Animal Spirits Podcast - Talk Your Book: Quality Growth Investing

Starting point is 00:00:00 Today's Animal Spirits Talk Your Book is brought to you by Jensen Investment Management. Go to Jenseninvestment.com slash ETF to learn more about the Jensen Quality Growth ETF, ticker JGRW. That's jenseninvestment.com slash ETF. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not. reflect the opinion of Ridholt's wealth management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ridholt's

Starting point is 00:00:39 wealth management may maintain positions in the securities discussed in this podcast. We're joined today by Kevin Walshush. Kevin is a portfolio manager for Jensen investments. Ben, when thinking about different sort of factors, I think probably the two that come from mind right away is value and growth. Yep. then maybe momentum, maybe small, or size. Is quality the forgotten factor or the one that's least discussed? Well, quality is the new one, right? We had the original Fama French three-factor model, right?

Starting point is 00:01:13 Which was... Was this the fourth or maybe the fifth? Profitability was in there somewhere. Yeah, I guess profitability and quality are kind of similar, but yes, it's probably the newest one. And I think if you deconstructed Buffett's returns going far enough back, quality is probably a bigger piece than most people realize. I think if you were to look at just like one business metric, I think quality would keep you out of trouble.

Starting point is 00:01:35 Yeah, I can see that. Right? Like over over a full cycle, whatever that means. Yes. Not saying that quality businesses can't get dinged if they miss or something goes wrong, but that it's, it keeps you out of the really big, big losers. You know what? I just came to my mind. I was listening to the conference called Disney.

Starting point is 00:01:53 Great company, not a quality business. That's true, which means quality businesses can change. right they don't say that way forever yeah yeah so anyway so we we talked to we've talked to jensen investments before uh we talked to kevin walchish today and we talked about their their quality growth ETF and what I like about Kevin is he said listen we're in the large cap growth space which is which is doing great but we're underperforming and I love the I love when active managers admit that saying this is just not the environment for our strategy right now to keep up when you have this AI boom going on and recognizing that factor as well. So here's our talk with Kevin Walcush from

Starting point is 00:02:36 Jensen Investment Management. We're joined today by Kevin Walcush. Kevin is from Jensen Investment Management. Kevin, welcome back to the show. Great. Thanks. Great to be back. I have a question for you that is kind of hard to answer maybe. I try to explain to my kids the other day what rhetorical means, which is harder than it sounds. But I'm curious, investing in a, a place like large cap growth stocks where everything is seemingly going well. How do you figure out the difference between skill and luck when you are investing in a segment of the market that is doing really well and seemingly outperforming all comers? How do you think about this question of I'm riding the wave, but also we're picking the stocks and how do you try to decipher for this?

Starting point is 00:03:18 You know, I think time is a great differentiator. You know, in that case, you know, we think of ourselves as a long-term manager in a market that's very short-term focused and increasingly short-term focused. And in that regard, you know, you think about efficient market theory, all the information is priced in, but the reaction can be very disproportionate in terms of a risk perception and a value perception in the short term. We think that plays out over the long run. And so, and we think that our ability is sort of long-term managers to look at current market conditions through a different lens, sort of enables us to sort of help distinguish what we think is, first and foremost, our companies, our quality companies that can really generate.

Starting point is 00:03:58 generate what we think is a very strong value over time. And we think that that value our shareholders can participate in. And so what I'm saying is maybe long form, but really what I mean is that ultimately the long term sort of sorts out the luck from the skill. But I would also say that luck is still a part of the business. Yeah. And I'm just curious, how do you prepare for the inevitable other side of this mountain if there is a period of underperformance for this? this specific type of investing for large cap growth? How do you think about that period when maybe it's not just not going to cover off ball all the time? Well, again, you know, sort of as a long-term manager, you know, we want to look through the cycle. We want to manage to the full

Starting point is 00:04:42 cycle. We know the downturn is going to come at some point. As a quality manager, you know, we're looking for those businesses that are durable, battleship ready, all weather in nature in terms of being able to weather sort of the volatility that, you know, market. can experience over a full market cycle. So, and then as a long-term manager, you know, long-term holding, average holding for our period, for our strategy is seven to eight years. And the thinking is, is that our businesses can sort of navigate the, the volatility that we would experience or expect to experience.

Starting point is 00:05:15 So right now what we've seen is as high market concentration, really focused really on an AI trade in our opinion, that we just don't believe is sustainable. having managed this strategy since even before the dot-com implosion, you know, really dealing with that sort of bubble, also dealing with 0708, what we saw financials, energy, and home builders build. You know, we didn't really participate in those. And that's sort of the nature of our strategy being focused on quality businesses that are very consistent.

Starting point is 00:05:45 And so when those bubbles have popped, the value is, in our opinion, recognized of the businesses that we own, and that is sort of enables a strong recovery in that case from a downside protection standpoint. So in that sense, we want to manage for the full market cycle. We want to acknowledge the current challenges. Right now, AI is a little bit of a headwind for us. We would expect as the market sort of broadens out away from this concentrated trade that will see the value in the rest of our portfolio be recognized and then thus benefit our shareholders. Within the quality, segment that you all play. And I'm sure there's a heavy quantitative element to this in terms of R OIC or REO or whatever you guys are looking at, which we can get into. But is there a

Starting point is 00:06:34 qualitative element as well to the story? Well, so the way we sort of build up our portfolio or concentrate portfolio of 25 to 30 names, we want to look for first and foremost companies that have high returns on capital. And so in that regard, we do look for at return on equity. companies have to return in excess of 15% return equity for 10 years. To us, that sort of represents the ability of a business to generate high returns over full market cycles. And so from a quant perspective, then, we use that screen across all publicly traded companies, and that sort of narrows down our universe to about 350 stocks.

Starting point is 00:07:10 In that case, so it's a pretty high bar in that regard. And then after that, from a quantitative standpoint, we kind of, what we do then is we do a deep dive and analysis into our businesses to really sort of build out that thesis. And that tends to go down the qualitative path. And so when we think about then portfolio construction, the other sort of quantitative aspect would be valuation. You know, we're really focused on discounted cash flow. You know, we think we've done the deep dive and understand our businesses from a fundamental standpoint. So in that case, you know, through our DCF, we want to determine full value. And so that would be sort of the other sort of quantitative contributor to portfolio construction, which in our

Starting point is 00:07:50 mind really sort of marries up sort of the quantitative, but really the art and the qualitative to help us build our portfolio. So within your top 10 holdings, which you mentioned they're concentrated. So the top three, which I'm going to mention are 22% give or take. It's Microsoft Alphabet and Apple. Of the Mag 7, those are the only three that are in your top 10. So it's not here. And I wouldn't expect Tesla to be in here. We would not expect Nvidia to be in here just given that it's done this. It's rise. It's been meteoric and very quick and just wouldn't filter through the screens that you have in place.

Starting point is 00:08:24 But maybe we could use like meta and Amazon that aren't in here as a jumping off point to talk further about what quality means to you. So what is it about those two businesses that that might have them not in the top 10? I don't know if you own them or not. We don't own them. Amazon's easy. they have not generated that consistent return on equity that we're seeking. So they've not generated a minimum of 15% return in equity for 10 consecutive years. You know, they basically were on track years ago when the business was really focused on just sort of the core sort of retail.

Starting point is 00:08:58 But pretty much they went off track when they went into consumer electronics. And consumer electronics typically commoditized relatively quickly. and that sort of investment in that direction really sort of, in our mind, really compromise the return on equity. And so in that case, they don't qualify. Meta actually does qualify. We've done the fundamental work on the business. And this would be an example where we think about portfolio construction is you certainly have the fundamentals, the valuation, and security-specific risk. In this case, governance is incredibly important to us and also consistency in the business. So when we looked it's a good business. It's done really well from a stock perspective. But we feel like for

Starting point is 00:09:42 our type of investors who are really looking for stability and a degree of predictability, a couple of things really sort of stood out to us. One was just sort of the decision by Mark Zuckerberg to go into the meta universe and to kind of almost at that point sort of on his own decision really pivot the business in a massive way. And in that regard, that was a real concern for us from a decision-making standpoint and a government standpoint. Worst name change in the last 20 years, right? Got to be up there? It's got to be up there.

Starting point is 00:10:12 I mean, I think, you know, that's where, you know, branding definitely makes a difference. I think that one definitely took them off track from a name perspective. So, you know, Invidia not being on here is another one. And I want to touch on some of the thing you said earlier about the AI potentially being in a bubble. And I tend to agree. I don't see how, even if AI is everything that it's promised to be, I don't think we've ever had a handoff technologically where you get this huge cycle of investment from firms that's immediately handed off to usage for clients and businesses and that it just is never a smooth transition or handoff.

Starting point is 00:10:48 So even if AI is, everything people say it's going to be, I just don't see how we get from here to there without a bubble deflating at some point. Is that the way you're thinking about this? Yeah, definitely. I mean, when we look at, you know, what right now is where it's the constraint. It's around compute, and so the value is sort of accruing in that direction. We know historically semiconductors have been relatively volatile and very cyclical. We think as soon as the constraint moves away from chips, we think that will be that time where that bubble sort of pops.

Starting point is 00:11:20 But then we sort of expect, you know, we think about AI long term. We're excited about it. We think the opportunity for value creation is amazing. In our mind then, you know, after that sort of shift and that realization, that all the value is accruing to a handful of chip companies, but it's really sort of broadening out. We think at that point, you know, that certainly will be sort of that catalyst where the market will,

Starting point is 00:11:43 this market bubble will pop. I want to ask you about that specifically because it's a weird thing where, if you think back to like the internet bubble, dot-com bubble, there were so many companies. IPO is going up a couple hundred percent on the same, on the day it came public. This is a different sort of bubble. if we're going to call it that, where it's really focused in the mega, mega, mega, mega,

Starting point is 00:12:05 tech. I don't know if that's better or worse, but it's a weird dynamic where you're not just seeing all of the like, oh, we're also an AI company. You're not seeing like a dozen of these companies pop up and just go vertical. That's just not happening. It's really accrued to the invidities of the world. And I guess it's a short list beyond that, you know, AMD, micron, et cetera. Right.

Starting point is 00:12:25 I mean, well, it's interesting to those, you know, you kind of compare to the dot com time. You know, there was a lot of companies that would, you know, basically put a lot of investment into hope, so to speak, and the idea around it, meaning, you know, you'd sort of see like a web van. A web van would do a massive sort of investment in supply chain and try and sort of do a build it if they will come sort of faith-based type opportunity. And that really compounded. And I think that, you know, the value the people didn't really drive towards that business quick enough. In this case, you know, it's interesting, you know, in our mind, these businesses, the semiconductors, the semiconductor equipment, they are creating a lot of value pretty relatively early, in our opinion. And we also see that value on sort of the platform businesses, like a Microsoft and an alphabet. And so I think that's what makes this one probably a little bit trickier, is that there is some value creation going on. The runway looks interesting. But then I think the challenge is is we're not exactly sure. where this is going to sort of the cadence of how this is going to play out in terms of

Starting point is 00:13:35 what are the services that we're really all going to benefit from. And so I think that degree of hope is still relatively high, but there is some value creation going on. But I think at that point where hope realizes the value is not coming as quick as was hoped for is when we'll see sort of that bubble pop. And I think that's just that uncertainty this time. And, you know, it's sort of like Mark Twain said, you know, history doesn't repeat itself. it just often rhymes.

Starting point is 00:14:02 And I think that's sort of the rhyme from this experience that I think, you know, relative to the internet bubble, but then also different bubbles that have sort of we've experienced over, you know, many markets. Do you find that the quantitative aspect of your strategy makes it easier or more difficult to invest in this kind of market? Like, because I guess if you have these hard and fast rules, it just keeps those companies out regardless, right? You have your rules. You stick to them. On the other hand, it's like you see some of these. companies may be going ballistic and you think, geez, I wish we could invest. So how do you,

Starting point is 00:14:33 how do you think about that? Yeah, I think that's just sort of the discipline of what we want to employ with our strategy and that sort of long-term focus. So typically our strategy, so we, we are underperforming in this kind of market. Yeah, who is it? Get in line. Yeah, exactly. It's kind of binary. Either you own and video or you don't. And in that regard for us, and we've seen this before, as bubbles inflate, we tend to not keep up. And the more they inflate, the more difficult it is for us to keep up. But typically when they pop is when we really sort of show the value that we can deliver with our type of portfolio of quality businesses. And so in that case, it's a matter of adhering to the discipline, to not style drift, to not get tempted to kind of go after

Starting point is 00:15:20 these names, especially when we think valuations can be pretty high for these names. And to really sort of, in essence, be a little bit on the faith-based side, but also a belief that we don't know when the market will turn, but we just, we have a high confidence that it will turn at some point. You, the 15% ROI, that's a, that's a pretty high threshold, as you mentioned, only 300-some-odd companies meet that criteria. What's the valuation overlay? Because naturally, these companies, these wonderful businesses are going to be trading at a higher multiple. They deserve a higher multiple than the market. So how do you think about, okay, this is trading at a premium, but their premium is too high? Well, it's interesting. So our, you know, our portfolio, so like right now,

Starting point is 00:15:58 you know, you have this concentration, a handful of names. We think the market's undervaluing other large number of companies in the market, especially our quality businesses. So when we look at our valuation and the way we build it up, we still see a lot of opportunity. And so that valuation run, so to speak, isn't as apparent in terms of being really restricting what we're trying to do from a valuation perspective. And I get it. Like you look at the handfuls of NVIDIA and these other names that are just running, but there's a lot of other names that we don't think their value is being recognized at this point. And so valuation is actually, in our opinion, look pretty good. We should mention we're talking here about your Jensen Quality Growth ETF,

Starting point is 00:16:43 because there's an ETF that's coming out, but a strategy that you guys have employed for a number of years. Is a step into ETFs here for this type of strategy, just this is just the way things are going? Because I think people don't realize how really big the mutual fund and separately managed side of the business is, especially for institutional investors and such, is this just a way to open up the access to more people for this kind of strategy? Absolutely. For us, it's another channel. Our strategy certainly was initiated on the mutual fund side. We've evolved over time for separately managed accounts, UMAs. And this is just another channel that can offer value to customers who like our strategy, but maybe more tax sensitive, just because ETFs can deal with

Starting point is 00:17:31 capital gains in a very different way, in a more favorable way. In that regard, what's interesting is our strategy already, because of its low turnover nature, has historically been relatively tax-friendly, but not necessarily tax-free. And so for our clients who are looking for that incremental edge from a tax advantage standpoint, we think this can help solve their needs in that regard. So, so again, we think it's an opportunity to sort of really broaden out the appeal of our strategy. Kevin, I'm not expecting to have a great answer for this, but I'll throw it out anyhow. These businesses that we're talking about here, because that's what they are, they're not just stocks. They are actually companies. How does the share price converge with the value creation?

Starting point is 00:18:16 Like, how does that happen? Sure. Well, I mean, I think it's a matter of recognition in the market is really, that's the measuring stick, so to speak. And in that regard, you know, our perception of value may be mispriced in our opinion in the market. And so we think time, our belief is fundamental bottoms up investors is that the return of a business will ultimately get reflected in the share price. And combining that with the dividends would create a total shareholder return. We just think that the market can take longer than we identify that. And so in our opinion, our belief as fundamental investors is that, the market will ultimately move in that direction and recognize the value creation.

Starting point is 00:18:59 So the goal for us is to really, you know, when we want to initiate a position, we want to see whether we think the market's maybe missing that value opportunity. And we want to invest with a discount to that, what we think is the full value. And that gives us a margin of safety, but it also gives us an opportunity for value creation, that recognition. Do you think in terms of catalysts or do you care about catalysts? Because I think you could say this not just for you picking high quality, large-cap stocks. You could say this for people picking small caps or midcaps or international stocks or dividends or low volatility, whatever.

Starting point is 00:19:30 Pick any other strategy besides high-flying growth stocks. That would say the fundamentals are better here. The valuations are better. Do you ever think through here's the catalyst that could cause these companies to have that price and value come together? Or is it more just we think this is mispriced and we think eventually the market is going to figure it out? I mean, some of both. I mean, it's really sort of business dependent. And what we find then is that, you know, as we build our portfolio, one company at a time,

Starting point is 00:19:58 25 to 30 stocks or companies within our portfolio, some may need in our mind, may have a catalyst that the market hasn't recognized. But others, it's just a matter of good execution, nothing specific, just sort of a market misunderstanding that we think will evolve over time. You know, as far as catalysts, I'm trying to think of something right now. You know, I think right now, I mean, catalysts right now are moving around. are large-cap names, Apple, Microsoft, Alphabet, there's a lot going on in that space right now. And so, you know, I think the market's kind of waiting for catalysts in terms of clarity,

Starting point is 00:20:35 in terms of value creation, probably also looking for clarity on the regulation side and also on the litigation side. And so in that regard, you know, you could say that we're waiting for that market to kind of recognize that. For other names where we're looking at, you know, we like health care. Health care is a very strong fit for our type of strategy. Specific names, like a striker. Stryker isn't necessarily, so Stryker, leading producer of artificial knees and hips.

Starting point is 00:21:05 Based in West Michigan. Sorry, yes. Based in West Michigan, just like me. Barry just got a new hip. I wonder if he's got some striker in his body. But we like, I mean, so that would be a name where, you know, I don't know if we're looking for a catalyst in like a name like Stryker, but we're looking for really good execution in terms of their dominance within their markets, their robotic surgery,

Starting point is 00:21:22 technology, that high degree of lock-in, that building out that share. You know, we don't need a catalyst from something like that. We just need them to continue to execute and get that reflected in the market. One of the big differences between this environment and, say, the last, I don't know, 15 years are the level of interest rates. You mentioned that you do discounted cash flow. What did higher interest rates do to your models? I mean, it's certainly, you know, that risk-free component on figuring out a cost of equity definitely was up. So in that regard, you know, certainly pressured. Were you like, holy cow, we have to sell everything?

Starting point is 00:21:57 I mean, it was, yeah, it's interesting. I mean, we certainly, you know, this market period has been a great opportunity for us to kind of make sure, go through all our assumptions, our processes, and make sure we're still continue to be on point in terms of that. And so valuation was no different. Cost of equity is no different. And these high interest rates were no different in that regard. What we found, though, is that when we look at interest rates, we create interest rates

Starting point is 00:22:22 on a per company basis. We look at fundamental factors within the business. And in that regard, even with higher interest rates and, let's say, valuations that are a little bit more stretched, we still saw a lot of value opportunity in our businesses through our models. And so in that regard, it helped us sharpen our pencils, but it was very confirming what we're doing. I'm curious how you stress tests on those models.

Starting point is 00:22:45 I remember my very first job in this industry, I worked for a group of sell side analysts, and they basically the first day said, here's all of our. Excel models, go through these discounted cash flow models and macros that we've created on Excel and figure out the pivot points, like where you can make the biggest change from your biggest assumption. So it's, you know, the garbage in, garbage out theory. And going across all those different spreadsheets, it took me, you know, weeks to untangle this web of connections here. But how do you think through this and how do you recognize that, like, you know, these two or three inputs and interest rates are probably one of them can really make a cause

Starting point is 00:23:21 a big shift here and how do you figure out like how much certainty we have in some of these inputs for making models like that that kind of try to determine the value? You know, you're hitting the nail right on the head in terms of evaluating what are the sort of the trigger points. You know, we've done this for a long, long time. We've really honed our process. So we've had good opportunities, we think, to sort of test it over time and see where those sensitivities are. Interest rates definitely are a big driver in terms of sensitivity in the valuations. More so than, you know, if you're building a DCF and you're starting from the top line. You're working your way through the profitability. And then you're looking

Starting point is 00:23:55 through cash flow. The biggest sort of sensitivity is around those cost of equities. And interest rates definitely has a big influence on that, more so than volatility on the top line or profitability. So in that regard, for us, then, it's a matter of, you know, when we're testing it and we're really sort of evaluating is, A, you know, we're certainly updating our assumptions around cost of equity determination. We're also building out confidence intervals on our our cost of equities as well. And so we sort of build that out to help us in our mind sort of capture what we think is that variability that one would experience in your sort of assumption set.

Starting point is 00:24:35 So that's our methodology. That's kind of how we think about it and how we sort of move forward in terms of evaluating that over time. Kevin, let me maybe slightly pushback all the second. It's more of a question than a pushback. When stocks got creamed in 2022, it's hard to know whether that was like because of interest rates were higher, but I would argue that it was more of an inflation, like inflation killed multiples more than interest rates, at least because we had interest rates hold steady

Starting point is 00:25:01 over the last 18 months. But inflation came down and then stocks came roaring back. So do you think, like, are you surprised that stocks were able to weather the higher level of rates? Or do you think that, no, that's not what it is at all, dummy. They're looking forward to lower interest rates. Like, how do you untangle that? That's a good question. I mean, that's more of a macro and that's monetary policy. We're not, we don't really hold ourselves out as experts on that front. So I would take whatever. That's actually a great answer. That's a good answer. For bottom of stock pickers, like that's your job is not to forecast or interpret or any of that. You focus on the companies. We do focus on the companies. I mean, we certainly knowledge macro. We want to think about how it will affect our companies. We look at it from the, from each company's perspective. And then we think about it from a.

Starting point is 00:25:51 bottoms up sort of portfolio construction. In that case, too, it's like, yes, we recognize it, but the market's going to do what the market's going to do, and especially in the short term. And so we don't really worry about that as much in that regard. So I guess if you are a long-term shareholder, you know that interest rates are going to fluctuate. So it's not like you're taking this terminal value and going, okay, 5% is here forever. Because if you knew what rates are going to be, then your DCF model would be way easier. But the point is that these things change and fluctuate And companies know that too, right? Correct.

Starting point is 00:26:24 That's our sense. You know, when we think about ourselves as investors, you know, we have a couple of mentalities that we think of. We think of ourselves as sort of business owners and we're co-investing with management teams. So that, I think that enables us to sort of look at sort of valuation and kind of how we think about these business long term through a different lens. We also, through the quality sort of focus is we also think of ourselves as risk first.

Starting point is 00:26:46 We have a risk-first mindset to our investing. So while, you know, we're in the equity space, we have the volatility, you know, we tend to think that by focusing on sort of a risk-vers mindset, we think we can deliver that sort of lower volatility over full market cycles, but still perform really well. When you say risk management, are you talking about risk that like the businesses are well insulated or the actual price of these stocks? Because, as you know, those are two very different things. Sure. On the business side, you know, we think, you know, first and foremost, we're focused. on mitigating business risk, you know. And so we think, you know, being fundamental bottoms up, we think that if we do a deep dive on these and build a concentrated portfolio on businesses that

Starting point is 00:27:27 we think we know well, we think we've identified the risk, they're very consistent and help us mitigate that risk. We think that's a very strong component. On portfolio construction, there can be security specific risk aspects that we want to accommodate and think about when we think about portfolio construction. So in that regard, you can have a great stock or great business fundamentally, you know, wonderful competitive advantages, great pricing power, coupled with good growth drivers, great financials, improving profitability, great teams. You know, those to us are hallmarks for great quality business. You can have a good discount to the market, but then maybe the stock will trade in a way that

Starting point is 00:28:02 doesn't really reflect that. A good example of that would be, and it's coming back to this sort of, you know, risk question that you have on the security specific side is then, you know, for example, Texas instruments we have that in the portfolio. We think fundamentally fantastic business. We think the valuation is very compelling. But we find that the stock can trade commensurate or be relatively influenced by the group as a whole, even though their semiconductor markets can be very different than others. And in that regard, we want to be able to account for that risk. And so that would be sort of that systemic pricing risk in a way. And then evaluation, there would be pricing risk as well

Starting point is 00:28:41 in terms of what kind of discount do you want when you enter a position, you know, do you have a margin of safety through that sort of pricing aspect? So that would be, I guess, another element too. So business, pricing, and security specific risk. I have a two-part question. Talk to us about position sizing because this is a very concentrated portfolio, which if you're hiring an active manager, I would argue you certainly want that over somebody that's going to essentially track the index and charge you a way more fees to do so.

Starting point is 00:29:09 So from a position point of view, how do you think about sizes of these things and then also be curious to learn about the cell discipline? Sure. In terms of position sizing, max position size for us is seven and a half. All of our positions, because we have 25 to 30 names, typically have outsized positions relative to the benchmark. So we're taking big overbets on the names that we've chosen. And so that's relatively inherent in terms of that kind of concentration of a portfolio. When we think about the sell discipline, it's really three things. If it reaches full value, we're going to sell it.

Starting point is 00:29:44 We're going to go through our cell process. We're typically not all our nunners. We typically a dollar cost average. And depending on what the valuation is relative to the market price, if it's really what we think is overpriced, you know, we could certainly accelerate moving out of that position. If it's close to that full value, we may dial it back. But it's really up to us.

Starting point is 00:30:04 So that would be one. So valuation would be one reason. if a company no longer can generate that 50% return in equity, in that case, in our mind, it really has lost its quality capabilities. So we'll exit out of the position as well. And then the third reason we'd sell a position is we think we have an opportunity on our bench, names that we think are candidates not in the portfolio that we think could be a better fit for the portfolio, then we could trade out those names.

Starting point is 00:30:30 And so that would be another reason to sort of exit a position. How many, do you have a huge watch list of companies that you're just, saying, once they hit our levels or our quantitative screens, like, I can't wait to own this company? It's, I would say our bench would be comparable about to our portfolio size in that regard. So, and then we're, you know, we're constantly trying to evaluate and we're constantly updating our bench. We're doing that through fresh, fresh research.

Starting point is 00:30:59 We're also basically taking names that have qualified for the bench, but then we've evaluated them over time and realized, really, as we've gotten to know them, as they performed or underperformed, we don't think they're really going to be worthy candidates. And so we want to take them off our bench. We want to keep our team very focused on what we're doing. We don't want to carry, so to speak, dead weight on the bench. So we're very active in terms of managing our bench, just like our portfolio. So as someone who tracks higher quality companies, Michael and I have talked about this for a few years now, how impressed we have been with just corporate America's ability to handle different situations, especially the last four years or so, and

Starting point is 00:31:36 the fact that margins keep improving. Now, some of that could just be technology, but your sense for being in the business now for a while, do you feel like these higher quality companies are actually becoming more higher quality, like CEOs and business leaders are becoming better at managing these companies through different environments? Is that a thing, or is that, am I, are we way out-based there? No, I think that's a component of a quality business. You know, these quality businesses improve over time. It really comes back to, you know, one thing that they all share in our mind is that they have deep and sustainable competitive advantages. It could be innovation, brand, network effect, economies of

Starting point is 00:32:11 scale, economies of scope, create some sort of pricing or cost advantage for the business. And what's key for us is finding a business that can sustain that for the long haul. And that's sort of the hallmark, the foundation of a quality business. And in that case, for us then as growth managers, we want to find that these companies have diverse and long-term sort of growth drivers. And so we combine that, then that creates that environment with that pricing power really enables, and with the growth, creates stable top line growth and improving margins. And that pricing power really became obvious during this recent high inflationary period. And quality businesses were able to sort of maintain and sort of grow price. And so we saw

Starting point is 00:32:59 that. And so is that the business? But we also, it's important to us as these strong management teams that can sort of steward these businesses. These businesses don't run on autopilot. They need to continue to compete. They need to continue to have investments made to at a minimum maintain their competitive advantages. But even better, we love seeing our companies management teams make investments to enhance competitive advantages and to really sort of build out that value creation. So in that regard, you know, we think what we see is these improvements of businesses is very intentional

Starting point is 00:33:33 when we see it as very long term. And we think that really plays well in terms of value creation that we think ultimately gets reflected. Kevin, for people that want to learn more about the Jensen Quality Growth ETF, that's ticker JGRW, where do we send them? To our website, jenseninvestment.com, backslash, great thanks Kevin thank you okay thanks again to Kevin remember check out Jenseninvestment.com slash ETF to learn more about the Jensen Quality Growth Fund that's ticker JGRW and email us

Starting point is 00:34:06 animal spirits at the compound news.com see you next time

Your Ad Here

Animal Spirits Podcast - Talk Your Book: Quality Growth Investing

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.