cost of capital would make true cash profits Ė and ultimately accumulate wealth so long as returns remained consistent and cash was reinvested.Ē
Q: What is the history and investment philosophy of the fund?

A: Although the Guinness Atkinson Dividend Builder Fund was launched on March 30, 2012, the fundís co-manager Ian Mortimer and I have been working on the strategy for longer. After becoming interested in companies that generate high return on capital, we started developing the philosophy behind this fund in 2010.

It was our belief that companies that consistently generated returns on capital above their cost of capital would make true cash profits Ė and ultimately accumulate wealth so long as returns remained consistent and cash was reinvested.

To examine this idea more thoroughly, we looked at 25 years of history for approximately 16,000 companies and identified 500 or so that met our criteria of consistently high return on capital.

Drilling deeper into this universe revealed a number of interesting things about the companies. We found an extremely high level of persistency in those with a 10-year history of generating very high return on capital, meaning they were likely to continue to do so.

As a group, they were attractively diversified across defensive industries like consumer staples and health care, as well as in growth sectors like consumer discretionary and information technology. They were geographically diverse as well, with roughly half in the U.S., a third in Europe, and the rest in Asia and emerging markets.

Most interestingly, about 90% of these high-return-on-capital companies paid dividends, and many were growing the dividends consistently. Not all were necessarily high yields, but solid, and on average had a yield well above the benchmark.

So, having identified such a robust set of companies, we thought it was an attractive starting point from which we could build a concentrated portfolio of dividend growth companies. The strategy was originally offered in Europe as a UCITS funds, or a mutual fund based in the E.U. After seeing demand for the strategy in the U.S., this fund was launched in 2012.

Today, assets under management for both strategies exceed $450 million.

Q: Would you describe your investment process?

A: Our process starts by identifying companies that have generated a high return on capital each year for the past 10 years. It is a very difficult screen for companies to meet and excludes around 95% of companies globally. We then look for a strong balance sheet and a market cap of over a billion dollars and that comprises our investable universe of about 500 companies.

To narrow this list down to a portfolio of just 35 names, we apply a strict discipline that assesses value in a number of ways.

First, we search for companies trading at a discount relative to their own history; a company trading below its average price/earnings (P/E) or EV/EBITDA over the last 10 years would be attractive.

When we find a company that has been trading one standard deviation below its historic average multiple, it poses several interesting questions: Will its return on capital actually stop fading? Has the market perhaps overreacted to a negative narrative about the company, a story we can disagree with?

For example, in 2012, some defense companies were trading at one to two standard deviations below their historic averages due to concerns that the fiscal cliff in the U.S. could lead to large cuts to government spending. To us, though, the situation didnít appear overly dramatic, so bought a couple of stocks and saw rapid re-ratings after that based solely on that multiple expansion.

The second way we look at value is versus peer groups. Because a company can appear expensive relative to its own history but cheap relative to its peers, we want to be sure not to exclude these opportunities.

Third, we use reverse discounted cash flow analysis to figure out the long-term growth rate baked into a companyís valuation.

In each of these crucial valuation steps, we are drilling into everything that may be a risk to a company, including fundamental factors like its balance sheet and credit metrics. We assess its return on capital to see whether itís growing or fading, and what the main contributor to this evolution is.

Finally, we look at a companyís dividend. Having this as the last step is quite unique among dividend funds, which normally begin by screening for a specific level of yield and then determine whether a business is attractive.

Q: Do you invest in non-dividend-paying companies?

A: Our quality criteria are applied to every company around the world. The crucial point, though, is that while 90% of the companies that remain after this screen do pay a dividend, we think all of them have the ability to do so. Then it just comes down to the priorities of management and the board regarding how they want to spend cash.

If a company hasnít yet paid a dividend, we wonít invest in it. However, if our conviction is strong that it will begin paying one in the near future, we might add it to our watch list so long as the company was otherwise attractive. So far, though, we havenít run into this.

Q: Can you highlight your process with an example?

A: Northrop Grumman Corporation, an aerospace and defense technology company, comfortably met our criteria for high return on capital, which at the time was one standard deviation below the 10-year historic average.

We moved forward on Northrop with modeling and due diligence and looked back over 15 years of company financials to learn how the company had evolved and grown. Generally, we examine things like growth rates, margins, and the evolution of working capital to see how a company has spent its cash historically.

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Sources: Data collected by 123jump.com and Ticker.com from company press releases, filings and corporate websites. Market data: BATS Exchange. Inc