311Polen Focus Growth commentary for the third quarter ended September 30, 2015.
- During the third quarter of 2015, our Focus Growth Composite Portfolio (the “Portfolio”) returned +0.97% gross of fees. Our positive return was in sharp contrast to the significant market decline during the quarter, with the Russell 1000 Growth and S&P 500 indices (the “Indices”) returning ?5.29% and ?6.44%, respectively.
- During the twelve months ended September 30, 2015 the Portfolio returned +18.11% gross of fees, outperforming the Indices by an even wider margin and ranking the Portfolio as the top performer in our peer group*. The Russell 1000 Growth returned +3.17% and the S&P 500 returned ?0.61% over the same period.
- As many factors have conspired to depress already modest underlying market growth during the trailing year, the strong and persistent earnings growth of our Portfolio has been more readily recognized.
- While we have certainly made some good adjustments to the Portfolio during the past year or so and are pleased that several of our highest conviction ideas and largest Portfolio weightings are among our leading contributors, we think the main driver of our significant outperformance during the past year was due to maintaining our investment discipline and focus on the fundamentals, even when the fundamentals did not seem to be driving the market.
- We believe that we have been able to outperform with such consistency over our 27?year history because owning a concentrated portfolio of the highest quality growth businesses drives stronger absolute earnings growth than the broader market can structurally deliver over the long term. Strong absolute earnings growth has driven strong absolute and relative returns for the Portfolio.
Polen Focus Growth – Commentary
During the third quarter of 2015, our Focus Growth Composite Portfolio returned +0.97% gross of fees. Our positive return was in sharp contrast to the significant market decline during the quarter, with the Russell 1000 Growth and S&P 500 indices returning ?5.29% and ?6.44%, respectively. During the twelve months ended September 30, 2015, the Portfolio returned +18.11% gross of fees, outperforming the Indices by an even wider margin and ranking the Portfolio as the top performer in our peer group. The Russell 1000 Growth returned +3.17% and the S&P 500 returned ?0.61% over the same period.
As many factors have conspired to depress already modest underlying market growth during the trailing year the strong and persistent earnings growth of our Portfolio has been more readily recognized. Our firm and our Portfolios are singularly focused on protecting and growing our clients’ assets, and we are proud that we have been able to achieve this once again in a period of high stock market volatility and poor industry returns.
The Indices have not posted negative returns in seven years, so it is worth taking the opportunity to provide some perspective on how the market tends to work during shorter periods, especially ones of exuberance, and to focus on why our investment discipline has worked very well over longer periods of time.
Only a little more than a year ago our trailing 3?year relative performance did not look all that impressive. Today, our 3?year relative performance is in the top quintile of our peer group*. We can say with equal confidence that we were neither significantly less smart a few years ago nor significantly smarter now. The market simply goes through cycles where expectations, or “what is working”, drives stock prices rather than the fundamentals of the underlying businesses themselves. As the legendary investor Ben Graham said, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” There have been periods ? mostly shorter periods ? when we have trailed the market, and there will be more, but when viewed in longer periods (i.e. 3?year, 5?year, 7?year) our Portfolio has significantly outperformed the Indices. In fact, on a rolling 3?year basis, the Portfolio has outperformed the Indices approximately 75% of the time; on a rolling 5?year basis, approximately 87% of the time; and on a rolling 7?year (or longer) basis the Portfolio has outperformed the Indices 100% of the time. We believe these powerful statistics demonstrate that it is only over longer periods of time that the earnings power of businesses truly compounds, and then over these longer periods the market eventually “weighs” those earnings appropriately, just as Ben Graham said. In the short term, the market remains a mere voting machine. Earnings growth may be influenced by the economy or an industry cycle, but over time it is easier to see which companies have persistent earnings growth driven by some unique competitive advantage. Our expertise is not in predicting short?term movements in stock prices. We have a discipline of identifying and constructing a portfolio of only the most competitively advantaged businesses with wide open opportunities, and nothing less. We also have the patience that is required to let those companies do what they do – compound earnings and returns, usually for a very long time.
We believe that we have been able to outperform with such consistency over our history because owning a concentrated portfolio of the highest quality growth businesses drives stronger absolute earnings growth than the broader market can structurally deliver over the long?term. Strong absolute earnings growth has in turn driven strong absolute and relative returns for the Portfolio.
Over long periods of time the market typically delivers roughly 6?7% nominal earnings per share growth (highly correlated with nominal GDP growth). Dividends paid and reinvested contribute another 2?3 percentage points which, when added to the earnings growth, total to an annualized return of approximately 9?10% over most long?term time horizons. Since the inception of our product on January 1, 1989, the Russell 1000 Growth and S&P 500 indices have compounded annual returns at 9.67% and 9.87%, respectively. Our Portfolio has compounded a 14.40% annual return gross of fees since inception, driven primarily by consistent and sustained double?digit underlying earnings per share growth, and complemented by a roughly 1% dividend yield and a very small benefit from multiple expansion. In essence, our Portfolio has outperformed so consistently over the long?term because it has sustainably delivered stronger earnings growth than the Indices.
While the market swings around (sometimes erratically) during shorter periods, we visualize the market compounding annual returns at that 9?10% rate and our Portfolio compounding on a higher plane. We believe a portfolio that is able to sustainably compound earnings per share 12?15% annually over the long?term will outperform the market because the broader market simply cannot deliver that level of earnings growth. This is because “the market” is made up of both exceptional and poor companies, and everything in between, so what you get is more or less a cross section of the economy. Simply stated, by weeding out the average?to?poor companies and only focusing on exceptional businesses with durable advantages and growth, we believe the Portfolio will continue to significantly outperform over longer periods.
The chart below shows the S&P 500 rolling 3?year earnings per share (EPS) growth set against our Portfolio’s rolling 3?year excess returns during the past fifteen years. Keeping in mind that since inception we have