Animal Spirits Podcast - Talk Your Book: High Quality Growth Stocks

Episode Date: June 13, 2022

On today's show we spoke with Allen Bond from Jensen Investment Management about finding high quality growth stocks and investing during a bear market.   Find complete shownotes on our blogs...  Ben Carlson’s A Wealth of Common Sense  Michael Batnick’s The Irrelevant Investor  Like us on Facebook  And feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation.  Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits Talker book is brought to you by Jensen Investment Management.com. Go to Jenseninvestmentmanagement.com to learn more about their quality growth and quality value strategies. They also have a bunch of research up there to talk about the type of companies they're investing in, how growth companies and value companies perform during inflationary periods, earnings, all this stuff, Jensen. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. Nick and Ben Carlson work for Ritt Holt's Wealth Management. All opinions expressed by Michael and Ben or any podcast guests are solely their own opinions and do not reflect the opinion of Ritt Holt's wealth management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Ritthold's wealth management may maintain positions in the securities discussed in this podcast. Welcome to Animal Spirits with Michael and Ben. On our talk today, Michael, I thought this was interesting.

You mentioned in a quality value fund, you'd assume to see certain names. and that kind of strategy. I think you named Target and Walmart and Costco and you don't see them. So the person we're talking to today, Alan Bond from Jensen Investment Management, they have a more concentrated portfolio. So it gets like 25 to 30 holdings. I actually think that's one of the interesting ways to stand out as an investment manager is by having a more concentrated fund where you're not necessarily holding the stocks

that people would assume you're holding because if you hold the stocks people assume you're going to hold, why not just buy an ETF or, a quantitative fund that just does it for you. I think the days of closet indexing, what do you think closet index funds peaked? Pre-pandemic, hopefully. I wouldn't have peaked like in 2011. Yeah, like 2013-ish.

I hope so. One of the big focuses of Jensen is quality, which is kind of squishy. There are quality ETS and stuff like that, but it was interesting to hear them unpack it. And I was going to ask, but he beat me to the punch. They actually do discounted cash flow analysis

on all the companies in their universe. I remember my very first internship in investment management was with a cell site analyst, and he had one of craziest Excel spreadsheets ever seen, just formula upon formula and a million different tabs. He's like, take a few days and just go through every tab here and fear out what this formula attaches to this. And so I'm trying to learn what it doesn't is. So you saw that and you immediately said, not targeted fund.

Pretty much. But it was the most beautiful Excel spreadsheet I'd ever seen. And then once you learn like what all flows to what and what, changes what? So many of the inputs have a marginal, marginal chain on like the valuation, and then you get to the discount rate, and that changes everything. It's like, oh, okay, so this is the lever. So all that other stuff that we built was like very pretty, and it shows that you know how to do these cool tables and macro whatever. Yeah, the discount rate is the wrecking ball. It's really, yeah. Which is what we're seeing today. I guess it's not even garbage in,

garbage out. That's the real stuff that goes in. That's the good stuff that changes everything. But you're right. I love to see not only discount rates rising, but inflation. rising and how that impacts how people think about valuation. It has to have the impact. Oh, you think? That's going out on the one there. Just a little bit. By the way, the quality thing, it's interesting in quality growth because that obviously

has to hurt you on the way up a little bit because when things are going crazy, no one cares as much about quality. You throw quality out the window, but when things are going bad, that's when it matters. 2021 was the year of growth at any price, and we are approaching there's no growth at any price. levels. We're on the other side of that. For some of these. But yeah, we get into a bunch of stuff on inflation and thinking about tech stocks as inflation hedges because, I mean, there was IBM. There were tech stocks in the 70s and early 80s, but nothing like we have today in terms of the sheer breadth and size of these things.

So this is a whole new thing when you have inflation as a variable to new. So the way the market is functioning today. It wasn't like that back then. So here's our talk with Alan Bond from Jensen Investment Management. We're joined today by Alan Bond. Alan is a portfolio. manager and head of research at Jensen, Alan, thank you for coming on. Yeah, thanks for having me. All right, let's start here. One of the biggest variables or inputs that you guys use to assess whether you're going to invest in a company is quality. So when you think of that, is that like qualitative? Is it quantitative? What is the framework through which you make that selection? I think that's a great question. And maybe we'll start with how we define it because it's funny.

has been around for a long time. There's quality factor products. There's a lot of academic literature about quality as a factor. But as far as we know, there's no real standard agreed upon definitions. So I think what you've identified here in terms of quantitative and qualitative is the way we think about ROE. Starting on the quantitative side, factors that are generally thought of to be consistent with quality would be return on equity, return on invested capital, earnings and dividends, consistency, balance sheet strength, profit margin, so on and so forth. And there's a variety of different quantitative factors that are used to determine quality. And if you look at some of the factor-based quality products, they're going to use some of

these factors, maybe measured it or different time periods. And we think that can be really confusing. For us, the big quantitative metric that we use is return on equity. And specifically, we look for businesses that have generated a high and consistent return inequity in the past. And then what we try to do, and that's our quality screen. That's the one real bright line in our process. Our job then as analysts and portfolio managers is to pick companies that have passed that quality screen and have the qualitative factors that we think will allow them to remain high-quality businesses in the future. So from a qualitative standpoint, the big

focus for us is on competitive advantages and on the sustainability of competitive advantages. We think that's really the key factor that allows a business to be high quality and to be high quality for the long term because that's what's going to allow it to generate those business returns, measure them via return in equity or return in invested capital that are ahead of capital costs. And to kind of defy economic theory, economic theory says that if you're generating excess returns, it'll be competed away over time. But not if you have a competitive advantage and it's sustainable. So that's really what we look for on the qualitative side, in addition to free cash flow strength in addition to attractive long-term growth prospects, solid management teams,

so on and so forth. But really, it's a focus on high and stable return on equity that is supported by a sustainable competitive advantage. You have a quality growth strategy that you run. And I think it would be interesting to understand how using that quality framework could have helped people avoid some of these stocks that are just massively down big. Some of these stocks down 70, 80, 90 percent from their highs in 2020. And maybe you could talk through some of the quality stuff that people might have missed that would have helped them avoid some of these landmines. I think that's a good question.

And I think that the best way to think about high quality versus low quality is really about kind of the sustainability of business models. And it really does come down to that competitive advantage that I talked about. I think there's some good examples, some really high-flying stocks that may have been darlings during the pandemic period, where, their business model was really well suited to that period, but their competitive advantages maybe weren't quite as powerful as people thought, and now was we're sort of evaluating what things look like as we're reopening, as new competition enters the space, maybe those

businesses models weren't sustainable. And I think what's interesting about that is you mentioned stocks that are down 70% from peak. And that can mean one of two things. Either one is the market was massively wrong in terms of how it was valuing that stock before it was down 70%, or it could mean the market was correct, but now has real concerns about the stain power of that business. Generally, that's a pretty big move in a stock. And so there's a real signal there. On the other hand, high-quality business. We definitely see price dislocations with high-quality businesses, but we're not used to seeing them that large because these businesses tend to have characteristics that give them stain power. So even if certain trends economically or an industry

goes against them. They have resiliency because of the same power of the business, because of their financial strength. That's going to allow them to course correct over time. And so we just don't see the declines of that magnitude. And we think it's really important as long-term investors to focus on know what you own, know your business, know its competitive advantage, know its financial strength and how it makes money. And we think these are the things that can help keep investors out of trouble during periods where we see big drawdowns like we've seen here recently. Maybe the poster child of what you're describing as Zoom, where early on in the pandemic,

everybody was all about the Zoom meetings, throw Zoom on your calendar, and then, I don't know, if it took Google six to nine months to catch up, and where you could literally just add the Google video onto a calendar invite. I went from 100% Zoom-based video meetings down to probably, I don't know,

it feels like 50-50 right now in the course of 12 months. Ironically, when I pulled up this meeting invite, I was expecting it to be on Zoom, and it wasn't. I had a little bit of a learning curve to get through to figure out Google, but to your point, it was fairly easy. Let's just put this into the context of competitive advantage.

In a theory, Zoom had a massive first mover advantage, if you will, during that pandemic period because it was kind of the standard technology. We were all, I say we, those of us that had to transition to work from office to work from home, had to transition very quickly to a video format. Zoom was that was readily available, easy to use software for that. and we all transitioned. And so big first mover advantage for Zoom. When we think about competitive advantage, though, is did Zoom do enough? Was there enough unique about Zoom that created a network effect that made for a sustainable competitive advantage? And I think to your point, the answer to that

seems to be no. The market gave them $150 billion in market cap. It took it right away. Take it right back. And that's what we talk about long term versus short term. In the short term, we certainly recognize the strength of the Zoom business model and the upside potential financially for Zoom. But when we think about the long term, it's like, what's the stain power? And that's really one of the biggest differences between high quality and low quality in our opinion

and sort of the way we think about it as long-term investors is let's understand the short term, but more importantly, let's understand the stain power in the long term. When you see the type of wreckage that we've seen, do you and your team get excited about this? Does it almost require you to have more patience and do some work on some of these names

when you see these types of drawdowns and understanding, like, there's obviously a difference between a huge drawdown and undervaluation. They're not the same thing. So how does a period like this for you go, where growth has had this amazing run, and now we're seeing the other side of it where there's so much carnage, even in some of the bigger names. How does your team feel in an environment like this? It's a little bit twofold. On the one hand, we didn't own a lot of the high-flying tech stocks that are being really

punished so far this year. It's sort of nice to see vindication, if you will, of, okay, yeah, we were focused on long term and we probably missed a little bit upside in 2020, 2021. But now we're seeing the market course correct. We've avoided that. On the other hand, it can present opportunities. I mean, one of the really important things that we do, in addition to all the different quality work that I talked about is valuation. Identifying the high quality business, is this kind of the easy part of the business? It's hard. I mean, there's a lot of work that goes in trying to figure out whether or not a company has a sustainable competitive advantage. But making sure you pay the right

price for that and having the patience to do that, because there's a lot of investors that are going about try to answer that question as well. And so when we see these drawdowns from evaluation standpoint, this is where you do really get excited and you think, okay, wow, there's a really high-quality business here that, yeah, in the short term, we can recognize maybe there's a bit of a headwind, but in the long term, we know it's a powerful business model. We maintain discounted cash flow models on all the businesses in our portfolio and all the ones in our opportunity set. And when we see these dislocations, that's oftentimes where we're able to, I think, we think upgrade the portfolio. We can add a high-quality business at a really attractive

price for the long term. Al, you spoke about doing discounted cash flow analysis, and I was listening to Oswald the motorin on Invest Like the Best with Patrick O'Shaughnessy the other week. He was talking about how there's no sustainable advantage in something that's so easily available on the internet where you can just run a screen, sort, whatever. In terms of calculating return equity, doing discounted cash flow analysis, how much of that is actually getting in there versus just pulling what's available on Bloomberg fax at whatever? First of all, with Professor Dammitorn, he's been a big influence.

for a lot of the work we've done in terms of building out our valuation models. If anyone's interested, he's on his website at NYU, it's incredible. And he's been really generous in going back and forth with us over time as well. So nothing but respect for him. I guess I want to understand your question. Are you talking about the discounted cash flow tools that are available online? Are you talking about more about screening for businesses? Pardon me.

I guess that was convoluted. When you're just talking about return on equity, do you take it at face value what you're seeing from whatever data said you're using or are you cleaning that up a little bit? This kind of cash flow analysis, it's, in our view, the right way to value a business, but it's really, really hard. It's really subject to your inputs that can be very sensitive. I mean, the most simple input that's very influential on a discounted cash flow model is your discount rate. And how do you build up and how do you determine that discount rate, especially when interest rates in the market go up and down so fast? How do you

maintain a relevant discount rate, which is really your opportunity cost? But at the same time, balance out the fact that the markets can be very volatile. We've seen that happen in a big way. We saw it happened in a big way two years ago when interest rates declined as a result of the pandemic and then the Fed's response to that. And we're seeing it right now as we've got inflation concerns and interest rates arising. We think there's a lot of nuance involved in that. And then as important are how you're projecting cash flows, how you're determining cash flows and the sustainability of those cash flows today and the future. And then I kind of talked about competitive advantages in how that allows businesses to generate excess returns. In your model, how long are you going to

model that out and assume a company can do that? These all have big, impacts on the valuation and the price you're willing to pay. And so we think it's really, really critical to think it through and to understand what the inputs are. And I think that's the biggest difference in our opinion between discounted cash flow and like multiple-based valuation. I mean, if you think about a multiple like price or earnings, whether or not people realize it, they're doing discounted cash flow. It's all in there. The discounted cash flow is all in that earnings multiple. We would rather be able to unpack that multiple, understand the drivers and then try to make a decision based on that understanding.

I suppose one of the biggest inputs these days that none of us have had any experience dealing with is inflation at 8%. So it hasn't happened for 40 years. For most investors today, this is a new thing. So how do you deal with a new variable like that that is so high? And even though you're not doing valuation-based analysis, if you look historically, when inflation is higher or when it's rising, valuations tend to be going down. So inflation has a huge impact on that side of thing. So how do you build that into your model? It's something we're certainly grappling with. Really high level, we believe that quality businesses benefit on a relative basis during inflationary environments. There's a couple reasons for that. The first is I talked about discount rates. And typically the way you build up a discount rate is you start with risk-free rate, which is usually going to use treasuries as proxy risk-free rate. And you're going to apply a risk premium. So that says, okay, how much more do I need to get because I'm taking equity market risk and company-specific risk? And that's just kind of the general framework for building up a discount rate. Well, that risk-free rate is to be sensitive to inflation, and we've seen a big increase in interest rates this year as the

market is trying to grapple with the magnitude of inflation and how long it's going to last and then maybe any kind of fredd response. The reality is there's been a lot of volatility in those interest rates this year. But like you mentioned, as inflation increases, interest rates generally rise in line, which means all else equal, discount rates will rise, and a higher discount rate, all else equal means lower stock price valuation. So that's true. Now, why do we think quality companies have an advantage? Well, there's two reasons. One is that that high-quality businesses generally tend to be a bit shorter duration than lower-quality businesses. What I mean by that is they're generating more cash in the near-term.

So that cash in the near term is less sensitive to rate increases relative to low-quality businesses. That's one of the reasons we've seen the correction in tech stocks. These high-fline tech stocks, their cash flow generation may be way out in the future. They're going to be more sensitive to interest rate changes or interest rate increases than a higher-quality business with more cash today. The second thing in what we're really focused on more fundamentally trying to follow the companies is on pricing power. And one of the things about competitive advantages is generally will give a company the ability to raise prices to offset costs. And that's what we're seeing and

that's what we're really monitoring with the companies that we own and our portfolio is their success at raising prices and not destroying demand. And we think companies with competitive advantages with resilient and markets have that ability more and can offset that higher inflation more than a lower quality business where maybe they're more of a price taker. And so we think that this environment is challenging for stocks and the market's obviously down quite a bit this year. But we do believe over time high quality stocks have a benefit because of their high near-term cash generation and in pricing power. You have two like broad strategies, the quality value, the quality of growth, which are both separate. And I'm thinking about there are certain

consumer names that might be able to pass along costs, but there are others where due to the nature of their business, there's only so much cost that can be put to the consumers, whereas they have to eat it, and obviously that will impact their margins. So I'm just eyeballing this in front of me. I don't see Target or Walmart in here. I'm looking at the quality of value fund where maybe you would expect an generic sort of portfolio of value stocks. So it seems like a pretty deliberate decision to exclude. I don't see Dollar General or anything like that. Can you talk about maybe how that factors into your decision? Is that a macro thing? What's going on there? And that's a great question. That really does come down to our requirement, our demand

that a company has what we think is a sustainable competitive advantage. Retail is always a hard sector. It's a challenging sector because they tend to be very low margin businesses. And so mistakes can get magnified. It's kind of a razor thin margin of air, if you will. Both Target Walmart pass our initial quality screen, but we've chosen not to invest in those. Where we've gotten more excited about retail is what I would consider differentiated retail. I think a really good example of that. One of our holdings and our quality growth fund is TGX companies. TGX runs off-price retail, so Marshalls, T.J. Max. Ross. Is that Ross? That's a separate company. Okay. TGX is that a big concept as home goods. And what's differentiated about this is they essentially take advantage of kind of perpetual problems in the supply chain for traditional retail. So they're able to buy later in the cycle. So they buy overruns. They buy mistakes that were made essentially later in the cycle. They buy them at a discount. And then they can sell them at a discount. And so they benefit in multiple ways.

one is they're able to offer value on name brand merchandise to consumers. And that's why those businesses held up relatively well, even in recent periods when consumers have been under a bit more pressure with inflation and so forth. The other thing is it just kind of naturally gives them pricing power, if you think about it, because if they're able to buy late in the cycle, it doesn't really matter what price they buy on a nominal basis. What matters is relative to everyone else, how did they buy because they're going to use traditional retailers' prices as the starting point for their discount. So if they're buying it in an advantageous, price, they can still get a nice discount, maintain their value perception for consumers and

kind of have this natural pricing power as supply ebbs and flows. And right now, they're at a great position from a supply standpoint because of some of the supply chain issues that we've seen have exacerbated ongoing supply chain issues that always exist there. And so we think they're in a really good spot, given that as a consumer that may be a bit more concerned of the value right now. One other name that's conspicuously absent is Costco. And I wonder, like, of those three company is not that you need to pick one right now, but I'm just asking, I'm assuming those meet the quality criteria, the quality screen. Would there be a valuation low enough where you say, okay, we're obviously familiar with this company. We know the competitive dynamics. Now it's a

valuation thing where we just feel like we have such a margin for error, whether it's, I don't know how much lower it would be from here, but just, is that something that you would do or is that not what you do? What I would say is that generally speaking to that, for us, the answer is no. And it really comes down to our investment process. So I kind of talked about the outset. quality screen. And that defines our investable universe. And that's based on high and consistent returning equity. The next step of our process is, well, let's identify the best of the best. Let's make sure we're investing in the best businesses. And so we basically were the role of business analyst or where the hat of business analyst for most of our process. So that means

understanding the business, understanding its competitive advantages, understanding its growth prospects, understanding strategy, so on and so forth. And only after we've gotten comfortable with a business for its own merits and saying, yes, we believe this is a business that can grow and create business value for the long term. Valuation is really critical to us, but it comes last in the process. So we're not going to consider a stock unless we believe in the business first, then we will do this discounted cash flow work and all the other valuation work that we do to take a view on as a stock and invest with what we believe is a margin of safety to help mitigate long-term pricing risk. And what that require a lot of times is patience, because we can really

love a business, and we may need to wait until we think the market is dislocated in the short term that allows us to have an entry point in the long term. And so it's not uncommon for us to do a lot of work on a business, maintain evaluation model, and just have to be patient in order to own to this stock. No one knows if high inflation is here to stay, but for argument and take, let's say that it is, and we get this repeat of the 70s that people are so scared of. It's the one period where there's still some people around that invested to that time frame. The one thing they didn't have back then was these huge monopoly-like tech firms. There was no Apple and Amazon and Facebook and Google, do you actually think that these tech companies, because of their

market power and position, that they actually could be good inflation hedges in a lot of ways if we have like some structural, secular inflationary period that lasts longer than people think? For those types of businesses, I think Microsoft's a great example of this is it just would come down to pricing power. Microsoft's one of our top holdings. We think they have two extremely strong franchises. They make Microsoft Office products, which we all use in our own. in workflow and would be very, very difficult to replace, certainly for businesses like ours. And then they have a very strong business where they have server software historically, but now that's become cloud software, and they're helping customers transition to the cloud

at their own pace. And so we think these are two phenomenal business models with deep competitive advantages. What's important about that is how they make money. So we always talk about know what you own. And to us, the most critical part about know what you own is know how this company generates revenue. These are mostly now subscription services. So, companies will subscribe to these services, they will pay a fee, and because they become embedded, because of the network effect and the power of that competitive advantage, it's very difficult for customers to replace someone like a Microsoft, and that gives them pricing power. So if Microsoft needs to raise prices, to offset costs, that's something that they've shown

the ability to do, and we think they could continue to do it in the future should they need to. We can go through the case for each of those big tech companies, but in the case like Microsoft, we think they're very well-advantaged to take care of an inflationary environment if they needed to. What do you think about this? Also, again, something to Moten said was people have been talking about the fact that this idea that Google is 150 companies in one. They've got a million different things in R&D and whatever else they're doing. But at the end of the day, I think he said 93 to 94% of their business was advertising. So they're doing all these other things. It's a search box. That's what it is. Is that something that will never come to fruition? Do you think that

that's just like a cheap option? What do you think is going on there? Generally speaking, the really high level, the way we look at Alphabet or Google or whatever, is think about it like a big funnel. The bottom of the funnel is that monetization model through advertising revenue. Everything else is to get users to get clicks into that funnel and start working their way down. They've been willing to take on a lot of projects where they've not been able to really monetize it in the near term that were really largely expensive. I mean, think about Google Maps and the amount of work that went into that when it was created. But now it's ubiquitous.

We all use Google Maps. When we use Google Maps, Google Maps will point us towards businesses, which pay for ads, which get us down further into that funnel where then Google actually makes money. So there's some stuff that does not fit into this model. But the way we think about Google really is they're trying to widen that funnel as wide as they can through developing products that will get people in and eventually ultimately lead down to where they can make money via advertising. Isn't advertising so cyclical, though?

Isn't that like one of the most economically sensitive areas of the market? How would you have pricing power in the event of economic downturn? There's definitely cyclicality to it, and with Google, they get a good chunk of their revenue from small businesses. So if we didn't have an economic downturn and there were bankruptcies, we would certainly expect to see some cyclicality there. What's critical about Google is they basically own the space for online ads. They own the online ad platforms, the buying platforms. You purchase the ads through Google and then you monetize or you place your ads through Google and then Google can monetize based on that. So the business model itself, we think, is really powerful.

The network affects being really, really high, switching costs high. So from a competitive advantage standpoint, we think it's very advantaged. Is there some cyclicality to it? There could be. And if that business becomes more mature, maybe that cyclicality increases. But that competitive advantage, and the way we look at it is we want to invest in businesses with sustainable competitive advantages. We believe Google possesses that.

As portfolio managers, making sure we're constructing our portfolio that we want it to, we want to make sure that competitive advantage is adequately reflected in our valuation. And so as that relationship changes, we may change the size of a business. position. We may change the size of a Google, but the competitive advantage we still feel is very strong. For the first time in a long time, value stocks are outperforming growth stocks by a pretty healthy margin this year and probably over the last, I don't know, 18 months or so we'll call it, where growth had this really great run for a long time. Michael mentioned you have a quality value and a quality growth screen. Could you get to the point where you have a company that

ends up fitting in both buckets where a growth name that's growing really healthfully but the market is punishing it and throwing the baby out with the bathwater fits both or do you have higher hurdle rates for your value fund in terms of what can go in there? We do a whole podcast on this. There's a whole theoretical question about, is there really any difference between a value stock and a growth stock? And there's a lot of work that's gone into this. I was going to use the Buffett quote, but I didn't want to go there. I just want to put that on the table. It's a great question. Tuss just comes down to investing kind of principles, investing 101, which is know what you own and make sure you're paying a fair price. And if the stock should

be trading it 40 or 50 times earnings, and that's the right price, then is it really a growth stock or value stock or vice versa, buy something at 10, but should be trading at 10? That's a meme stock. No, 100%. And so I think if you look at this year, why value stock's done well, energy stocks generally are classified as value stocks. Oil prices have gone up. Energy companies, by and large, tend to be price takers, meaning that they really benefit

if oil prices go high or natural gas prices go higher. And they've benefited a lot this year. In terms of what you ask specifically, I think there's a lot of examples of that. I mean, historically, we just talked about Microsoft. We're very long-term strategy. We own stocks on average seven to eight years. We've owned some for 20 years. Basically, as long as what I talked about in terms of that competitive advantage

and business fundamental framework remains intact. And we still think we're getting an adequate margin of safety. We will tend to hold a stock. So very long-term holding period. I believe we bought Microsoft back in 2006. And for a good chunk of the first part of when we own Microsoft, it was absolutely a value stock if you look at valuation metrics. But we saw still a company that we thought had competitive.

advantages and had good long-term growth prospects. The market at that point, in our view, was overly focused on some of their failures in the consumer market. They tried to develop a phone, they tried to develop phone software, and not the most fruitful of efforts for them. We instead looked at them as a really well-positioned enterprise software business with growth prospects there. Luckily for us, the market eventually came around to our view. That's why patient is sometimes required as a long-term investor. But it was what we thought was a powerful growth company that was valued like a value stock, we would say now it's fairly valued. I think the market's viewing it the right way, but there's certainly examples of that. How long does it take for value and price

to converge? And how do you know when you're wrong? I know it's like the supreme, like ultimately unanswerable question, but I don't know, give it a shot. Well, and really simplistically, we believe that stock prices will follow earnings or follow cash flow over time. So there's a really strong relationship between stock prices and earnings growth. But we know that doesn't always happen in a straight line so that price could get way ahead of earnings. or earnings could get away ahead of price. And it's hard to know exactly when that's going to happen. I think they say in our business being early and being wrong are often the same thing. I think that's why for us being really patient is really critical in not getting caught.

As a long-term investor, you can't ignore the short-term because eventually the short-term can become the long-term. So you need to be aware of the short-term, what's priced into the stock in the short-term. And be confident in that view, even if you think the short-term is wrong, but then why is the long-term right? And as long as there's patience around that and discipline, we're not going to really try to time it. We're not trying to look for a catalyst. This is, oh, this is going to make the stock re-rate, will be right? What we do want to say is, is this business still high quality? Is it still benefit from competitive advantages?

Is it still creating business value? And are we in it a fair price. If those things are all, we can check the box on all those things. We're willing to be patient and not try to be smarter than the market in the short term, but just really try to focus on what we can know for the long term. You have a more of a concentrated portfolio, 25 to 30 names, I think. Is that about right? Yeah. In a downturn like this, does that make things a little scarier for you because you could

have some sort of blowup risk with one or two stocks? Do you think it makes it easier to stand out from the crowd? How do you view that concentration in a bare market scenario? For us, and certainly address it in a bare market, but we would think more about it over the full market cycle. And we think that by being a high conviction allows us to differentiate from the overall market. And we think that's really important. we're going to invest heavily in what we think our best ideas are. And if you think about we were very demanding on the kind of quality that we're going to invest in and also want to make sure we pay a fair price, not always easy to find those opportunities. So it makes

sense to be concentrating when you do. In terms of diversification, I think this is really critical. We did a presentation a few years ago and talked about this. But from a diversification standpoint, the benefit that we get from diversification in the portfolio, essentially max out at about 20 different holdings. A 20 stock equally weighted portfolio, your diversification benefits or 90, I can't remember the number, high 90s percentage of the same diversification benefit you get in a hundred-stop portfolio. So you really do get diversification even in a portfolio like ours. We do think that's critical in a down market when risk becomes more apparent, but down markets tend to be where we have added value. It's really more about what you own

as opposed to how much you own, if that makes sense. And the types of companies we focus on are ones where we think business model is resilient, that free cash flow and earnings will hold up better, than the average company, and that in a lot of cases, these companies can come out stronger out the other side than they went into the crisis or whatever happened because of that financial strength and that resilience. So that's really how we think about investing in any market, but to us in a down market or in a volatile market, what you own and knowing what you own is really more important than how many companies you own. How important is management in all of this? Can a bad management team undo a lot of the tailwinds from a good product, good business,

good service, like, how does that factor into your decision-making? The answer to that is yes, trying to evaluate that in real-time is really hard. It's always pretty obvious after the fact, whether or not... Unless they're tweeting. Unless they're tweeting. Yeah, totally. None of the companies we don't have management teams that tweet a lot. I know what you mean. What we really want to see, we're trying to measure management team, is a relationship, consistently relationship between strategy, execution, and financials.

Meaning, tell us what you're going to do, do it, and then show us. that it's worked. And if those things all line up, stock investors tend to like that. We tend not to like negative surprises. We really like positive surprises. But even if just execution is consistent and steady, we'd rather have a straight and steady line than a big explosive line that may be subject to a big decline later. So that's really how we try to evaluate management teams is make sure we understand their strategy and then try to evaluate decisions that are made in the context of that strategy and then measure them based on how the financial results have borne them out. So that's how do it, but there's also a lot of art in addition to the science in that in terms of that.

Alan, where can we go to send people to learn more about your investment process? Jenseninvestment.com. We've got a very good website with insights. So some of the things we talked about today, we have a piece up there right now about high quality stocks during times of inflation. We've got a piece about how to think about earnings adjustments. And that's something that I know we haven't talked about today, but something we've seen more and more here recently this year is earnings revisions and earnings adjustments. And we've got a piece to talk about that. We've also got a lot of information about our mutual funds and separate account offerings. If you look us up on Morning Star, Morning Star has good write-ups to some of our funds.

Lots of resources. Our funds are available on all the different big financial platforms. But we encourage anyone to check out our website and try to learn more about what we do. We'd be happy to try to help people through the process as well. All right, Alan, this is great. Thank you very much for your time today. We appreciate it. Yeah, nice speaking with you all. Thanks again to Alan Bond. Remember jenseninvestment.com for more from them and shoot us in email Animal Spiritspod at gmail.com.