It’s well known that growth stocks tend to do well during bull markets, and David Rolfe (Trades, Portfolio), the chief investment officer in charge of Wedgewood Partners’ portfolio research, has taken full advantage of this. For full fiscal 2019, Wedgewood’s Focused Large Cap Growth Fund returned 31.96% compared to the S&P 500’s already-astounding 31.49%. Since inception in September 1992, the fund has achieved an average annualized total return of 11.36% compared to the S&P 500’s 9.72% and the Russel 1000 Growth Index’s 9.44%.
Rolfe holds a Bachelor of Science in Business Administration degree in finance from the University of Missouri – St. Louis. After leaving his previous position as a portfolio manager at Boatmen’s Trust, he joined Wedgewood in 1992 and serves as the “architect of the firm’s investing strategy.”
“The only thing I ever worried about was making money for clients. And I figured if we did that, everything else would follow suit. And it did,” said Anthony Guerrerio, the founder, Chairman and CEO of Wedgewood Partners. It was Guerrerio who set the tone of the company’s research to finding investments that would make the most money.
Below is a summary of Wedgewood’s investing strategy, as per the company’s website:
“Wedgewood's underlying equity investment philosophy is predicated on a strong belief that significant long-term wealth will be created by investing as 'owners' in companies. In our 'Invest as Business Owners' approach, we seek companies that the following characteristics: 1. A dominant product or service that is practically irreplaceable or lacks substitutes. 2. A sustainable and consistent level of growing revenues, earnings and dividends. 3. A high level of profitability, measured by return on equity without the use of excessive debt. 4. A strong management team that is shareholder oriented.”
Investing as business owners allows for a smaller number of stocks and a low portfolio turnover. Though the fund has typically stuck with around 20 stocks, it owns shares in 38 companies valued at a total of $1.13 billion as of the end of the third quarter of 2019. Both the variety of stocks owned and the turnover rate of 8% are higher than the fund’s historical numbers due to the increasing number of growth opportunities.
The fund’s top equity portfolio holdings are Apple Inc. (AAPL, Financial) at 9.89%, Edwards Lifesciences Corp. (EW, Financial) at 9.33%, Visa Inc. (V, Financial) at 8.72%, Facebook Inc. (FB, Financial) at 7.62% and Alphabet Inc. (GOOGL, Financial) at 7.03%. In terms of sector weighting, it is primarily invested in consumer cyclical (22.21%), technology (17.35%) and health care (16.24%).
While many investors see growth strategies as fundamentally different from value strategies when it comes to investing, Rolfe disagrees in the sense that a stock doesn’t have to be undervalued in order to provide value to shareholders. “’Value’ never dies. Never. Price is what you pay, value is what you get,” said the guru in a 2018 interview with GuruFocus, when asked if he agreed with the notion that value investing was dead. In other words, you don’t have to invest in undervalued securities in order to buy stocks that have “value.” The stocks that hold value are always changing, not just because of their business operations and fundamentals but also because of how Mr. Market values stocks with various characteristics in response to market conditions. “’Value’ in the 10th year of a historic bull market that is hooked on too many years of QE-zero interest rates? Good luck, and Godspeed,” he said in response a question about picking value stocks in health care. Fundamental value investing may not be dead forever, but the places where value can be found have shifted away for the time being.
Rolfe also prioritizes best-in-class businesses rather than investing in a large group of similar companies.
“Right out of the box, our focus to coin a phrase, no pun intended, is on those businesses that we think are best in class, that are uniquely competitively advantaged, that we believe at a minimum can double over the next three to five years. It’s not growth for growth’s sake, hyper growth, imprudent growth, risky balance sheet leverage growth. We’re looking for these terrific businesses, market share dominating leaders that don’t have to use financial leverage,” he said in a July 2019 interview with MOI Global.
Major market movers
“Visa is a marvel – an incredible cash-generating machine… We continue to expect Visa to benefit as electronic payments take share throughout the world,” reads Wedgewood’s 2017 letter to shareholders. From the time the fund first purchased shares in 2012, the stock has returned approximately 122.79%. With a wealth of markets around the world to expand to, Visa’s stock has certainly priced the potential in, but according to the Peter Lynch chart below, the market has been fairly consistent about valuing Visa at the top of its intrinsic value range.
Rolfe originally bought shares of aircraft giant Boeing in the first quarter of 2017, years before the drama with the 737 Max’s problems began and resulted in negative investor sentiment driving the price down. GuruFocus’ data estimates that the position has generated a cumulative return of around 93.65%. However, the 1,250-share position accounts for around 0.1% of the equity portfolio, meaning that the gain hasn’t had much of an impact overall.
Apple and Alphabet are well-known large-cap growth stocks, but Edwards Life Sciences isn’t quite as high on the popularity chart. This company develops technologies for the treatment and monitoring of structural heart disease, and it has returned around 69.40% since Wedgewood’s initial purchase of the stock in 2017. In the highly volatile health care industry, where R&D-focused stocks often remain in the red, Edwards has a three-year revenue growth rate of 15.5%. Perhaps just as importantly for a growth stock, the market loves it, driving it heavily into the overvalued range with a price-earnings ratio of 64.11% as of Jan. 10.
The Oracle of Omaha’s cash problem
One investment that Rolfe grew unhappy with was Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A)(BRK.B, Financial), which his fund initially bought shares of in 1998 and sold completely out of in the third quarter of 2019.
The main driver behind this move was Rolfe’s frustration with the cash pile that Berkshire has been amassing as it waits for a more attractive opportunity to show up. Shares of the conglomerate stagnated from the beginning of 2018 through the third quarter of 2019, and Rolfe sold out of Wedgewood’s $220 million in Berkshire B shares, disappointed with the lackluster growth when Buffett could have been putting the company’s $128 billion in cash to use.
“Thumb-sucking has not cut the Heinz mustard during the Great Bull Market of 2009-2019,” Rolfe wrote in Wedgewood’s third-quarter 2019 shareholder letter, referencing Buffett’s negative-return investment in The Kraft Heinz Co. (KHC). According to GuruFocus estimates, Buffett’s shares in the food company have declined a cumulative 59.11% since 2015.
As Rolfe pointed out in an interview with GuruFocus, growth strategies tend to outperform value strategies whenever bull markets charge into their later years. This was reflected even in the Oracle of Omaha’s case, with Berkshire Hathaway’s stock price gaining 11% for the year while the S&P 500 gained 29%. Although Buffett has been looking to put the cash to use and close another big acquisition, it has proven nearly impossible to deploy $128 billion with a value investing strategy in a bull market that has persisted for a decade, especially since he spent roughly that same amount of cash after the 2008 financial crisis, when value opportunities were everywhere.
Letters to shareholders
The Wedgewood Partners website publishes a newsletter every quarter that details the fund’s major movements and strategies, as well as observations and predictions about the financial market as a whole. It also reports how the fund has performed against the Russel 1000 Growth Index and the S&P 500 on a quarterly and yearly basis. The regularly updated fact sheet shows broader historical statistics.
The shareholder letters are written in a casual and open tone, with titles such as “The Fab Five” and “When The Punch Bowl Is Spiked With Debt.” The whole setup makes the letters a fun read, and the ideas in them are not inhibited by stilted, formal language or needlessly complicated vocabulary. The company commentaries provide valuable insight into the portfolio management team’s reasons for holding stocks, especially in the cases of stocks that they believe have a competitive advantage the market is failing to price in.
Bulls vs. bears
Averaging out the results of various online polls and analyst speculations across the web, approximately 56% of the general U.S. population expects to see a recession some time in 2020, while around 75% expect some sort of economic slowdown.
According to Wedgewood’s fourth-quarter 2019 letter to shareholders, Rolfe and the other portfolio managers are in the “soft landing” camp when it comes to recession outlook, holding an economic slowdown is likely but that it will be met with swift and effective action from the Fed.
“More than likely, at the first whiff of softer economic growth, we expect Powell & Co. to lend the Fed’s balance sheet to once again buttress any downside pain in the stock market.”
In support of this prediction, the shareholder letters cited historical data from NDR Research showing that Fed interest rate cuts almost always resulted in higher gains for the stock market, regardless of whether a recession was in progress or about to begin. In particular, rate cuts in a strong bull market that were not followed by a recession for more than a year showed the highest gains in the Dow Jones Industrial Average compared to other market configurations.
Although growth strategies tend to lose more during bear markets while value strategies take their turn to shine, Rolfe holds that a market correction in the near future will not result in a stock market downslide like the dotcom bubble or the subprime mortgage crisis that triggered the last two recessions.
To read more about David Rolfe (Trades, Portfolio)'s stock picks, be sure to check out his GuruFocus page here. You can also tab over to his current portfolio holdings, as well as his top growth holdings, profile performance, sector weightings and more.
Disclosure: Author owns no shares in any of the stocks mentioned.
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