In 2010, Hamilton Point co-founder Andy Burns penned a newsletter entitled, “Thanks Skip.” The piece was a tribute to an encouraging note he received from a mentor of his, Skip Wanders, on one of the darker days during the Financial Crisis. The note read, “This is the moment for clear heads to remain optimistic. Quality will be rewarded.” Andy used that note as inspiration to remind clients, prospects and employees alike what “quality” means to Hamilton Point.
Our Tip of the Cap
In this newsletter, we pay tribute to Andy, our mentor, who died from cancer in October of this year. We can think of no better way to honor him than to re-visit his words from “Thanks Skip” which outlined the investment philosophy he helped develop and refine over more than twenty-five years. Andy had a seemingly limitless repertoire of stories and anecdotes to explain nearly any investment concept in a clear, plain-spoken (and almost always entertaining) manner. The word he came back to most often in his lessons, though, was “quality.”
Andy’s strict definition of quality, learned from years of his own investment study combined with the influence of mentors at the original (emphasis Andy’s) Wachovia, was quite different from Wall Street’s very loose interpretation of the word. Just as the principles and lessons Andy articulated in the following paragraphs were a ballast for him in the wake of the Financial Crisis, they will remain the foundation of our investment philosophy as we move forward without him. What follows are excerpts from that newsletter, updated slightly for current numbers and such…
Quality is Not an Act; it is a Habit
By way of background, Hamilton Point’s proprietary Global Core and Equity Income strategies took shape nearly thirty years ago with an uncommon emphasis on quality. Of course, whether or not an investment is of high caliber has always been a matter of opinion, but the discussion now goes beyond what should be considered “blue-chip” as further qualifiers like green, sustainable and socially responsible have come into vogue. As indicated with our Sustainability Report, we remind investors of the benefits of careful in-house research and point out that selected global companies are exceedingly attuned to being good citizens, recognizing that treating employees, customers and suppliers well is perhaps the best way to enhance shareholder value over the long term.
Before discussing further, allow a review of the screening process we use to develop Hamilton Point’s buy list. We first select those public companies with market capitalizations of at least $1 billion, thus identifying some 2,100+ candidates. This list is pared down to around 200-300 after eliminating outfits with high debt, low margins and/or intermittent profitability. The most quantitative part of our process, this allows deeper research on only those companies with truly outstanding financial fundamentals.
We then sort out companies operating in industries with poor competitive environments like steel, autos, airlines and many retailers. The theory here is that—except in cases where you invest in a company that has a clear dominating advantage—a high-quality industry is one where most participants are healthy and act sensibly. We further eliminate companies and industries that lack regulatory clarity such as many healthcare segments and, most recently, banks and brokerage companies since they have largely become “wards of the state” rather than entrepreneurial enterprises, in our view.
Drop the Crow, Pick up the Dove
A critical hurdle a company must also pass is that of selling a value-added product or service. This is a subjective qualifier, not based on any moral twist, but strictly on business issues. For example, some tobacco companies pass quantitative financial tests but fail our criteria because their products are bad for customers and regulators despise the industry. Looked at it in this light, we ask ourselves the question, “If we want to invest to meet the demands of the emerging global consumer—and can do so owning companies that make useful products like food, toothpaste, sneakers or elevators—why would we bother owning tobacco or gambling houses?”
There is obvious subjectivity in the matter, but we do the best we can, directing our research in ways we believe will preserve capital and provide growth for investors while avoiding obviously malevolent businesses and unhealthy industries. Together with valuation discipline and the previously mentioned financial criteria, our process steers us clear of wide swaths of the market. The effect is dramatic when comparing our buy list of approximately 60 stocks (across both individually-purchased equity strategies) to index funds or those closet-index managers of many of the largest so-called blue-chip funds.
Investment performance cannot be guaranteed, but an investment secret of ours is that it is not only what we buy in client portfolios—what we avoid matters as well. For example, over 50% of the value of the S&P 500 is comprised of just 40 huge companies. If there is one thing the banking crisis should have taught investors, it is that poorly managed, debt-laden companies are not a source of comfort simply because of their size or brand name. Similarly, the Internet Bubble taught us that “buying the future” at any price, doesn’t always pay off for investors simply because a company is growing rapidly with seemingly limitless opportunity.
While we own many of the notable growth companies, we still own only 12 of the 40 largest companies in the S&P 500, favoring instead many smaller and mid-sized companies with high quality attributes and defensible valuations.1 Using the flexibility offered by our firm’s size we can be uncertain about the broad market while simultaneously being optimistic about our investing because we believe every stock we own is a well-managed, low-debt, consistently profitable company that operates in a rather clean industry with a modicum of regulatory clarity. A mouthful you say? Yes, but that is our philosophy just-the-same.
A Quality Person
The preceding content from “Thanks Skip” encapsulated so much of what Andy stood for. First, he always believed in open and honest communication. Second, the newsletter answers the timeless question that we should all ask ourselves periodically as investors, “What do I own and why do I own it?” which Andy liked to follow-up with, “…and could I go live on an island for five years and feel reasonably confident about what my portfolio will look like when I return?” Third, Andy was a big believer in helping others and in recognizing that same help when it is received.
For building an investment philosophy around true quality which has withstood decades of booms and busts; for demonstrating that transparent communication and candor—during good times and bad—builds strong relationships; for your leadership, friendship and helping to make our world a better place, we say “Thanks Andy.”
1) Please contact us for a full list of all Global Core and Equity Income strategy recommendations made in the last twelve months.