Value Investor Insight: Ports in a Storm
Value Investor Insight sits down with The London Company Founder and CIO, Stephen Goddard, and Principal, Portfolio Manager, Samuel Hutchings, to discuss the importance of downside protection in today’s market conditions.
“It was sounding rather old-fashioned until recently, but Steve Goddard has always highlighted protecting client assets on the downside as a key driver of long-term outperformance. That’s exactly what the primary strategies of his $15.2 billion (assets) The London Company have delivered. By outperforming in down markets more than it underperforms in up markets, its Income Equity strategy, for example, has since 1999 earned a net annualized 8.9%, vs. 7.2% for the Russell 1000 Value Index.
In a market where investors appear to be increasingly fearful, Goddard and co-portfolio manager Sam Hutchings are finding what they consider downside-protected opportunity today in such varied areas as coffee shops, videogames, industrial gases and financial technology.
It’s a good time to speak with someone who puts as much emphasis as you do on downside protection in seeking out investments. Why do you consider that important and how in practice do you do it?
Stephen Goddard: The rationale is fairly straightforward. We believe that by better protecting client assets in down markets we increase our chances of delivering meaningful excess returns. That’s consistent with what we’ve done. We’ve generally outperformed in down markets to a greater extent than we’ve underperformed in up markets, resulting in long-term performance over full cycles that has been better than the market.
As for how we do it, we try to embed downside protection into our process by focusing on companies with two primary characteristics, sustainably high and improving returns on capital as well as strong balance sheets. These afford management the financial flexibility to create value. Our time horizon is much longer than most – we prefer to hold companies for five years or more that can consistently compound value.
We manage concentrated portfolios – the Income Equity strategy, for example, owns 30-35 names – and if you look at the holdings in that strategy on an aggregate basis, the pre-tax return on invested capital as of the end of March was 23.2%, vs. 9.3% for the Russell 1000 Value index. Net debt to EBITDA was 1.4x, vs. 2.2x for the benchmark. With respect to valuation, despite our holdings’ superior fundamentals, EV/EBITDA is usually at or below the market level.”