AMI Asset Management generates investment ideas from a variety of sources. The team uses screens, but the screens are intentionally left broad, and are primarily used to weed out industries where the team will not invest because of the lack of recurring revenue, such as automobiles or farm equipment, or to exclude high P/E momentum names and low P/E value names. Quantitative screens cannot determine a company’s level of recurring revenue, so the main objective of utilizing these tools is to narrow the universe to 100-300 names prior to starting the due diligence process. Securities outside of the benchmark that possess all of the traits the portfolio team desires can be included in the portfolio. Beyond uncovering names through screens, AMI also uncovers ideas through a deep knowledge of recurring revenue industries (Healthcare & Staples), conversations with company management and industry experts (e.g. doctors), and through “feet on the street” research (walking grocery store aisles for example).
Once a candidate is identified, it is subjected to a rigorous due diligence process that examines its product portfolio, industry and competitive dynamics, and fundamental metrics, among other factors. AMI places a heavy emphasis on valuation. The team believes that quality, growing companies can be bought at a discount to their intrinsic value, generating alpha over the long run. The research team determines a firm's intrinsic value through a combination of discounted free cash flow valuation and earnings multiple analyses. AMI develops a discounted cash flow model to obtain a starting point value. AMI utilizes a discounted cash flow model to obtain an initial intrinsic value and then compares this to historical and peer P/E and PEG ratios. The research team views securities with at least a 10% discount as a candidate for the portfolio. AMI prefers sustainable EPS growth of 10%+ for the large cap portfolio and 12%+ for the small cap and SMID cap portfolios, recognizing that some higher growth investments may be passed up. It is the team’s opinion that high growth companies with accordingly high multiples do not make good investments over the long term and thus the firm prefers to leave these securities for more short term focused momentum managers. It is the firm’s belief that mispricing often happens because the street under or overestimates the company’s growth rate or risk, or investor emotional factors can cause a stock to be overly loved or hated. Valuation work is completed internally.
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Asset allocation for the large cap growth strategy is determined by Bill Tanner and Chris Sessing, who follow a bottom-up approach. Mr. Sessing is responsible for the portfolio construction decisions for both the small cap growth and SMID cap growth strategies. Given AMI’s focus on companies with recurring revenue business models and this bottom-up approach, portfolios are typically overweight Consumer Staples and Healthcare, and underweight more cyclical areas such as Consumer Discretionary and Materials. Sector weights usually remain in a tight range, but will fluctuate somewhat based on the quantity of attractive investments.
Due to the focus on recurring revenue, Healthcare and Consumer Staples have each historically been overweight in the portfolio as recurring revenue companies are more commonly found in these areas. AMI does not invest in foreign securities but will invest in foreign companies, provided they are listed on a U.S. exchange. The team does not seek to specifically minimize taxes; however, the expected portfolio turnover (25%-35% in large cap growth and 40%-50% in small cap growth and SMID cap growth) makes the strategies naturally tax-efficient. AMI attempts to stay fully invested at all times, with cash typically ranging from 1-3%. The team views cash as a byproduct of the portfolio management process, and the firm does not use it as a tactical tool. All three portfolios target 30-35 names. This has been consistent since each strategy’s inception. A typical initial position will be 2-3% and the team will average into larger positions over time. Derivatives are never used.
AMI Asset Management believes that the focus on recurring revenue is the primary risk control, given that these companies have less earnings volatility, and thus tend to contain inherent downside protection. However, AMI has also put into place additional risk controls to avoid too much exposure to market sectors or position allocations.
Sell decisions are most often triggered by deteriorating fundamentals and generally result in a sale of the entire position. These deteriorations can include factors such as worsening industry or regulatory conditions, weakening competitive positions, structural margin changes, and balance sheet erosion, among many other factors. AMI will allow “winners” to appreciate but typically begin to trim holdings when they exceed 10% of the team’s estimate of intrinsic value. The team will continue to hold smaller positions in securities that have been trimmed for valuation purposes if the growth story and fundamentals remain intact. Sell decisions are also triggered by sector or security weight limitations or if a higher conviction name reaches a valuation level that becomes more attractive. Given that the intrinsic value of a successfully growing company will continuously rise, AMI does not sell holdings when they reach a pre-determined price target or time horizon. Names will be sold out of the small cap growth portfolio once they consistently trade at a market capitalization above $5 billion and they will be sold out of the SMID cap growth strategy as they approach $12 billion.