Episode #152: The Rising Importance of Active Stock Selection

Episode #152: The Rising Importance of Active Stock Selection


Over the last 15 to 20 years, we have seen the rise of low cost, passive index investing. While this low-cost approach to investing has made it easier to invest and maintain long term investment discipline for the average household, there are downsides to this investment approach that can reduce your long-term growth rate.

A passive low-cost approach to investing will place client money in both the good and bad areas of the market. In this episode of Money Script Monday, Robert reviews LifePro Asset Management’s simple 3-step investment strategy to reduce investment headwinds, identify areas of long-term growth and the companies leading these areas of positive disruptive change.


 

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Video transcription

Hi. Robert Reaburn here from LifePro Asset Management. I hope that everyone's having a great week so far.

Today, we're going to be talking about the importance of active stock selection as part of an overall investment portfolio.

Over the last 15 to 20 years, we've seen the rise of passive investing.

Which is really synonymous with Vanguard and other large platforms, such as Fidelity that offer low-cost index solutions for investors to participate in the market, in a low-cost way.

But also coaches them on the importance of long-term investing and discipline through good and bad markets.

This has benefited investors tremendously.

We actively support these platforms in their quest for increasing investor discipline and making sure that clients stay focused on the long term, which we do as well.

But there is a downside to index investing.

As investors, when we buy an index product, we are investing in both the good areas of the market and the not-so-great areas of the market.

Today, we're going to be coaching clients and advisors alike on a easy, three-step process that we use here at LifePro Asset Management to try and help us, as portfolio managers, avoid, and steer client money away from those not-so-great areas of the market, while focusing our firepower and a lot of that dry powder that our clients have saved up over their lives in the more healthy areas of the market.

Because if we can simply avoid those areas of the market that are in long-term decline, our chances of picking a good stock, and finding a great company that's going from good to great, is so much higher, if we just focus more of our time on specifically those healthy areas.

The three steps that we use here at LifePro Asset Management are we try to avoid the areas of long-term decline, so in other words, we try to avoid zombie companies.

Second, we try to identify areas of long-term secular growth. What does that mean?

Those are areas of the market that are going to grow no matter what the business cycle is doing.

A great example would be Apple. iPhones were going up in sales regardless of the 2008 global financial crisis.

The third is once we identify those areas of long-term growth, what are the specific companies that are leading positive, disruptive change?

Avoid the Land Mines

avoid the land mines

The first step is avoiding the land mines. So, one analogy I always like to use with clients and advisors is if that we have two sprinters.

One is, we have Usain Bolt versus your average Joe. Who's going to win the race?

Ten times out of ten, it's obviously going to be Usain Bolt. But what happens if Usain Bolt has to run across a mine field, and the average runner has a clear open field to run across?

Who's going to win?

The average runner will likely win at that point. And that's really what we're trying to do with the investment landscape.

By actively researching and understanding the structure of the economy and understanding where the tailwinds are and the headwinds are, if we can avoid those areas of long-term decline, we're basically removing the land mines, so that we can get to where we need to be in a much more efficient and rapid way.

Part of this is avoiding zombie companies. It's a funny term, but what are zombie companies?

Those are companies where we know, quantitatively speaking, we can identify where their cost of debt, in other words, their cost to borrow money, is higher than their return on invested capital.

Essentially what that means is that you're getting a wealth transfer from equity holders over to debt holders, and that ultimately destroys value in a company.

The second step is we want to avoid areas that are in long-term decline. A couple great examples would be retail stores.

We've seen a huge shift from retail mall shopping over to ecommerce and online-based shopping platforms.

That is an example of one, where we see long-term growth, in terms of ecommerce, and then of course, long-term decline in overall mall business, with retail stores.

Third is whether it's a area of long-term growth or an area of long-term decline, we want to avoid companies that are poorly managed.

How do you do that? We base it all on math.

At the end of the day, a management team can come in our boardroom, talk about their company, talk about their history, talk about their goals, but the reality is, the truth is in the numbers.

Is their return on invested capital going up or down over time? Are they returning capital to shareholders? Are they delivering on capital appreciation, through higher enterprise value?

All these things are things that we look for when we're looking for those individual companies.

Once we've avoided the land mines, or at least for the most part avoided the land mines, the next thing we want to do is what are those areas of the market that are experiencing persistent long-term tailwinds?

Identify and Ride Tailwinds

identify and ride tailwinds

That's the key, is we want to make sure we're identifying long-term secular growth.

Now, part of this is understanding where are those areas of long-term positive technological disruption?

One area that we've been very positive on for a very long time has been the emergence of cloud computing, an essential computing going from on-premise, at the office, at home, to being stored at a remote location, saving the customer and businesses costs over time.

Once we identify that particular trend, we then say to ourselves, "What are the actual companies leading that charge?"

Identify Leadership

identify leadership

And that is the third step, is identifying leadership. And this is where a lot of portfolio managers, and a lot of investors, can ultimately fall short.

Once they've avoided the land mines, they've identified areas of long-term growth, they then make the mistake of saying, "Well, what are the companies that haven't yet participated in the growth?"

In other words, what are the junk companies that they believe will catch up to the leaders?

We do the opposite. We stick to the leaders.

What happens when we ultimately invest in areas of long-term growth, the leaders get stronger, because they're led by strong management teams, which is one of the big factors that we look for.

People are what make great businesses.

And when we invest in a great business, we're looking to invest in great people. And those people tend to make great decisions year in and year out.

Those companies that haven't yet participated in the growth are likely not going to, for the next year, two years, three years, until they change the management team.

Identifying the leadership, and where the strong are getting stronger, in other words, we're seeing companies that are going from good to great, and making sure that they have balance sheet strength.

Why is that important?

Because sometimes, investing can be hard in terms of timing, so we want to make sure that time is on our side.

If a company has a lot of debt, and we're wrong about the timing, we can lose clients a lot of money.

One way we avoid that is to make sure that companies have a low level of debt, in other words, if we think that stock is going to inflect higher in the next two or three months, but it takes six months, the good news is it doesn't matter, because there's not a lot of debt the balance sheet.

A strong balance sheet gives us time in order to have that investment play out.

Through a simple, three-step process of avoiding the land mines, identifying areas of long-term growth, and thirdly, and perhaps most importantly, identifying the leading companies that are leading positive, disruptive change.

We can focus our clients' money on the good areas of the market, avoid those bad areas, and hopefully, over time, generate long-term outperformance versus the market.

Contact LifePro Asset Management

If you want to see how this strategy has played out for us, in terms of our investment portfolios, feel free to give us a call at (888) 543-3776.

We're more than happy to walk through how our strategies have performed over time.

I think most people will be impressed with those performance numbers. But, definitely feel free to give us a call, and have a fantastic week, and thank you again for tuning in.




The information here is presented by licensed professionals and not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstance. These videos are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable. The information presented may change at any time and without notice.
Investment advisory services offered through LifePro Asset Management, LLC, a registered investment adviser. Investments involve risk and are not guaranteed. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy will be profitable or equal any historical performance. Discussion of any specific stocks are based on objective, non-performance criteria and such discussion neither serves as a recommendation nor as the receipt of, or a substitute for, personalized advice. Due to various factors, including changing market conditions, such discussion may no longer be reflective of current position(s) and/or recommendation(s).
S&P 500 is an unmanaged index of the shares of 500 widely held, predominantly large capitalization, U.S. exchange-listed common stocks. The index results neither include dividends reinvested nor reflect fees and expenses. Investors cannot invest in any index directly.

About Robert Reaburn

Robert Reaburn is the Executive Vice President and Head of Wealth Management at LifePro Asset Management. He works with financial advisors building diverse financial portfolios that best prepares their clients for their financial future and provides peace of mind.

Disclaimer

This information is meant for educational purposes only.

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