Welcome to Inside Active, a podcast about active managers that goes beyond sound bites and headlines, that looks steeper into their processes, challenges and philosophies and security selection. I'm David Cohne, i lead mutual fund and active Research at Bloomberg Intelligence. Today my cost is Gina Martin Adams, chief Equity strategist at Bloomberg Intelligence. Gina, thank you for joining me today as my co host.
Thank you for.
Having me and David.
So.
In your recent note US Equity Monthly Markets Signals, you talk about the rotation out of tech stocks and those stocks being among the worst performing as the rate cut trade persists. Can you tell our listeners what the rate cut trade is and what the sector rotation model is currently face.
Yeah, A great question. You know, I think that a lot of what we've seen in the equity market volatility can be attributed to a change in monetary policy prospects. Over the course of the last couple of months, it's become clear that the FED is likely to decrease interest rates, and that sparked some interest in some sectors that were otherwise dormants, some stocks that were otherwise dormant in the
s and P five hundred. So in addition to maybe some fundamental rotation, fundamentally driven rotation, you've got this kind of economic policy related factor that's driven interest in financials and utilities. Even real estate stocks are breaking out, with home builders really starting to rally here. So we're starting to see some rotation into other segments of the index.
I call that the rate cut trade. I think there are a few other things behind it, and I look forward to discussing that, among other things with our guests today.
Well, speaking of guests, I'd like to welcome Drew Shilling and Clark Shields from Wellington Management here. They do manage a part of the Vanguard US Growth Fund ticker BWUSX. Drew Clark, thank you for being here today.
Thanks very much for having us. It's great to be here.
Great to be here. David, thank you.
So i'd like to start off with asking, actually both of you, how you got your starts in the investment industry. So, actually, Drew, we'll start with you.
I actually was exposed to the markets from a very young age. My father was actually the first chief economist at Merrill Lynch back in the nineteen sixties. At the time the bond houses all had economists, but the stockhouses did not, and that changed and he was the first chief economist there. So I heard about markets and investing
around the dinner table from a very young age. And I started investing in individual stocks as a teenager, not in a huge way, but with my lawnmowing and house painting money, and and that definitely got me more and more interested about all of the research involved and the intrigue about figuring out an investment case for security. And following that through out of college, I was in the investment banking world as a m and a analyst, and
that continued my exposure to the markets. And after I graduated from business school, I came to Wellington Management and I'm in my thirtieth year here, So it started early and just developed over time.
Nice Clark, how about yourself?
Yeah, So I would.
Say in college I kind of found my way to the business school and started studying finance and really enjoyed it. And like most college kids who liked finance, I got convinced that I had to go work in investment banking and that was the end all of you all. So I did that for a couple of years, and I really enjoyed the people I work with, but I want
to be allocating capital. And so in May of two thousand, I moved to Boston and I joined an early stage venture capital firm, and it was literally within ten days of the NASDAC peak, you know, the Internet bubble peak. So my timing could have been a little bit better, but it was an amazing experience, you know that. You know, I saw the I saw the funding environment at that time where you had highly speculative businesses getting, you know, raising tons of money at very high valuations, and then
all of a sudden, it just collapsed really quickly. And I have memories of going to office buildings with entrepreneurs we had invested in with and you know, literally shutting the buildings down and turning the lights off.
And so I kind of saw that speculative activity and collapse.
But at the same time, we had also invested in a small company in a suburb of Boston called Curing, the Coffee Company, and they only had.
Thirty million dollars in revenues.
They only sold coffee machines into the office space, and when I was affiliated with that company, they transitioned in the consumer space and started selling coffee machines in the consumer and that company absolutely took off and was ultimately sold for like fourteen billion dollars. And you know, Karig had a great management team. They were attacking a really big addressable market. They had competitive advantage because they had a lot of patents around the technology that they own.
And so I think back then that actually started to initially shape how I thought about growth investing, being able to look at the specultive stuff that never got anywhere and blew up versus a qureig that ended up being worth fourteen billion dollars.
So I did that for about four years.
I went to graduate school, and then I joined t ROW for about a decade in Central Research down in Baltimore, and now I've been at Wellington for about ten.
Years working with Drew here on a growth team.
Well, it's funny you mentioned two thousand. That's actually I started my career in late two thousand, right when everything started going kind of crazy towards the end. So's you mentioned that, But I do want to mention for our listeners. Vanguard's active equity mutual funds are managed through external subadvisors, usually with multiple managers and I mean that's the case with the Vanguard US Growth Fund. So can you tell us what your investment process is for your slice of the fund.
Sure, So I'll start, and then you know Drew can obviously jump in.
I'd say the first thing we're looking for is secular growth, right, so we're looking for high levels of compounding. We want companies that are benefiting from tailwinds. Conversely, we think it's really hard to generate alpha in companies where they're structural headwinds. So that could be a physical retailer losing share to Amazon, or it could be traditional TV losing share to streaming. The second thing we look for, and perhaps this is
the most important, is structural competitive advantages. So we want to invest in companies where they're doing something that's really hard for others to replicate. So if you think about putting those first two things together, the secular growth and competitive advantage, that's what enables high levels of earnings and free cash flow compounding over intermediate timeframes.
Third, you know, we.
Have this idea in our team that we refer to as timeframe arbitrage. And this idea speaks to market inefficiency, and I also think it speaks to our team having a longer time horizon than most market participants. So with timeframe arbitrage, we're looking for some sort of short term noise for security or in the market, and that could be a soft quarter, it could be an industry being
out of favor. Maybe there's some sort of cyclical soft patch, and we want to go in and buy these really exceptional companies when you have that dislocation.
A couple of examples off the top of my head.
So in the spring of two thousand, at the start of COVID, everybody was moving into safe havens, and we owned American Tower, right, and American Tower was going up every day.
Is more and more money crowded in there.
But the other end of the spectrum, you had AMX, and nobody want to own AMX right. It's travel oriented, it's credit. Who knows what's going to happen to the consumer, and so we were trimming America Tower at that point in time and buying as Another example would be the
fourth quarter twenty twenty two. It's hard to believe, but nobody wanted to touch semiconductors in the fourth quarter of twenty twenty two, numbers had come down, the stocks had underperformed, and so we were looking at that space, We're like, all right, this is a good time to go overweight Semis. We went overweight in Vidia, then we went overweight ASML at that point in time. And then the final thing I'll mention before turning over Drew is we really believe
in portfolio balance. So I think a lot of the growth portfolios are structured in a way that they have very pronounced bets in certain areas and really a lack of risk controls and diversifications.
So, for example, you.
Could have a thirty or the security portfolio where it's almost all high beta internet and high beta software, and that can be great in twenty twenty, and that can be great in nineteen ninety nine, but then when things turn the other way.
You can have really severe underperformance. And so we pay a lot.
Of attention to risk controls and diversification and balance, and we don't want to have that extreme up and down ride that you can find with a lot of other growth portfolios, Drew, what else would you like to.
Yeah, just adding to Clark's last point, one of the evergreen realities in the investment world is that it is still very much human nature is still very much at play in terms of how the market moves, certainly in the medium shortened medium term, and we do have these cycles that go cycle from greed to despair and back to greed again, and that happens on individual stocks, and it happens on the market itself, especially when you have oft economics coming up and you have strong economies ahead
of you. And so we really think about how that impacts investors. And you get the same with individual performance of individual mutual funds. And when an investor sees a mutual fund that knocks the ball out out of the park, they're very happy. But if that's a highly volatile approach and it's just as likely to have a mirror image
period of underperformance. Human nature is such that they could do the wrong thing at the wrong time, which is to sell your mutual fund and move on to someone else's when in fact that might be the exact time when you should be buying it. And this human nature destroys value over time, and it means that most investors don't actually enjoy the long term return stream of the equity markets. And so we think very carefully about that when we think about balance in what we are delivering
to our clients and particularly to Vanguard. We don't want to get too far away from from from you know, that pure growth investing, thinking about what the characteristics of the benchmark are, and then we're going to find, you know, great companies that that we hope, over time outperform that benchmark. But we don't want our clients to experience extreme volatility.
Great, thank you. Can we dig in a little bit more on a couple of a couple of those points in terms of your process, I'm just curious how you define and identify secular growth. So what are you doing specifically to identify those companies that do have those long term secular growth prospects? And then also following on the other point that you make about seeking companies with competitive advantage? What are some metrics or identifiers of companies with competitive advantage?
How are you finding those companies? How do you identify competitive advantage specifically?
Yeah, so.
I'll take a crack at that, and then Drew can obviously jump in, and so we do. We're bottoms up, okay, and so we're looking for great businesses feeding off of secular growth, and we find them in lots of different places. And we recently did an exercise where we looked at the entire portfolio and we said, how many different primary secular growth drivers do we have across the portfolio And the number was actually like twenty seven, So there's a lot in there. So for example, we own a company
called Copart. It's an auto auction business. It's an amazing business, very high market share, they're very dominant. They feed off of more technology being added into cars. Right, every year a car is more and more like a computer with more and more semiconductor content, and so that's what they feed off of. That said, when we look at the portfolio from a high level and we say, like, what
are big recurring themes? Right, so that you know semi content and autos isn't a big recurring theme, what are some big recurring themes? You know, you would have things like obviously e commerce, you would have online advertising, increased usage of data, adoption of software, shifting software workloads to the cloud, innovation and semiconductors, healthcare innovation and you know those last two we could talk about gen ai and GLP ones in terms for the second point for competitive advantage,
there's actually eight different things we're looking for. So if you're to study, for example, at Harvard Business School with Porter, you would say, well, there's these two things that you want to look for. You want to look for some sort of differentiation or you want to be a low cost provider. And we actually have kind of a more detailed list of things that we're looking for based on our experience. And so one is really unique intellectual property
that other people do not own. That would be one. Another big one that shows up as network effects, right, or it can be high switching costs, barriers to scale.
We probably don't like brand quite as much, especially in this area era when people can create brands more easily with the Internet and social media, and low cost advantage may actually be our least favorite because in a lot of ways, I think that's saying that if there's a nuclear winter in your industry, you survive, which is really doesn't really matter how we want to invest, and you will.
I think you will.
Find over time that companies that have, you know, that sort of competitive advantage to your question about metrics, A lot of times those are very profitable businesses with high returns on capital that sustain themselves over time. And so if you can identify those financial characteristics.
You then can kind of do like a deeper.
Business model, almost qualitative assessment on the competitive advantage pieces.
True, all this work is really informed by our very broad and deep research engine at Wellington. So we have almost sixty dedicated global industry analysts in our central research pool and they are responsible for covering sectors in tremendous depth.
These are career positions. These are folks that do this in depth research on a narrow group of companies their whole careers, and so having that fundamental engine behind is what helps us identify not only identify the areas of secular growth, but also helping us as we go through
our wide mote analysis. We have over four hundred investors at Wellington, so not just our gias, our central research, but our growth team and our dedicated growth analysts and all the other portfolio teams around Wellington, so we develop a very wide mosaic of information where we have a
very collaborative culture. It's a it's a very important part of our approach to things and and the reason we value that so highly is that when you have all these people out turning over rocks literally around the world, you need a way for that information to be shared and integrated, and by having a highly collaborative culture, that is the best way to do that. And so we bring all of this work together to help us with these insights.
And determinations that your bottom up. You have a lot of analysts sort of powering some of the ideas, collaborating with the analyst community. How do you collaborate with the macro researchers. How do you integrate any kind of macro consideration in a predominantly bottom up process.
Yeah, so I would say, you know, there's there's a huge amount of resources Wellington. So there's market strategists, there's macro people, there's risk people, there's different teams. Some teams are investing just in emerging markets, fixed income alternatives. And so I think that kind of speaks to a broader question of how do you interact with everybody? Right, because you know there are a lot of people here and you don't want people siloed. And I think we have
a lot of channels to encourage communication. And then we have a culture that places an extreme value on collaboration. So we have had since the firm's founding, a morning meeting, a morning investment meeting every single day on a global basis where people come in and share ideas, and that's all investors, and that starts conversations and may not give you an answer, but it starts conversations. And yesterday a material piece of that conversation was on US employment trends
and the macro economy. So we have all sorts of people participating in those meetings. We also have obviously broad email distribution lists for investment emails. Some of those are specific to a sector, healthcare or tech, others are more general. And then we have other meetings that can be specific
to some sort of theme or idea. It could be, hey, come to a lunch because we have a macro meeting today, or it could be the financial services team is sharing best ideas, and so we have to have all these different channels. So I feel like we have access to that information and Drew can obviously out of this. But I also say in terms of macro, I would describe us as macro aware, like we need to know what's going on. If we're becoming more negative on the consumer,
it might make sense to take down travel names for example. Right, But going back to this idea of balance. We don't want an extreme bet in the portfolio. It's extremely unlikely that we would ever say there's going to be a recession. Let's take our beta way down, let's park all the capital and staples and reads and utilities.
Because if we get that wrong, we're going to get creamed. Right.
And so we're macro aware and we'll shift a little bit based on that information. But again, really from a portfolio construction standpoint, the thing we really value is this idea of balance.
Yeah, I think macro informs the background under which the individual companies we're looking at operate. So to Clark's point, if the consumer is healthy and the macro factors appeared that the consumer will continue to be healthy, then that informs how we're investing in the consumer sector. But what we don't do is make big, a lot of big decisions in the portfolio and the position and the portfolio
based on big macro factors. So people have tried their whole careers forecasting big macro factors like interest rates and the direction of the price of oil and natural gas, and and it's very very difficult to do with any consistency, and so that is not uh, that is not a
big part of what we do. And and the reality is if you look at most years, most years that any one of the companies, the publicly traded company we're going to invest in most years is a moderately positive growth economy, right, you have, you have, you have recessions, you know, every so often, but it's a minority of the environment you're operating in. So that's kind of your starting point is moderate economic growth and can we find
companies that can really thrive in moderate economic growth? And then obviously, when there are ways to lean in to areas of the macro forecast that we can feel comfortable with, we can lean but we're not going to try to make the portfolio act in a certain way based on a large macro forecast.
Very fair, And if we were to sort of tie this back into the conversation that we started with, where it feels to me like we're at this pretty big change moment with respect to monetary policy where we're going to have suddenly interest rates are falling. Would you ever have a macro consideration like that where interest rates are
potentially now going to reverse direction? Does that ever spark idea generation for new ideas to potentially add to the portfolio new industries that might benefit from a macro shift like that. Do you ever think that way or is it a much more methodical process than I'm kind of assuming or alluding to.
Well, I would say, we go ahead. Well, I was going to say, we'll certainly think that way. So, for example, we have this pool of exceptional companies that we've identified that makes sense for our portfolio, and different people on the team are responsible for their different pieces of the pool,
if you will. And so if it's obvious that interest rates are going to go down, you know, one thing we could do is we could say, you know, we own a couple super high quality reads, should we buy another one?
Right?
So, for for sure, we're willing to do things like that and to tilt. And so I think you know, the way we kind of just describe it is will kind of shift in this direction a little bit, or shift in that direction a little bit, which is separate obviously than making some very big bet across the portfolio where if you get it wrong you're in a lot of trouble.
Yeah, I mean, you know the the right now the course of interest rates, you know, really is depends on mostly inflation and the growth of the economy, and the two were very closely like. So again, trying to forecast inflation tough to do with any with any accuracy and consistency.
But you do have a very long track record of the Fed, you know, generally winning out in terms of doing what they're trying to do, and they have made it very clear they're trying to squash inflation, and and so it does you know, the the likely path here is that inflation, as we've seen, has gotten under control more so than it was a year or two ago,
and it's possible it could go lower. I think at this point it's it's not entirely clear, so you know, what is going to be the ongoing level of interest of inflation and thus interest rates hard to know exactly. But when the when the Fed got on this interest rate cutting path that they got on, it was pretty clear they were going to be on that path for some period of time. Now it's a little less clear, so you know, I think obviously easing on the short side,
but what does that mean for the longside. The longsidees come down so much relative to where it was now, not relative to the last five years, but relative the last thirty years, So those are you know, I think we're in a period now where, yeah, short term rates I think people think are definitely going to come down. That's probably priced in the market.
H Clark. You had mentioned earlier about buying semiconductor stocks when they were out of favor, and so I'm curious how you think about valuations. You know, do you kind of look at you know, it's a growth portfolio, so I'm assuming you're not looking at deep discounted companies, but is it more of kind of like reasonable valuations or you know, what would you consider?
Yeah, so I would say, given how we're investing, we definitely think for most of the companies, we have to be thinking out longer term, and we have to be thinking in terms of a range of outcomes, Okay, And so what we're generally doing is we're taking the companies that we're investing in and we're building a ten year DCF model and going out, you know, saying, well, here's how many subscribers Netflix is going to have in twenty thirty three, and here's the average fee per user, and
here's how much they're gonna spend on content, and this
is what margins will look like that. And then we'll take that base case scenario, bring it back to a president and they'll say, well, could be even better than that, or it could be worse than that, right, And so then we have this kind of view evaluation based on those different scenarios, and then we can see, you know, relative to where securities are trading, what looks underpriced or overpriced, And you do get into periods of time the past
few years, you've certainly gotten into periods of time where I feel like there were almost you know, fat pitches based on the style of company you want to invest in. So if you go to the summer of twenty twenty one,
like nobody wanted anything even remotely boring. It's like, hey, these these soft these mid cap software companies at forty times revenue, Maybe they'll go to fifty time revenue, right, fifty times revenue, And so then you could look in that environment, you can say, well, these compounding stocks, which could maybe be more like an O'Reilly or Connections or a Progressive some other names that we own, their lower
beta look great. Then twenty twenty two, when we started taking up the semis, it was the exact opposite off twenty twenty two, the market was in a massive risk off mode. We want to own defense, we want to own staples, we want to own energy, and we don't want any of the growthy stuff. And so then we
were sitting there in twenty twenty two. We could look at this the pool of securities again, and the higher growth names, including SEMIS, think about that ten year view, use timeframe arbitrage, you know, as the way to describe it and initiate those positions when they were out of favor and when we thought we had a really fat pitch.
So I'd say that's generally how we do it.
You know, sometimes with some slower growth companies we'll look at pe multiples, like probably doesn't make a lot of sense to build a ten year in DCF for TJX for examples, Maybe a little bit of overkill.
But for the higher growth names, that's generally what we're doing.
And are you ever using multiples or valuations or your time for arbitrage in the reverse direction so multiples get too high, we see valuations as too extreme. Are you shaving positions on the same methodology or do you employ a different sort of perspective for when to get out or when to shave some of your positions.
Yeah, I mean, I would say time frame arbitrage does need to go both ways. You know, the example of trimming American Tower when COVID first started, right and then the end of twenty twenty two, anything that was a safe haven was probably extremely expensive.
And so yeah, I would say, you know, if we have a.
Security, we like, a company we like, we've known it and owned it for a long time, and it looks very expensive, that is certainly an instance where we are likely to trim it but not eliminate it.
Yeah, we really are. We're really trimming stocks based or eliminating stocks based on two things. Either the fundamental case that we had laid out when we purchased it is not working out. You know, we made a mistake, the fundamentals have developed in a different way. That would be one of the reasons. And the other reason is that the valuation is no longer compelling, and we have other
opportunities that we we think have more upside. And so those are really the two things at play when we're you know, when we're adding and trimming.
So I want to kind of move over to more of a qualitative question, you know, you're talking about, you know, the different numbers you look at for companies, but what do you look for in management teams of companies?
Yeah, yeah, I'll take I'll take a stab and then Drew can add on there. You know, I remember early in my career there was someone I worked with and he had just said this really long list, like there're a literal checklist on like, here's.
All the things that I'm looking for, Like, that's a long list.
It was like, what can that be consolidated down to a couple of key ideas? And so for me, there's two key ideas and what is you know, how talented do you think the management team is?
Sony?
Any assets going to have some sort of inherent trajectory, right, And so then the question is will this management team inflect that trajectory trajectory higher or could they actually take it a lot lower through really bad decisions? So I think that's one really important question. And then you can say,
all right, well how do you think about that? And quite frankly, some of it is just spending time with a management team and getting a sense in your gut, you know, how do they talk about strategy, how do they talk about the business, what's kind of their vision, what's their track record of execution, is their depth on the team, things of that nature.
Do they outcate capital well?
And then to me, the second question is, you know, do we trust them with massive information in asymmetries? So going back earlier to when I worked in BC, there were no information these symmetries, right, the company gave you whatever you wanted. When you're dealing with public companies, there very selectively deciding what to give you and what not to give you, right, And there's gonna be information that they're not going to share with you, and so then
there's this element of trust. And again that comes back to kind of gut instincts. But the other thing I'd say is, I think that's why it can be very encouraging to see management teams that own a lot of stock, because then you have aligned interests and it's easier to trust them. And then also i'd say another thing that we look at there is corporate governance behaviors and are they reflective of really kind of ethical, thoughtful behavior that's
shareholder appropriate. So those are kind of like two big categories. I mean, drew other stuff that you want to add on.
Yeah. I mean, I'd just.
Add to that, you know, do they have a value creating mentality? And I'll contrast that to a mentality of a CEO or a management team that's enthralled with the trappings of the job and all the perquisites that go with it. But if they have a value creating mentality, then you have that shareholder alignment, you know, an empire builder versus somebody who runs the business relative to creating good and growing returns. So that's very important. What what
is management focused on? And what are they incentivized to do by the board's incentive structure. So we spend a lot of time looking at those the incentive structure. What
is it that we're paying management to do? Because most people do what they're paid paid to do, and and so you know, one of the things that we do we have a we have a very substantial ESG effort here and an entire uh separate group of research analysts who focus on the ESG factors for for you know, the companies that we invest in, and we dig through those filings and make sure we fully understand exactly how these managements are our incentivized and we in many cases
work with the companies and we reflect information, we reflect opinions back to the boards, and you know, we're on the phone with with lead independent directors, chairman's of the board if they're not the CEO, and expressing our views if we see room for improvement, and that can be a really important part of driving the behavior and thus or returns on and when you're talking about an individual company. The other one other thing that I really love is
management that really knows the numbers cold. They know every number, they know every detail, and it's amazing the range that you get when you talk to managements your whole life. Like Clark and I do. You know, some managers are a little more up in the clouds and they delegate a lot to their people. But remember when you're making big strategic decisions, you know, every day, every week, every month, really understanding the nuts and the bolts of the business,
I think likely leads to better decisions. So I love to see that.
I do want to ask also about risk and how you manage risk for the portfolio, especially during times when growth is out of favor.
Yeah, so risk is a huge part of what we do. It's part of our daily workflow. So you know, if we think about our team compared to other growth teams that I know in the industry, you know, I think our focus on competitive advantage is very differentiated. I think a lot of growth investors are looking for just some great story where there's high projections on the cell side.
But if you don't have a moat around that business, that's going to collapse, right like a peloton at the end of the day, Peloton makes stationary bikes, right, And so that's one thing differentiate differentiates us. But also folio balance is another thing that I think really differentiates us.
And kind of the key tool.
There are risk tools, and so we have tools on our desktop where every day we can be looking at high level metrics. So it could be what's the tracking risk, how does it compare it to the past, how do you break down that tracking error between different pieces, what's your predicted beta? But then we can also use this
desktop tool to go deeper. We can say how much risk is coming from a sector or industry, how much risk is coming from a security how much risk is coming from the mag seven as a bucket, because they're very big in our benchmark.
So we have those tools there every single day.
We also have a quarterly formal risk review with our risk team, and our entire team participates in that, and so we'll look at all sorts of metrics. But another thing we do is we run forty to forty five stress tests across the portfolio. So a stress test could be interest rates go way up or way down, a massive smid cap rally, value rally. You can replicate something like what happened after nine to eleven, things of that nature.
And we look across those stress tests and try to find instances where we would have a more extreme reaction to that environment than what we want.
So we're using these tools all the time.
And I will come back to the MAG seven a little bit, because you know that's probably where we.
Use the risk tools the most.
If you are naked or if you have a halfway in a MAG seven stock, that can actually start to end up being twenty thirty percent of the risk in the portfolio right because of how our benchmark is constructed. So we watch those very closely. The one we probably watch the most closely is Tesla. So our risk team says they have never seen a company with that market cap behave like a smidcap biotech. It literally has the behavior patterns of a MidCap biotech. So we watched that
really closely. The second part of your question, I you know, I'll let Drew jump in here. I apologize for the long way to the answer, but you know, in terms of like when growth out of favor, we would certainly use risk tools then, but I think we're at that point we're almost more looking at our opportunity set, kind of like the end of twenty twenty two, where it's more like, hey, ASML is amazing, and video is amazing,
Netflix is amazing. I'm just throwing somebody out there and they look really really cheap now because they're out of favor, let's take those up, and it's probably a little bit less of a risk tool exercise.
Drew, Yeah, I mean, I think it's important to remember that we're, you know, we're growth investors, and so growth is out of favor. We try not to have a huge tilt in the portfolio, either growth or value relative to the growth index. So the exercise is really just identifying the best wide mode growth companies that we can
find given the market environment we're operating in. So if growth is out of favor, it depends how growth is out of favor, but it can often mean that some of the moderately high growth, really high quality companies looked particularly attractive, and we would use that opportunity to add to those in the portfolio, and the sources of funds would likely be the stocks that have lower growth, more value oriented characteristics. So this goes back to the This
goes back to the twenty twenty with COVID. You know, anything that was that that that smelled of safety to the market got bit up to very high valuations. While everything that had economic sensitivity, you know, particularly anything related to travel or you know, anything where you know, staying at home and not spending outside the home was going to restaurants, you know, that was that got hurt. And we weeded through all that and just you know, that
was a safety market. Probably more value are in market. That unearthed tremendous opportunities for us to kind of reload the portfolio for the end of twenty and into twenty one, which was a very successful period for us.
Okay, well, I just have one more question actually for both of you, what do you consider the most overrated investment metric just in investing in general.
I'll jump in on that. I think PE is very overrated. And the first reason that PE is very overrated is the earnings are are accounting earnings in the PE ratio, they are not cash flow generation. And we believe that value you creation is how much cash do you produce now. You may not produce it this year, it may be next year. But that's why we use this DCF mentality to capture a growing business that may be investing now, but later on they're harvesting the cash. But we can
model that out. Is it a cash generative business or is it not. I'll give you an example. Airlines over time have appeared to have very low pees. But when you look at the free cash flow generation, the free cash flow generation is very low, and so the earnings quality. You hear people talking about earnings quality, the earnings quality is low the way we look at it because those business models require so much investment upfront, and you have to ask yourself do they actually get a good return
on that investment. And I would suggest to you the reason that airlines typically have very low PES is one they are closer to commodities than a lot of businesses, so very competitive and to the returns on a cash flow basis over time have been have been not high. And so I think when we are investing companies, we are looking at the free cash flow generation of the business, not the accounting earnings. Accounting earnings can be very much manipulated.
It has to do with all kinds of assumptions. What are your depreciation assumptions, what are your accrual assumptions. And if you go back to WorldCom and Enron, both of those situations were predictable if you focused on the cash flow and not on the accounting earnings that they were generating.
Clark, Yeah, I'll share like a more slightly different answer where it's maybe a little bit more nuanced, And it's just this idea that I think you need to be using tools that make sense relative to the task at hand.
And I had a.
Graduate school professor and he's like, there's this class on using a DCF, and he's like, you gotta be really careful because once you give a baby a hammer, everywhere he looks, he sees a nail, right, And it's like a DCF can work great in certain instances. A PE multiple is fine in other instances. EV even does, and but you don't want to just have this one thing
where you just slap it on everything. And I think you really kind of want to view yourself more as a carpenter, right, And you've got a tool, a bunch of tools on your toolkit, and sometimes you want a sledgehammer to knock a wall down.
Maybe that's ev to sales, and.
Other times maybe you need to do some really nice detail work and be a bit more precise, which could be like a really thought out DCF model. And so I don't I'm not sure there's like tools or metrics where I'm like, well, this is just universally bad. But I do think investors need to have kind of like situational awareness and make sure the tool they're pulling out of the toolkit is appropriate relative to the task.
Well, makes sense, Clark, Drew, thank you so much for joining us today.
Thank you for having us, thanks for having us.
Enjoyed it, Gina, thank you for being my co host once again.
Thank you, David, and it was really great to meet both of you. Thanks for joining us.
Until next week. This is David Cone with Inside Act