Morningstar Advisor - April/May 2010 - 51

The types of companies they select are growing faster than the economy, but not unsustainably fast. That allows them to provide more-consistent performance.
Advisor David Copeland

buybacks, and acquisitions. Yet the stock is trading at near 12 times free cash flow,” Hartch says. “Wall Street expectations are quite low, but the company has very strong franchises and an effective management team. This is not a high-growth play, but given the valuation, it is quite compelling.”
Sustainable Leaders

meeting with Hartch and Keller. Zagrobski liked the fund’s low-turnover, tax-efficient strategy and the fact that it invests in a limited number of names that the managers know inside and out. “What impressed us is their depth of knowledge about the management and financial metrics of all their holdings. We had to cut them off after five or 10 minutes on each stock [in order to get to everything].”
Fact-Based Stock-Picking

measured against a market benchmark for sector weights, there was no need to maintain exposure. Credit concerns are still an issue, says Keller, but the fund recently bought its first bank stock since then, U.S. Bancorp USB. “USB was consistently profitable through the credit crisis, and they passed the government’s stress tests rather easily. Our capital is better protected in a bank where the credit underwriting culture is conservative and has been for many years.” Again, this is a bet on a particular bank, not banks in general. “People think that there is not much difference among commercial banks, but USB’s strong underwriting discipline has differentiated it, and it is primarily a deposit-funded institution, so money is coming in the door regularly at low cost. The stock was trading well below even conservative estimates of earnings, and we were pleased to bring it into the portfolio.” Johnson & Johnson JNJ, another fourth-quarter purchase, is in many ways a similar story. Hartch acknowledges concerns for the industry as a whole, in this case pricing pressure on U.S. health care. But Johnson & Johnson sets itself apart with strong consumer brands that are essentially unaffected by health-care reform issues. What’s more, its medicaldevices business promises to grow steadily, and its pharmaceuticals will be relatively less vulnerable to generic competition than competitors’ over the next few years. “The company’s free cash flow is greater than its net income and can be used for dividends,

Steady, single-digit growth is a common refrain here. That’s the theme that attracted David Copeland, a principal of Strategic Wealth Partners, in Deerfield, Ill. “The types of companies they select are growing faster than the economy, but not unsustainably fast. That allows them to provide more-consistent performance.” Several favorite picks dominate fragmented markets and so have room to grow simply by gaining market share. Dentsply XRAY, for example, produces light dental equipment and consumables. The dental industry promises significant long-term growth as developedmarkets populations age and emerging markets evolve higher standards of care, and Dentsply is well positioned to strengthen its lead. Despite a global recession, management increased investment R&D and its sales force in 2009, and the company gained a significant share of the implant market. Then there’s Ecolab ECL, “one of the best fits for our criteria,” Keller enthuses. “The growth opportunity is almost unbounded.” The company leads a highly fragmented market, selling cleaning and sanitizing products to hotels, restaurants, and food-sanitation and health-care companies. These are essential services, and an innovative leader can gain and retain customer loyalty. “Ecolab has the scale to reinvest in R&D and continue to innovate. Their products cause less color loss to hotel textiles, for example, and require less water for dishwashing,” and so can command a premium price. Other holdings are already entrenched leaders. Intuit INTU dominates small-business

Indeed, as Keller describes it, stock-picking at BBH is an exhaustive collaborative process. The managers and their team of seven analysts “will spend hours sitting in the same room trying to develop a shared conviction.” They check their own emotions against fact-based, written summaries developed for every investment before it is added to the portfolio. They add to positions in companies that continue to live up to their risk/reward profile when discounts to intrinsic value deepen, and they begin trimming when the price rises within 10% of that target. That deliberative process led to a decision to sell the fund’s bank stocks in 2006, one factor in the fund’s subsequent category-leading returns. Keller makes it sound so simple: “It was a credit-related decision.” The management team worried that credit concerns would affect even the best commercial banks— a weakness obvious to many only in hindsight. That said, the managers were not making a sector call against banks; they never make top-down calls. Rather, because they prefer to err on the conservative side when estimating earnings growth, the credit risks made these stocks uncompelling. As the fund isn’t

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Morningstar Advisor - April/May 2010

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