A Core Leaders Portfolio Q & A
November 2022
Davenport Asset Management’s Core Leaders Portfolio, launched in 1984, was our first managed money strategy. Modeled after our very own profit sharing plan, the portfolio was built on the notion of investing alongside our clients. Core invests in high-quality large cap companies that can deliver competitive and durable returns for investors. We recently sat down with Investment Policy Committee Chair, George Smith, to discuss the Core Portfolio’s mission.
Q: What is the overall objective of the Core Leaders Portfolio?
A: Put simply, we seek to generate competitive returns by owning a collection of the world’s most established, dominant and durable companies. These are generally large companies that have wide competitive moats and a proven ability to create shareholder value.
Q: You just used the term “moat”. Can you elaborate on that concept?
A: Sure, by moat we mean a durable competitive advantage that insulates a company from threats and allows it to sustainably generate profits. A strong moat can yield beautiful things such as pricing power, commanding market share and elevated returns on capital. Even the strongest of companies can fall victim to disruption from new technologies or products, so we are always monitoring these moats for competitive threats. Ultimately, we want companies that can stand the test of time.
Q: How important is a company’s balance sheet in your analysis?
A: Extremely important. A great company can run into trouble if it takes on too much debt. We want companies with manageable debt levels and strong credit ratings. Such entities typically have ready access to capital and rarely find themselves in a pickle when economic conditions worsen. In fact, a solid balance sheet can allow a company to take advantage of distressed conditions and emerge stronger on the other side.
Q: I assume this requires faith in the company’s management team?
A: You got it. This falls under the broader umbrella of capital stewardship, which involves not only balance sheet management, but also investment opportunities and the use of free cash flow in general. We want talented management teams with a history of investing wisely or returning capital to shareholders when the time is right. Shrewd capital allocation tends to be the single biggest driver of shareholder returns over time.
Q: How do you think about how much to pay for a company’s stock?
A: Valuing a company’s stock can be more of an art than a science. However, we generally hope to get a fair deal. We take into consideration a company’s price relative to its cash flow, the broader market, its peers, and the company’s own history. In the end, we are hoping to be opportunistic and get a fair deal for what we are buying.
Q: How do you think about a company’s growth rate when making this decision?
A: We certainly consider any company’s valuation in the context of its growth rate. We are looking for companies that have growth tailwinds and a favorable earnings trajectory versus the broader market. Provided we don’t overpay for a company, above average earnings growth should yield above average returns. That said, great companies can become overvalued and generate below average returns if bought at the wrong time. We are more than willing to pay a fair price for a fantastic business, but will typically avoid momentum situations with frothy valuations.
Q: I assume this is an important element of risk management?
A: Absolutely. Avoiding high flyers can make you feel like you’re missing out on a party sometimes. However, valuation discipline can help protect against downside risks. This discipline, our focus on quality and our emphasis on stout balance sheets should allow us to demonstrate less risk than the broader market over a long time horizon.
Q: Great. Any parting thoughts?
A: All told, we are looking to generate competitive returns with manageable risk. Our investors should take comfort in the fact they own some of the highest quality and most venerable franchises in the world. These companies have generally seen it all, including recessions, and have proven an ability to both survive and continue building value for stakeholders. We think this portfolio can provide a high quality component to an investor’s overall asset allocation.
Important Disclosures:
Any opinions expressed here are statements of judgment on this date and are subject to future change without notice. This information may contain forward looking predictions that are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. The information contained herein has been compiled from sources believed to be reliable; however, there is no guarantee of its accuracy or completeness. There is no guarantee that a company will continue to pay a dividend. The investment return and principal value of an investment will fluctuate. Small and mid cap company stocks may be more volatile than stocks of larger, more established companies. The portfolios may invest in foreign securities which are subject to additional risks such as currency fluctuations, political instability, differing financial standards and the potential for illiquid markets. The information provided in this letter should not be considered a recommendation to purchase or sell any particular security.
Risk is measured by standard deviation. Standard deviation is the variability of returns around the average return.