There’s a certain Hollywood mystique around the image of the rogue investor with the fortitude to diverge from the crowd on the quest for The Next Great Investment. The un-glamorous truth, of course, is that unearthing hidden opportunities actually takes equal parts elbow grease and know-how. Par Rostom, portfolio manager and vice president of Franklin Equity Group®, is that
roll-up-the-sleeves kind of guy. He’s not looking to invest in companies just because they are household names with splashy advertising campaigns. The companies he hunts for are the ones he feels are “best in class” in their particular niche, but that you’ve probably never heard of. Surprisingly, he’s finding some of them in the eurozone, a place the crowd is largely avoiding today. Here’s a summary of his approach, in his words:
- We’re looking for companies that grow sustainably in terms of free cash flow over time.
- We look at the returns profile for a company historically, and we project that out three to five years.
- We also make sure that we would view the corporate governance as best in class.
- A concentrated portfolio allows our analysts to focus…it allows us to take advantage of transient dislocations.
Kind of like the “four C’s” used to judge diamond quality, Rostom judges the quality of companies by the “four C’s” of cash flow, company metrics, corporate governance and concentration.
Cash Flow. “We are looking for companies that grow sustainably in terms of free cash flow over time, companies that have a track record of reinvesting the free cash flow they generate into the business, organically or otherwise, in doing acquisitions. We go back in the history of the company to make sure that we appreciate that the drivers of free cash flow are sustainable.”
Company Metrics. “We also try to make sure that these are indeed quality companies. We look at the return profile for the companies historically and we project that profile looking out three to five years. We look at metrics such as return on equity (ROE) and return on invested capital (ROIC).”
Corporate Governance. “Additionally, we verify that we would view the corporate governance as best in class. Once these metrics—in terms of free cash flow, in terms of returns are met—that’s when we would be interested in investing in the companies.”
Concentration. “A concentrated portfolio allows our analysts to focus. Each analyst covers five to 10 names, so they are intimately familiar with the growth trajectory; the material issues that have impacted the companies or will impact the companies looking out. That allows us to be nimble. If the market decides to focus on issues that are transient to the company or not material for the long-term, that allows us the potential to take advantage of that. So, we have this contrarian rebalancing strategy. If a stock pulls back, we would generally be looking to add to the stock. And, conversely, if the markets decide to be euphoric and overly reward a company, we would most likely look to trim the name. So, in-depth coverage of the concentrated portfolio allows us to take advantage of these transient dislocations.”
So, what does Rostom see as possible gems right now? And where in the global markets is he finding them? Rostom’s focus is mainly on the northern part of Europe, which he believes is more insulated from problems plaguing other areas. And he’s been mining Asia and Latin America for stocks that meet his criteria, too.
“Just to give you an example, we own what we feel is a leader in healthcare equipment in Sweden. We also own a German manufacturer which has half of its revenues derived from emerging markets. In Latin America, we own a company in the e-commerce space. So far, many of these companies have been, to a degree, insulated from the downdraft that’s happening in the European periphery.
We are looking out three to five years and we have active engagement between the analysts covering the names, the management of the company, and the supply chain that the companies are in. So we are intimately familiar with how the bottom-up picture is panning out for these companies and we remain optimistic on their growth potential.”
Following this insight into Rostom’s contrarian views, we’d be remiss if we didn’t mention Sir John Templeton’s choice words about following the crowd. “Avoid the popular. When any method for selecting stocks becomes popular, then switch to unpopular methods.”