Equity markets have rebounded well from the pandemic‑related lows of March 2020, displaying an encouraging level of resilience. While this is positive, we remain circumspect about the potential time frame for economic recovery. Our sense is that the current crisis could have a longer‑than‑expected tail, delaying the recovery beyond what the market consensus is currently anticipating. Meanwhile, the environment is likely to remain uncertain for some time.
Regardless, our investment approach and portfolio focus remain unchanged. We continue to look for high‑quality companies that can potentially produce durable growth in earnings and free cash flow over time.
Given the extreme economic dislocation, near‑term earnings forecasts for many companies have become clouded. To better understand the longer‑term picture and potential outcomes, we allocate the companies within our investment universe into three main categories.
- Category 1—Long‑term losers: This includes companies that are being negatively affected by the current health crisis and the severe economic dislocation in the short term, but that are also likely to be negatively impacted on a longer‑term basis.
- Category 2—Long‑term beneficiaries: This includes companies that are negatively impacted by the current crisis in the short term but that we see as being potential beneficiaries over the longer term. These companies could emerge from the crisis in a potentially improved position.
- Category 3—Short‑ and long‑term winners: This category has fewer names but contains those select companies that are currently benefiting in the short‑term environment and are also expected to be key longer‑term beneficiaries.
Identifiers of Quality
The companies that we look to invest in have various, consistent qualities that single them out as potentially advantaged long‑term businesses. Such attributes include high barriers to entry, low availability of substitute products, industry leadership, and pricing power with both suppliers and customers. Also essential is capable management that can allocate capital effectively and efficiently. These quality identifiers are particularly relevant for companies currently allocated to Category 2, for example. Despite earnings being negatively impacted in the short term, and share prices falling sharply in some cases, these qualities give us confidence that the companies can not only recover, but go on to excel, longer term.
At this point, it is worth highlighting some of these "all season" growth companies—examples from both Category 2 and Category 3—and what we believe are the durable qualities that identify them as potential long‑term growth compounders.
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