July 2018

Benefits to Investing in High-Quality Growth Companies

Key Takeaways

  • For Geneva, high quality means finding companies with superior management teams, stable balance sheets and a consistent record of growth.
  • High-quality growth companies are well positioned to benefit from corporate tax reform as they have more discretion on how to spend that tax savings than low-quality companies.
  • Small cap and mid cap companies will likely see more of a benefit from tax reform than large cap companies; resulting in increased M&A.
  • We believe that we are currently in a fundamentally driven bull market, one of which Geneva has historically outperformed.
View Transcript

Chapter One: How are small and mid-cap companies spending tax reform savings?

There are three aspects of how Geneva defines high quality. The first one is buying great management teams. We truly believe that if we invest in companies with great management teams, those are people that are going to be running the business day to day that are able to see around corners and adapt to the environment and we want to invest our clients’ money in management teams that are able to make good decisions for the business. The second aspect is companies with a low degree of financial leverage. So those companies are, will have the flexibility to invest in difficult times, they are profitable and are able to generate their own cash flow to self-fund their business. So in many cases, these companies are able to invest in themselves in the difficult times whereas high level competitors wouldn’t be able to have the flexibility to do so. And the third aspect is consistency of growth. So even though we like to have fast forwarding companies, just as important is the consistency of that growth rate because we believe low volatility leads to better returns over the market cycle.

Chapter Two: In what types of environments does Geneva tend to perform well?

Basically, we divide or we classify markets in three types of markets. The first one is fundamentally bull driven markets which is the type of market we’re on and our types of companies tend to do very well on a relative basis. We also do very well in down markets so we protect capital on the downside very well. The only type of market where we tend to lag on a relative basis, even though on an absolute basis you should expect us to do well, it’s in speculative markets. These are usually markets that are post recession so 2003, 2009 and in the recent period with of accommodation from a central bank perspective when the Fed was pumping liquidity into the system, investors really reward companies that were what we call lower quality which are companies that aren’t profitable and high degrees of leverage, we turn to all the types of companies that we invest in necessarily. Now the type of market that we’re in right now, we believe it’s actually the Geneva type of market where we tend to do really well. We’ve been in this type of market for the last couple of years, actually since 2014 as the Fed started ending the Quantitative easing program, we started seeing a shift back towards high quality and that’s exactly the type of market that Geneva tends to very well because the factors driving performance are rewarding companies that again, have low degrees of leverage and as interest rates increase, the cost of capital increases. And we believe as you continue to see normalization in interest rates, normalization from a monetary policy perspective, not only in the US but around the globe when you look at the European Central Bank also engaging in and in the Quantitative easing program over there, which they expect to end at the end of this year, we believe as interest rates rise again, you want to own high quality companies that can self-fund their business with internally generated cash flow. They have high profitability to be able to do so and have that flexibility versus investing in companies that have high degrees of financial leverage and aren’t profitable and are relying on the capital market, specifically that that market’s to be able to fund their business.

Chapter 3: How is corporate tax reform affecting high quality companies?

We believe that high quality companies are very well positioned not only because of the recent summation in terms of higher interest rates benefitting high quality companies, but tax reform would actually allow for high quality companies, higher returns on investment capital companies to have more discretion on how those tax savings will be spent. Willing investors have done the easy math in terms of high tax rate paying companies. We’ll see the benefit as you have to pay 21% tax rate, but the difficult math or the difficult thing to assess we think is high quality companies will have again, more discretion versus low quality companies, how those dollars get spent. And that will just reemphasize that you want to own the businesses that have higher competitive advantages and not have those tax savings competed away either in the form of lower prices for customers or higher wages for employees, for example, but actually have discretion to invest in the business for the benefit of the long run of the shareholders.

Chapter 4: How is tax reform affecting high-quality companies?

It’s early to tell. We believe that the repatriation of profits from some of the large companies will ultimately filter down or trickle down into buying small cap and mid cap companies so that will definitely benefit that space. And in addition, that goes back to you want to own high returns investment capital companies. Mid cap and small cap companies that will have more discretion on what to do with those savings.

Chapter 5: What is your current market outlook?

In terms of our outlook, if you think about how we’ve performed historically, we tend to do very well in fundamentally driven bull markets. We strongly believe based on our outlook, that that’s the type of market we are currently in. And if looking again at our historical performance, we tend to protect capital very well on the downside. So if you think about the next couple of years being so healthy, bull market, fundamentally driven, followed by ultimately a recession, we think we’re very well positioned to perform very well on a relative basis over the next few years.

The opinions and views expressed are as of the date published and are subject to change without notice. They are for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security, investment strategy or market sector. No forecasts can be guaranteed. Opinions and examples are meant as an illustration of broader themes and are not an indication of trading intent. It is not intended to indicate or imply that any illustration/example mentioned is now or was ever held in any portfolio. Janus Henderson Group plc through its subsidiaries may manage investment products with a financial interest in securities mentioned herein and any comments should not be construed as a reflection on the past or future profitability. There is no guarantee that the information supplied is accurate, complete, or timely, nor are there any warranties with regards to the results obtained from its use. Past performance is no guarantee of future results. Investing involves risk, including the possible loss of principal and fluctuation of value.

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