Episode #304: Damon Ficklin, Polen Capital, “Even Though We Are Clearly A Growth Manager, A Lot Of Us Have Value-Oriented Roots
Guest: Damon Ficklin joined Polen Capital in 2003. Mr. Ficklin is Head of the Large Company Growth Team and the lead portfolio manager of the firm’s Global Growth strategy. From 2012 through June 30, 2019, Damon Ficklin was a co-portfolio manager on the Focus Growth strategy. Prior to joining Polen Capital, Mr. Ficklin spent one year working as an equity analyst with Morningstar and four years as a tax consultant to Fortune 500 companies with Price Waterhouse.
Date Recorded: 3/31/2021 | Run-Time: 58:19
Summary: In today’s episode, we’re talking high quality, concentrated growth investing. Damon starts by describing his process for analyzing companies and the key metrics they look for when doing so. Then he covers the paradigm shift we’ve seen in the last year and how companies have adapted to the new norm. We talk about companies that have navigated the shift to e-commerce like Estee Lauder, and others that have transformed their business model like Adobe.
Be sure to listen until the end to hear why one of Damon’s most memorable investments is Invisalign, a stock that has soared in the past year.
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Links from the Episode:
- 0:39 – Intro
- 1:23 – Welcome to our guest, Damon Ficklin
- 2:28 – Damon’s early career in accounting
- 3:41 – Polen Capital’s investment framework
- 4:25 – Investment guardrails for Polen’s large company growth team
- 5:53 – Polen’s approach to research and analysis
- 8:27 – Identifying long-term strategic opportunities
- 10:43 – How Estée Lauder fits into Polen’s framework
- 13:29 – Sell discipline
- 16:04 – The benefits of a concentrated portfolio
- 17:10 – Investing during the paradigm shift in the technology sector
- 19:10 – Growth opportunities as we head into a more normalized environment
- 20:25 – Why Nike and Adidas are ahead of the curve
- 27:10 – Core growth opportunities with Adobe
- 29:03 – Adobe’s competitive advantages
- 31:37 – Companies on Polen’s watch list
- 32:09 – Polen’s long research process
- 33:20 – Why Polen has stayed away from Amazon until recently
- 34:35 – The exciting aspects of Amazon’s current business model
- 38:31 – SAP as a case study of Polen’s approach to share price declines
- 41:20 – Polen’s team-driven approach
- 43:03 – Why Polen is positive about long-term investing in China
- 48:22 – Why Damon is excited about Polen’s portfolio coming out of 2020
- 50:00 – 2020’s compressed cycles
- 51:42 – Polen’s mindset towards strategic evolution
- 52:50 – Why Align Technology is one of Damon’s most memorable investments
- 57:18 – Find out more about Polen Capital
Transcript of Episode 304:
Welcome Message: Welcome to “The Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Hey, friends. Another great show today. Our guest works at Polen Capital where he is the head of the Large Company Growth team and the lead portfolio manager of the firm’s Global Growth strategy. In today’s show, we’re talking high quality concentrated growth investing. Our guest starts by describing his process for analyzing companies and the key metrics they look for when doing so, and he covers the paradigm shift we’ve seen in the last year and how companies have adapted to the new norm. We talk about companies that have navigated the shift to e-commerce, like Estée Lauder, and others that have transformed their business model, like Adobe. Be sure to listen to the end of the episode where we hear one of our guest’s most memorable investments, the stock that has soared in the past year. Please enjoy this episode with Polen Capital’s Damon Ficklin. Damon, welcome to the show.
Damon: Thank you, Meb. Great to be here with you. Thank you for having me.
Meb: Where is here? Where are we chatting with you from?
Damon: So I am based in Boca Raton, Florida, which is where the main headquarters is for Polen Capital.
Meb: I imagine you aren’t celebrating the spring break with all the spring breakers down on South Beach, but man, it looks like the world is ready to reopen if Florida is any indication. Is that about right? Is that the vibe?
Damon: Yeah. Yeah, definitely some concerning activity down in Miami this year, but I didn’t participate in that.
Meb: Well, it feels like the world, U.S., in particular, I think, is ahead of the curve but is ready for this lockdown to end. I think people are itching to get out and about if the beaches in Los Angeles are any indication, and hopefully, fingers crossed, it happens. Let’s chat stocks. You guys are a well-known shop that we’re going to get into, that’s been around for a little bit. Give me your quick origin story. You came from accounting, MBA, analyst background. Is that right?
Damon: Yeah, yeah. So I actually got an undergraduate degree in accounting, and then a master’s in accounting, and then spent a short stint, about four years, working for Pricewaterhouse, primarily in their international tax business. It wasn’t my long-range career aspiration to remain a tax accountant, but I thought it was a good training ground. And then I used the University of Chicago really as a stepping stone. I went back, earned my MBA there, with concentrations in economics and finance, used that as a stepping stone really to get into the asset management business, which was my long-range goal.
Meb: So they didn’t teach you the efficient market hypothesis, and you just moved on to a different world. You’re a stock picker now. When did you join the Polen crew?
Damon: I joined Polen Capital in 2003. So I’m in my 18th year now. I think, at this point, I am the longest-tenured member of the firm. The CEO, Stan Moss, joined two weeks after I did, and so I think we’re the two longest-tenured employees, been with Polen for quite a while now.
Meb: Awesome. Well, tell us a little bit about your shop. What’s the philosophy, framework? How do you guys think about the world?
Damon: We are a high-quality, conviction-driven, long-term business investor. So all of our portfolios are relatively concentrated, by industry parlance, so call it roughly 20 to 30 holdings across portfolios, and really invest in what we think are the highest quality growth businesses in different realms. So we have portfolios that focused on the U.S., portfolios focused outside the U.S. And then I manage with Jeff Mueller, my co-PM on the Global Growth strategy, which gets to invest in the best businesses wherever they reside throughout the world.
Meb: So concentrated, my favorite type of investors. Talk to us a little bit about what you guys are looking for.
Damon: Really, we have five investment guardrails, and I’m speaking for the Large Company Growth team here. We have a Small Company Growth team based in Boston and also an Emerging Markets Growth company team in London. They’re essentially looking for the same things in terms of managing concentrated high-quality growth portfolios investing in strong businesses, but the application could be slightly nuanced in those different universes. But for the Large Company Growth team, we have 5 investment guardrails that have been in place since day 1 at Polen Capital, more than 30 years ago, and that’s, you know, high returns on equity, so 20% or greater returns on equity on an underlying economic basis, better than average earnings in free cash flow growth, so think of it as high single-digit to low double-digit in terms of, kind of, the lower end of the growth bar, high and improving margins typically, so not just growth but growing profitably, low levels of debt, and then, finally, true organic revenue growth.
So those five things…any one of those five hurdles would remove a lot of companies. We’re looking for all of them. So it really whittles down a very large global universe to a much more manageable number, and that’s really where we begin to do our deep-dive research.
Meb: Talk us through the process. What does the research look like? Is it old school security analysis? You got the accounting chops. You guys, oh, I’d say, used to go visit the companies, but what’s the process? What do you from once you got the starter list?
Damon: Once we apply those 5 investment guardrails, that takes, you know, roughly a 3,000-plus-stock universe down to a few hundred companies. So very efficiently removes 90% of the universe. And then go from that 300 down to our coverage universe, which is roughly 150 companies globally that we think are the most likely candidates for 1 of our 3 large company portfolios. We’ll eliminate anything that’s highly economically sensitive or true cyclical businesses. You know, some of these businesses might meet our criteria at a point in time, but very few of them sustainably deliver what we’re looking for over time. And then we’ll also eliminate any businesses that we just think have sustainable competitive advantages.
Sometimes you find businesses that have good growth, good economics, because they’re seizing a short-term opportunity, taking advantage of a fad or a fashion. If we can’t get confident and comfortable that they’re going to be able to sustain this type of performance, you know, three, four, five-plus years, it’s really not what we’re looking for. So both the cyclical-oriented businesses and more fashion or temporal-oriented businesses require a timing element, and we’re not trying to time anything. It’s really about owning companies for the long term, letting their results drive our investment results. And so that gets us down to that coverage universe, and that’s really where the team starts to dig in. And I’ll pause there to see how deep you’d like me to go.
Meb: We’re going to go super deep. Our listeners love the rabbit hole. So perhaps a fun way to do it is, sort of, tell us some case studies. Maybe walk us through a name, and we can do two, three, four, five of them, and just give us a little insight into how you think and how it fits the process, all that good stuff.
Damon: Sure, sure. So once we get down to that 150, you know, roughly, coverage universe, we’re doing what you would expect from, you know, a fundamental investment manager. We’re reading all the regulatory documents, reading the annual reports, listening to the investor day presentations. We do go meet with management teams. I would say, it’s not always the most important element of what we do, but we’re doing more and more of it as we’ve grown the team and, you know, expanded into a global universe, where tough and important to go, get in touch with management teams, certainly different cultures, understand how they think and operate, so all of the normal stuff. I don’t know that that would be too different from what you probably hear from most money managers. I think what is different about us is that we really do have a long-term orientation.
So our average holding period is five-plus years. So we’re always really thinking about the long-term strategic opportunity within the business and very focused on the business model, how sustainable it is, how durable it is, and what’s going to keep competition at bay. Because right at the end of the day, microeconomic says, if you’re earning above-average returns and seizing strong growth opportunities, competition is going to come in, right, and whittle those returns and those economics down to cost of capital. So we’re really looking for businesses that we think can defy that and can hold competition at bay and continue to grow at, you know, substantially better economics than your average business. So that’s really what we’re after.
In terms of ideas or companies that we could talk about and maybe good examples, we have significant positions in Visa and MasterCard for quite a long time. I think it’s a great example if we talk through the structure of that business and why we find it so attractive. We have pretty healthy exposure across software and technology as well. So big position in the global product is Alibaba, also Tencent. And then we have some great companies in the more consumer discretionary oriented field as well, like Nike, Adidas, we added Estée Lauder this year, great franchises for long term. And then one other example is Abbott Labs, which has been a very interesting business, you know, recently. We’ve owned it for many years in the past as well, but most recently, certainly contributing to testing around COVID and helping the world get back to a more normal environment. So on top of what’s already a very stable, highly cash generative business, multiple different businesses within the health care space, it’s certainly been a big winner from COVID’s perspective as well. So I’ll pause there and see, if there’s any of those, in particular, you’d want to go into, I’m happy to talk about any or all of them.
Meb: All of them. Let’s start with one that you mentioned you added more recently, Estée Lauder. Tell us about what was attractive, why you guys think this is a stock with a lot of upside potential.
Damon: Absolutely. I mean, as we look across the global landscape, one of the areas where we didn’t have a lot of exposure where we thought it made sense was kind of the luxury end of the market and even in the luxury cosmetic space. We’ve studied Estée, we’ve studied L’Oréal, we even looked at Shiseido, but we really felt that Estée Lauder was heads above the crowd. Its business is completely focused on the more luxury end of the market, right? So L’Oréal has a very big luxury business, luxury cosmetics business, but also caters more to the mass market. Nothing wrong with that segment, but it doesn’t grow quite as well. The brands aren’t quite as powerful. And so Estée Lauder is really focused on the most attractive segment of the market. They are the leader there. And they’ve been taking share over time. So when you put all that together, it’s a very positive backdrop. This is a business that they can grow their revenues at a high single-digit rate. That’s what they’ve been delivering. They’ve actually been delivering better growth in that historically.
And this is an interesting situation too as you can kind of extend this logic across Adidas, Nike, and some other companies that do still depend on selling through brick-and-mortar doors to some extent. But what we saw, so when we went into the pandemic, it’s kind of a first-order negative, right, “Oh, man, the stores are closed. How are they going to deliver strong sales growth and profitability?” Definitely was a short-term headwind, but the longer-term opportunity is to move more and more of their business to the online channel. And definitely, in the case of Estée Lauder, their most profitable…one of the most profitable segment is selling directly to consumers through an online channel. So I think it’s a really interesting trend and a really interesting opportunity. Not all brands are going to successfully navigate this shift to omnichannel and online, but I think Estée Lauder is proven to be quite adept at that, especially if you look at Asia and China, where a lion’s share of growth is coming from in this market. They’re very well ahead of the curve, and you know, most recently, we saw, you know, north of 40% online sales within their business.
So short-term headwind, long-term positive, as they’re going direct to consumers. They have this online relationship. You know, these luxury cosmetics companies have been in the business of creating brand, and narrative, and story, and content to support that for a long time. And so I think, as the world moves more online, it really plays to their strengths.
Meb: So once you add a name like Estée Lauder, walk us through…you say you typically hold positions five years. How do you think about getting rid of it? Like, what’s the sell discipline? Is it valuation? Is it the laundry list of other, sort of, reasons why? Is it a composite? How do you guys think about getting rid of something?
Damon: Yeah. There’s really a handful of reasons that we would sell something. I think one of the most important, even if not the most frequent, is if we thought that the franchise was deteriorating or really at risk or being threatened in any material way, we would be quick to move aside. As I said, that does not happen very often but a very important reason to sell. When you manage concentrated portfolios, you don’t want to take any undue risks, and frankly, we know from our long history that we’ve produced really strong results, not because we’ve taken big risks and been right, but because we haven’t taken unnecessary risks. So that would be a key reason that we would step aside.
I’d say the more common reason that we would sell something would be a combination of one of two things. One, the business is just not quite living up to our expectations. So given the quality bar that we have, it’s very rare that a business is really deteriorating in a meaningful way, but it is very possible that they just haven’t quite lived up to our expectations. And in connection with that, despite a low level of turnover and that kind of long-term orientation, we’re constantly trying to find better ideas and upgrade the portfolio. Every now and then, we’re successful in that regard. And so it’s kind of a gradual upgrade/replacement type of a process. That’s the main reason I would say that we end up selling something.
And then you mentioned, and I think it’s also an important reason, would be valuation. We are sensitive to valuation. I don’t think the most important thing is the P/E ratio. If you’re thinking over the next 5 years, you know, whether you’re buying something for 22 times or 26 times is probably not the most important factor. It would be much more about, is this company actually going to deliver 14 or 15, or you know, whatever the earnings per share growth expectation is? That’s going to be much more determinant about the success of your outcome than the P/E multiple precisely. All that said, valuation certainly does matter, right? And so, as we think forward and try to understand if it’s still fairly valued at points, you know, you said, love the business but the valuation is just demanding a lot. And if we can’t get comfortable and remain confident that we can get a double-digit investment return going forward, then that really becomes a trigger to trim or, in some cases, sell outright.
Meb: And what does the broad landscape look like today? Are you guys finding a ton of opportunities? Is it slim pickings? How does the landscape sort of look like? We’ll start with the U.S. and then look globally as well.
Damon: I’d say the backdrop is that the market has done pretty well for the past decade and I’d say even pretty well last year despite a lot of uncertainty and the cross-currents of COVID. That does make it, you know, at a high level, more difficult to find quality ideas at attractive prices, but this does come back to an advantage of concentration, right? When we’re looking for the best 20 or 30 ideas across portfolios, we still feel like we’re able to do that very successfully, right? We’re not owning the whole market. There are areas of the market that, I’d say, valuations do not seem particularly attractive at the moment. But when we are able to concentrate and really pick our spots, we really feel good about our ability to construct best-in-class portfolios at reasonable valuations. I’d say our portfolios, on average, are, you know, at the higher end of average but not outside of the normal bands of what we would consider as, you know, fairly valued.
Meb: Any particular sectors or geographies stand out as either really interesting or really concerning?
Damon: You know, I was talking a little bit about the technology space, and I think we have had a real paradigm shift or a step function up the esker, right? If you think about what went on during the COVID environment, there was this big push to online, all things online, whether that’s online advertising, online entertainment, online payment, you name it. We were in an environment where you really had to engage in that way. And so many of the businesses that we own, like Alphabet or Facebook, have been kind of climbing this esker for a very long time. PayPal, we added during 2020. There’s been ongoing shift to online payment and then mobile online payments, which they’ve been benefiting from for years.
So it’s not new, but there was definitely kind of a step up that esker where, all of a sudden, they call them silver tech. These are, you know, 55 and older consumers that aren’t traditionally the most technologically savvy consumer and didn’t engage with some of PayPal’s products as much of the younger cohorts did. But during the environment, they did, right, they tried, they had to figure out how to pay for groceries or buy other goods. And as soon as they tried some of PayPal’s products, they realize how easy it was. So consumer adoption went up pretty meaningfully, and then engagement was very high, too, because you had to repeat this behavior, right? PayPal says that if a new consumer tries the product a few times within the course of the first 10 days or a couple of weeks, it’s a very positive signal that they’ll probably be lifelong consumers. The environment supported that, right? And so definitely a big benefit for these businesses, and you can really go across the technology landscape. I think there was a real positive theme and push behind what was already secular themes that were in place.
And then we’re talking a little bit about Estée Lauder, and for certain consumer companies, it’s a similar story, right? It’s kind of, the first-order effect is a challenge, but the long-term impact is really positive. So we found some interesting ideas or opportunities in that space as well. And then health care is, you know, there’s different segments of health care and, certainly, businesses that, you know, depend upon patients going into the hospital or getting procedures done, or some of that had a near term negative impact, but all things being equal, many of these health care companies are quite stable, and, you know, I think as the world gets back to “normal,” you’ll see their businesses bounce back again. You know, Abbott, I mentioned Abbott as a health care company that we have a significant position in. If you deferred getting in a cardiac stent, or a cardiac resynchronization device, or something like this, you can defer that for a quarter or two or maybe a little bit longer, but it’s not the kind of procedure you can defer indefinitely. You need to get taken care of. So many of these businesses, I think, have still attractive growth opportunities that are somewhat insensitive to the environment as we get back to a more normalized environment.
Meb: You mentioned Nike, a couple of consumer brands. Maybe talk to us a little bit about any of your favorites there, what’s the opportunity, what was attractive, and why you continue to hold them.
Damon: So we own both Nike and Adidas. We think, in the global portfolio, we own Adidas in our international portfolio and Nike in our U.S. portfolio. So we think both companies are very well-positioned. They’re essentially driving the market for athletic shoes and apparel, the athleisure trend, if you will. Incredibly dominant businesses. Nike spends more than 4 billion a year in demand creation, which is, you know, a fancy term for athletic endorsements and brand-building advertising. And then Adidas spends roughly, you know, more than €3 billion. And then, from there, the numbers get considerably smaller. So they’re way, way out ahead of the crowd in terms of their competition. And that’s really the lifeblood of a brand, is the brand support and building it, right, and then the innovation that comes underneath of that as well. Both of these companies do a very good job with that.
And, again, if you step back, their businesses, historically, were largely wholesale, through wholesale channels, so selling through other retailers, but they’re going over the top, if you will, and going more direct. First, it was opening some of their own stores and competing directly, if you will, with some of their channel partners. In many businesses, it’s very hard to actually go from a wholesale to a direct retail model because your channel partners don’t really like that, right? You’re competing with them. But if you look at a Dick’s or a Foot Locker, or you know, some of the major channels that sell athletic footwear, you look at their wall, 80% of the product is Nike or Adidas. It’s pretty hard to walk away from them and say you’re not going to sell their product anymore. And so these two companies are really in a unique position to go more direct without disrupting their wholesale partners.
And then you have online coming on top of that, right, which is even better. And you can take some of my comments as it relates to Estée Lauder, and it’s the same situation. So now, we have a more efficient distribution mechanism. You don’t have to open a store in every country or every state within every country. You can open some marquee stores, and you can have a direct digital relationship with the consumer, ship the goods straight away, get a good profit, stay engaged. And that’s more profitable. So all of these things, they’ve been going on for a while. Nike and Adidas have been investing ahead of the curve to make this happen even before COVID through gasoline on this transition. But I think they’re very, very well-positioned for the future. And it goes without saying, like, if you’re going direct and you’re selling through an online channel, there’s really not all these layers in fees involved as selling through the wholesale channel. And so it’s not only are you having a more direct and powerful, profitable relationship with the consumer, but you’re bringing more, a higher percentage of that sale, you know, 100% of that sale on your books as opposed to selling it, becoming a cost of goods sold, right, for another retailer.
Meb: I was smiling as you’re talking about Nike because the most expensive pair of shoes, I think, I’ve ever purchased was Nike sneakers, although I got kind of defaulted into it because the sneaker had investors picked up all the shoes that I was trying to buy. Because they were a Virginia championship basketball shoe, means they’re orange and blue, which I guess a double duty for me as Bronco colors. So I could justify the cost as dual, but it was funny because they got bought up on the SNKRS apps, which is an interesting new player to people that are buying a lot of these collectables, as they would call them, for investment purposes, which is interesting. I just wanted to wear them to games. That’s all. But Nike is crushing it, for sure. What was the pandemic like for you guys? You have a growth-focused fund. It’s done exceptionally well. Its growth has certainly been the leader for the past, I don’t know, four or five years, it seems like. Was the impact that have a large amount of rotation involved for you guys as you’re upgrading or trading in and out names and some got demolished last year, or was it more of a sit-on-your-hands sort of year that went by?
Damon: It actually turned out to be a fairly average year from a turnover perspective early in the year, so, you know, call it first and second quarter as we were first, kind of, going into the teeth of the pandemic and then starting to recover. We were a little bit more active. You know, we were able to add Autodesk at the bottom of the market in March. We bought PayPal during the second quarter as we were starting to recover. Then added Estée Lauder in the third quarter, I mentioned before. But in aggregate, we ended up with turnover that’s very indicative of our history, so slightly less than 20% turnover. One way to look at it is, you know, while we were active and I think we were able to upgrade both the growth and the quality of our portfolio, which was already considerable coming into the year, 80% of our portfolio remained unchanged. And so we were well-positioned going in, and I think we did well throughout the environment. Our Global Growth strategy was up about 24% during 2020 and outperform the MSCI ACWI Index, our primary benchmark, by about 8%. So it was a good year.
There were definitely segments of the market that were more negatively impacted, and there were, certainly, segments of the growth market that did even better. But we think we’ve struck the right balance of delivering a strong investment result “the right way.” And what that means to me is supported by fundamentals with businesses that have durability and sustainability. There’s nothing about what we’re doing that’s kind of timing driven or looking for what’s going to perform the best in the next 6, 12, 24 months. It really is about maintaining a portfolio that can drive that mid-teens earnings growth profile over the next five-plus years, recognizing that if we paid fair prices and we actually hold the businesses over this time period, that’s going to drive the investment outcome. And that’s going to be a good investment outcome, right? If you’re able to deliver mid-teens type returns over long periods of times, there’ll be periods where you’re trailing, there’ll be periods where you’re ahead, but when the dust settles, that’s going to be a really solid result. And that’s what we’re trying to do for our clients, trying to deliver that over time.
Meb: Well, I don’t think anybody would be upset with mid-teens, anything in this world of sub 2% interest rates. Another name you guys consistently have chatted about is Adobe.
Meb: Tell us what’s the thesis there.
Damon: Yeah. So Adobe is one of our highest conviction weightings in the global portfolio. We’ve owned it for several years. I think it’s compounded returns at roughly 50% over the past 4 years. You know, an incredibly advantaged growth company. So there’s really two primary segments to the business. One is digital media, and the other is digital marketing, which they call experience management now. So the digital media is, you know, what many people think of Photoshop, Illustrator, you know, all those tools that are really creating content, photo, and digital photo content. And they’re nearly a monopoly in this business, right? I mean, there’s not really a near-peer in this business, and so a very dominant position. And then they transitioned starting in the 2012, ’13 timeframe to purely a cloud platform instead of selling a license to boxed software, which then the consumer can use until they needed to buy a new set of boxed software and upgrade to a more cloud subscription model, where you’re just paying an ongoing subscription and updates are rolled out on a constant basis.
So this took what was already a very good business and made it an exceptional business. And there really wasn’t much of a risk from our point of view in this migration to the cloud, because it really was the same product. Like I said, it’s kind of a near-monopoly position in that, whether you’re a hobbyist or a professional content creator, it’s a must-have tool. And so you definitely were going to transition with them to this cloud model. And now, it’s an ongoing subscription. On top of that, then they have this digital marketing business. And because, I guess, they’re a leader in that business, regardless of even having the digital media business, but the real advantage is that they also are dominant in digital media. So these two businesses really feed each other. As you think about the digital marketing opportunity, it requires digital media content to support it. And so they really lead in this dimension, and it’s something that is very, very hard for anyone to replicate, because no one else in digital marketing really has that digital media asset.
It’s a growth business, and again, we were already marching towards more digital media and engagement online across all business. But the 2020…the COVID environment, kind of, if you didn’t have a digital marketing business at the beginning of 2020, you quickly learn that, “It’s one of my only ways to actually engage with consumers, so I better develop that.” And so what was already a strong growth business really maintained that strong growth, and the opportunity is probably increased as time has passed. And we think, as I said, there’s really no near-peer. So we think this is a business that can continue to grow at, you know, 20-plus percent rates for many years to come and has outstanding economics. I mean, if you look at most cloud companies, very few of them are earning 40% plus operating margin, while having a nearly completely recurring subscription model that’s growing at the rate that they’re growing.
Meb: Yeah. I’m a big fan of their Scan app. It’s made my scanner totally useless at this point. I’m a convert, for sure.
Damon: Yeah. And I didn’t even really mention, you know, they do have a document cloud business too, you know, with the Adobe, the Reader, Writer, digital signature capability, scanning, all the things that you’re mentioning. Like, that’s another…that’s a third very attractive business. It’s just a relatively smaller part of Adobe. But when you have a business that’s that attractive, that doesn’t even get mentioned because you have two other businesses that are even bigger and more attractive, that says something pretty powerful about Adobe’s overall position in the market.
Meb: Any names out there that…I know you guys focus on this sort of limited universe, which gives you consistent familiarity with certain companies because of the long holding period, the valuation being a big determinant of entry and exit, what companies out there are on your watch list that you would love to own just not right now where, you know, either they don’t fit the screen criteria or the valuation checkbox, but you say, “Man, if this was 50% less, I’d be interested”? Anything come to mind?
Damon: Yeah, that’s a hard one, and there’s definitely other high-quality businesses that, you know, would be even more attractive if the valuations were lower. But it’s hard to pinpoint and make a specific example.
Meb: I’m only giving you a universe of 10,000 possible securities. So I laugh because there’s a quant. Many times, it’s the opposite, sort of, familiarity for me is I’m not even clear what some of these companies are or do, which is a total nightmare, emotionally, for the opposite. But the benefit of…I was listening to one of your partners chat about the research process where, in many cases, you guys take upwards of months, quarters, or a year to work on a company before they go into the portfolio. That’s a pretty long lead time and to really put in that amount of research, which, I imagine, is significant.
Damon: That is, and I would say, the typical is probably two-plus years before we ended up actually owning something. We could certainly move, you know, a little faster if there was reason to, if we found something new or something that we thought would fit into one of the portfolios relatively quickly. But with concentrated portfolios in low turnover, we’re usually not looking for 10 new ideas every year. We’re looking for a handful of really good adjustments to the portfolios. So we do tend to study things for a very long time. There are certainly high-quality businesses. Amazon is something that we actually just added in the global portfolio and our U.S. Focus strategy in the first quarter of 2021. Happy to talk about that.
Meb: Yeah, what’s the thesis there? You said Jeff’s finally out of the way. He’s done enough.
Damon: This is a business and it’s probably one that we’ve been asked so many times over the years, why don’t we own it, because it is a very dominant business and has done well for most of the last decade. We did own it for a brief period in 2008 to 2010, in our U.S. Focus Growth strategy. But then, from there, they were investing so heavily and aggressively in fulfillment and distribution and unnamed projects, which we now know was AWS, Amazon Web Services. And so despite really good growth in terms of units or revenue growth, they were seeing profit pressure, and really that was just hard to get certain of what the structural long-term valuation of the business was, not knowing all the things that they were investing in.
So we stayed on the sidelines for many years, but as we’ve fast-forwarded to today, the online retail business, which is still a major part of Amazon, I’d say, is not necessarily, into itself, in isolation that much more attractive than it was 10 years ago. In fact, even though it’s very hard to break apart a portion of the profit pools, specifically, we think it’s probably, you know, near a break-even business. But what we’ve seen over the past several years is they’ve really developed two highly attractive businesses on top of their online retail business, and one being AWS, which is a very profitable business that’s growing at a, you know, roughly 30% rate. We think the market for infrastructure as a service is going to continue to grow at a nice pace for many years to come, they’re the leader in this space. So they’ve birthed a very competitively advantaged, highly profitable, high growth business on top of their core online commerce business and, essentially, taking all the infrastructure that they had to deliver an online commerce business and say, “How do we productize this and sell this to other businesses?”
And certainly, we’ve talked quite a bit throughout this conversation about the move to the cloud and the shift that’s going on globally. And then they also have an advertising business, which has gone from fairly insignificant a few years ago to being quite a large player, and again, a very attractive economic business that we think can still grow at, you know, 30-plus pace for many years to come. So you have these really attractive franchises that have been built on their legacy business, and, of course, the legacy business is also benefiting from what everyone else online is benefiting from, is this stronger push towards the online marketplace.
So when you put all that together, even though Amazon has continued to march higher, we’re now at a point where we think there’s two really high quality, highly profitable businesses that support its valuation, and I think you’re getting the most dominant global online retail business, essentially, as a stub or a free part of that investment in AWS and the advertising business.
Meb: Yeah. Amazon has been an absolute rocket ship. The challenge for a lot of these companies, speaking specifically of Amazon over the years, but really any “security” is, you know, they regularly go through drawdowns, 30%, 50%. Amazon’s case, been through a 90%, 95%, maybe, decline. What’s your typical process as far as the price opportunities, granted many stocks tend to move together, but at times a zig and zag because of sectors or security-specific reasons? How do you guys approach a security that’s declining? Are you just going full martingale and doubling down every 20% it goes down, or is it a gut check of, “Did we get something wrong? How do we deal with this?” Thinking in terms of such a long, long horizon, what’s the sort of mental approach to how you guys deal with the pain of stock drawdowns, which are totally normal?
Damon: It’s certainly situation-dependent, right? You really have to look at each individual situation to determine how we will react. But as a high-level kind of point, the first thing I would try to understand, one, is this just kind of a market-wide phenomenon? Sometimes, you know, if you go back to late ’08, early ’09, all stocks were declining, you know. It wasn’t because something specific about the business was happening. It was just that was the market environment, right? And so it was just kind of market environment-driven, I think that’s a very different animal than, all of a sudden, you know, ABC Company is declining 30% when the market is doing well or is relatively stable. So we really focus on the fundamentals.
And so, I guess, if I could kind of put it in two buckets, if the share price is under pressure for one of the businesses we own and it’s not really for fundamental reasons, if we didn’t already have a full position, we’d be very apt to add more to that position, right? All of a sudden, now it’s just more attractively valued. But sometimes share price declines come from new information or, you know, something that affects our view over the next few years.
So one example recently is SAP, is a company that we own in the Global Growth portfolio, so the largest applications company in the world. And they had a challenging 2020 because they revised their longer range guidance and essentially said, “We’re not going to grow earnings much for the next couple of years.” And so, first order of effect is what’s going on, make sure we understand the business, and why they’re revising guides in the way they were. And in this case, very similar to the theme we’ve been talking about throughout is this shift to online. If you think about ERP, enterprise resource planning software, this is, you know, the bulk of SAP software business, it’s been very sticky and stable, and it’s slow to move to the cloud. Because when companies buy SAP and then they kind of modify, tailor, innovate on top of that ERP platform and really create a lot of customizations, it’s hard to move it to the cloud. And so it’s been an area within software that’s been slower to move to the cloud. But when we got into the environment in 2020, management suddenly realized, “I think companies are actually going to move more forcefully to the cloud, even in the area of our ERP.”
And so when you go from selling a license upfront, like a perpetual license, and then a small ongoing maintenance stream, to selling a cloud subscription, there’s an immediate decline in terms of the amount of revenues you recognize, but you have kind of a bigger tail, right? So the subscription is larger than the ongoing maintenance stream, but you don’t have that big upfront license. So as they’re expecting more customers to transition into the cloud faster, it’s having a near term negative impact on their revenues and their profitability, but year three, four, five, and beyond, as the subscriptions start to stack up, it should be a very positive thing.
So as we look at that situation, the shares have pulled back in 2020, in that case, we did not add to the position, because there’s a little bit of a transition going on in the business that will result in lower profitability near term. So you really have to think through each individual situation, but if a stock is down for a non-fundamental reason or the growth profile remains as expected and strong, we’d be apt to add. But we do also have to understand if there’s real changes happening in the business and how do we adjust our expectations over the next couple few and, you know, five-year period.
Meb: How does this work with a team? Is it you guys are each responsible for your own book? Is it a sort of combination approach to deciding what goes in, what goes out? Do you guys do sumo wrestle when you disagree? How does this all work?
Damon: Yeah, no. So we have a team of 11 on the Large Company Growth team, you know, all based in Boca Raton, Florida. And we’re one fully integrated global investment team. So we have three products. You know, we’re talking a lot about the Global Growth strategy, which I manage with Jeff Mueller. We have a U.S. Focus Growth strategy, which Dan Davidowitz and Brandon Ladoff are the co-portfolio managers on. And then an international, which is an ex-U.S. growth strategy, which Todd Morris and Daniel Fields co-manage. So three products but it’s one team. And so whether it’s a Japanese manufacturing company, a European luxury goods manufacturer, or a U.S. health care concern, if it meets our investment criteria, someone on our investment team is covering it as kind of primary coverage responsibility, and we take it through that process as a team, as one unit. Same philosophy, same process, just at the end of the day, there’s different geographic boundaries, if you will, across the three products. So it really is one team executing. It’s very much a collaborative, team-driven approach. But at the end of the day, the co-PMs make that final decision. We’re not big fans of a committee decision-making structure, but the real work is done as a team, together as a team.
Meb: You guys have, from what looks like it, decent sized positions in China. It looks like you’ve been there for a while. What’s the general takeaway from positions you guys have owned in the global space there? Are you still pretty bullish? Are we ever going to find Jack Ma? What’s the thoughts on China?
Damon: Yeah, no. We are still very positive on the long-term opportunity in China, and particularly, you know, in the investments in Alibaba and Tencent in the global portfolio. We may be evolving to a world where there are two different technology platforms, China and then everything outside of China, but if you look at Tencent and Alibaba, they are incredibly dominant within China. And China’s a big country, and the opportunity just within China is significant. So you’ve seen kind of a cross-current, one, general U.S.-China trade relations over the past year or more have been a little bit of an overhang. And then, in the case of Alibaba, specifically, the Ant IPO was scuttled late in the year, pushed back, as the Chinese government was rethinking some regulation around banking and some of the products that certainly impacted Ant. So when that happened, you saw some of the value of Ant, you know, leak out of Alibaba, as Alibaba owns about a third of that business. And then, most recently, at the very end of the year, the Chinese antitrust authority said that they were examining the online e-commerce business in China. And so that weighed on Alibaba as well.
All of those things, in our mind, really made the shares more attractively valued. We actually did add to our position in Alibaba. It was already a conviction position, but we added it, made it one of our highest conviction positions at the very beginning of 2021. We think there’s a long runway of growth here and that they’re well-positioned. And it’s not really…in terms of the antitrust review going on in China, I mean, this is going on in Europe, this is going on in the U.S., so this is not really just a China-specific issue. These companies are so dynamic and grow so rapidly that they outpace the ability for regulation to evolve, and so regulation has to catch up. And so I think if you look at these companies, they’re pretty well-aligned, specifically, Alibaba is well-aligned with the long-term Chinese government interest, and that being to create a more consumer-driven economy.
There’s very few companies that are actually doing more than Alibaba to make that happen, bringing in, you know, people from all corners of China, whether you’re a tier four or a tier five city, into the modern-day economy. And it’s a pretty straightforward business at the end of the day in terms of, it’s a platform. It’s just matching buyers who come on their own accord, their own choice, because there’s a wide variety of high-quality and affordable goods, and then vendors on the other side, right? Nobody is forcing them to sell through these platforms, but because there are so many users and buyers, it’s a very attractive place to go sell your wares. And in aggregate, Alibaba is taking a pretty modest, what we call take rate, you know, revenue recognition off of the gross merchandise value going across the platform. So while the Chinese antitrust authorities might want to clean up around the edges to make sure they’re all competing fairly, we really don’t think they have anything out for or trying to harm Alibaba at large. And we think Tencent is probably even further afield from that risk.
Meb: Interesting. What are some of the resources, inspirations for you as a PM analyst that you rely on? I would say conferences, but those don’t exist anymore, books, newsletters, banks, anything, in particular, come to mind as interesting areas for further study?
Damon: I think most of the inspiration or, you know, the historical inspiration was from great investors like Warren Buffett, Benjamin Graham, Phil Fisher. Most everyone on our team, that’s their DNA. Even though we are clearly a growth manager, a lot of us have a value-oriented root. And in fact, when the founder of the firm, David Polen, the namesake of the firm, created the philosophy and process, it was from studying those greats. In one way or the other, everyone on our team has studied those greats over the years and is now incorporating that. So I’d say those are the common threads across our team and the sources of inspiration. When it comes to modern-day “What are we doing to understand businesses,” it really is bottom-up, one company at a time, fundamental research. You know, 90-plus per cent of our research is internal. It’s us doing our own research rather than relying on outside sources. So other than the publicly available information that I mentioned before when we were talking about the process, it’s really an internal debate in trying to just understand these businesses.
Meb: As you look forward to the horizon, 2021, the world’s getting back to normal, what’s on your brain? I imagine you guys don’t spend as much time on, sort of, macro cross-currents. Maybe you do. I imagine it’s a lot more bottom-up-driven. But are there any sort of investment world things you’re pondering that either you’re really excited about or really confused about, or some combination of both?
Damon: As we look forward, I think there was, as I mentioned, a little bit of a dynamic change in the market in 2020. While we will go back to some semblance of “normal,” it really spurred a lot of trends to move faster, and I think that’ll play to the benefit of a lot of technology companies. Certain segments of the technology market were bid up, and it remains to be seen whether the fundamentals will ever catch up or come through to support what’s happened with those valuations. But the technology companies we own have the fundamentals to support it, and I think they’re also benefiting from many of these positive trends but in a very sensible way, at more reasonable values. So we’re very excited about, you know, our exposure to the technology companies we own. We think they continue to grow at a strong rate through the 2020 period, and I think they’re well-positioned to continue growing at strong rates going forward.
And then, in the consumer areas, we talked about, you know, some businesses, Nike, Adidas, Estée Lauder even. We didn’t really mention Starbucks. It’s another one that certainly saw some impacts in 2020. But as the world opens back up, and in the case of Nike, Adidas, Estée, more and more businesses is done online, we think they’re going to see strong recoveries in 2021 and beyond, and they’re moving to more attractive business models and really moving further away, separating further from their competition. Again, great economics, good growth opportunities, reasonable value. So we feel very good about the way we’re positioned.
In most of what we saw play out in 2020, it was really not unusual. What was unusual about it was that it was so compressed, right? You normally go through these cycles where you have, call it, fear, crisis, recession, some form of decline in the market that ends out bottoming out, and then you have somewhat of an orderly recovery as people move back into quality and feel comfortable with certain segments of the market. And then, eventually, you get back to what we saw a little bit in the fourth quarter and coming into the beginning part of this year, a little bit of euphoria, right? November, as we started to see progress in terms of vaccine development in November, the market became very ebullient. So none of this is unusual. It was just unusual that it all happened within such a short period of time. But we feel good about…at the end of the day, for us, the ideal environment is just an orderly, stable environment. It’s just probably unrealistic in the sense that that’s not the way the world works. But once the dust settles, once all the excitement subsides, you’re left with businesses that have grown and delivered the fundamental results, which will then drive the investment result, and you have businesses that haven’t quite lived up to the promise. So everything we’re doing is to find the businesses that really deliver over time, knowing that if we’re successful, if we’re concentrated into those businesses, it’s going to drive a good investment outcome for our clients.
Meb: And what’s the plan for you guys? Is it to continue to just manage the current funds? I assume you’re not launching a SPAC fund anytime soon, but who knows. As the business moves on, any plans? Are you hiring? Anything going on at Polen?
Damon: Yeah, yeah. Polen has been growing at a nice rate for many years now. So 2020 was no exception. We hired many people, and we’re continuing to hire in 2021. We talked a little bit about the three products in the Large Company Growth team today, but we have multiple other products across the Small Company team and the Emerging Markets team. And they’re pretty early in aggregate. Most of our products are pretty early in their lifecycle. And so we have a long, long growth runway for all of our products just by executing, and that’s what we plan to do. We always have eyes and ears open for other opportunities to add value. As we’ve added products or developed new opportunities, it’s been finding the intersection between where can we add investment value, right, and then what do clients need. So that’s kind of the mindset. We’re not trying to be all things to all people, but where we can marry investment capability with a demand or a need in the marketplace and we can create real value, that’s the way we’ve thought about evolving strategically over time.
Meb: What’s been your most memorable investment? Good, bad, in between, anything come to mind?
Damon: You know, one that I think is really interesting, and it remains an investment today, is Align Technology. So this one’s interesting in that we typically are owning businesses that are 10 billion market cap or higher, right, in the large company space, but we actually started studying Align when it was probably in the 3, 4-billion market cap range. And we had some real parallels or lessons learned from a prior investment in Allergan, not the Allergan that exists today, but the original Allergan, which was an eye care pharmaceutical company and the owner of Botox. We had a great experience historically with…that could have been one that I chose as well, because that was a really interesting story. But they owned Botox, and Botox was off-patent for many, many years, but Allergan was able to maintain, you know, 70%, 80%, or higher per cent market share across different countries across the globe. And part of this was adding, creating a real brand. If you think about their end customer, they were selling through aesthetic practices, sometimes dental or other types of practices that were essentially small businesses. And so they had to go knock on every door, create a brand, teach them how to sell or upsell a product, which might be outside of their normal wheelhouse, and they were very successful. And despite lack of patent protection, they remained dominant for many, many years, and ultimately were acquired at a very attractive price. And we did very, very well at Polen Capital with our investment in Allergan.
When Align came along, it had a lot of the same earmarkings. At first blush, you might say, “This is a little piece of plastic that helps move teeth. What’s so special about this? Why won’t it be copied?” But they had a 10-year head start in this business, and they’ve essentially scaled up, mass-producing using 3D printing and other advanced manufacturing capabilities. And I like to say that they’re producing snowflakes, right? If you know these Invisalign aligners, say, you have a normal case, you might have a series of 20 aligners. Every one of those 20 aligners fits to an individual’s mouth, and even each of those 20 is slightly different, because you’re going through this process of moving teeth, right? So they’re, literally, like, mass-producing snowflakes, sending them out to tens of thousands of dental or orthodontic practices that they had to go knock on the door and sell one at a time, teach them how to use these products, make them comfortable, right, and they had IP and protection around this, right, even though I was using the analogy with Botox where they were off-patent, Align has patent.
And so when we looked at this, you know, it might have felt a little less industrial or global in nature than some of the companies in our portfolio and had a shorter life, but we saw all of the things that we really needed to see in place to realize, “This is a really big opportunity. They’re really disrupting the market.” And you saw this even in 2020. Again, it wouldn’t jump to mind as someone benefiting from that environment or the move to digital, but it created this impetus for a lot of dentists and orthodontists to embrace digital dentistry in a way that they hadn’t in the past, because they realized, when we went into this pandemic, “Oh, wow, I can’t actually start a new case of, you know, braces, metal wires and brackets, because nobody wants me to put my hands in their mouth right now. And I can’t continue to check up and treat some of my existing patients.” But if you have Invisalign and you’re…they started to push out apps very quickly to allow for checkups, you know, digital type checkups, using modern tools. And so it’s a really interesting business in that, despite being very advanced, despite having dominant market share, they’re still treating a small fraction of the cases that they can treat. And we think, if you fast forward, you know, 5, 10, some period of time, it’s really going to disrupt the old model, which is just wires and brackets. And as they’ve already taken a good run at starting that process and done very well, we think there’s still a pretty interesting opportunity over the next 10 years.
Meb: I love it. That’s a great decade-long horizon. In a world of Robin Hood, days, weeks, I shouldn’t even say days, hours, days, weeks, months, quarters, decade is a good one. The old coffee can portfolio, put it in and put it away. Damon, it’s been so much fun. Where do people go to find out more about you guys, your funds, what you’re up to?
Damon: You know, we’re available through many intermediaries. So if you have a financial advisor, odds are we’re on their platform, and we may be an option. But you can always come direct to Polen Capital as well. We have mutual funds that are accessible, you know, for as little as a few thousand dollars, and you certainly could invest much larger sums as well. But you can see the polencapital.com website, and we have relationship managers that could certainly direct you to anything that you need as well.
Meb: Awesome. Damon, thanks so much for joining us today. It was a blast.
Damon: Yeah. Thank you, Meb. It was a real fun time getting to talk stock with you today. Thanks so much for the invitation.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love this show, if you hate it, shoot us firstname.lastname@example.org. We love to read the reviews. Please review us on iTunes and subscribe to the show, anywhere good podcasts are found. Thanks for listening, friends, and good investing.