There’s a certain Hollywood mystique around the image of the rogue investor with the fortitude to diverge from the crowd on the quest for The Next Great Investment. The un-glamorous truth, of course, is that unearthing hidden opportunities actually takes equal parts elbow grease and know-how. Par Rostom, portfolio manager for Franklin International Growth Fund, is that roll-up-the-sleeves kind of guy. He’s not looking to invest in companies just because they are household names with splashy advertising campaigns. The companies he hunts for are the ones he feels are best in class in their particular niche, but that you’ve probably
never heard of. Surprisingly, he’s finding some of them in the eurozone, a place the crowd is largely avoiding today. Here’s a summary of his approach, in his words:
- We’re looking for companies that have grown sustainably in terms of free cash flow over time.
- We look at the return profile for a company historically, and we project that out three to five years.
- We also make sure that we would view the corporate governance as best in class.
- A concentrated portfolio allows our analysts to focus…it allows us to take advantage of transient dislocations.
Somewhat like the “four C’s” used to judge diamond quality, Rostom judges the quality of companies by the “four C’s” of cash flow, company metrics, corporate governance and concentration.
Cash Flow. “We are looking for companies that grow sustainably in terms of free cash flow over time, companies that have a track record of reinvesting the free cash flow they generate into the business, organically or otherwise, in doing acquisitions. We go back in the history of the company to make sure that we appreciate that the drivers of free cash flow are sustainable.”
Company Metrics. “We also try to make sure that these are indeed quality companies. We look at the return profile for the companies historically, and we project that profile looking out three to five years. We look at metrics such as return on equity (ROE) and return on invested capital (ROIC).”
Corporate Governance. “Additionally, we verify that we would view the corporate governance as best in class. Once these metrics—in terms of free cash flow, in terms of returns—are met, that’s when we would be interested in investing in a company.”
Concentration. “A concentrated portfolio allows our analysts to focus. Each analyst covers five to 10 names, so they are intimately familiar with the growth trajectory, the material issues that have impacted the companies or will impact the companies looking out. That allows us to be nimble. If the market decides to focus on issues that are transient to the company or not material for the long term, that allows us the potential to take advantage of that. So, we have this contrarian rebalancing strategy. If a stock pulls back, we would generally be looking to add to the stock. And, conversely, if the markets decide to be euphoric and overly reward a company, we would most likely look to trim the name. So, in-depth coverage of the concentrated portfolio allows us to take advantage of these transient dislocations.”
So, what does Rostom see as possible gems right now? And where in the global markets is he finding them? Currently, Rostom’s focus is mainly on the northern part of Europe, which he believes is more insulated from problems plaguing other areas. And he’s been mining Asia and Latin America for stocks that meet his criteria, too. He shares a few of his current picks:
“Just to give you an example, Elekta1 is a name we own in Sweden. We view the company as a leader in making radiotherapy equipment. We own a company called Symrise1, which is a flavors and fragrance manufacturer out of Germany with half of its revenues derived from emerging markets. We own a company called MercadoLibre1, which is in the Latin American online auction space. So far, many of these companies have been, to a degree, insulated from the downdraft that’s happening in the European periphery.
We are looking out three to five years and we have active engagement between the analysts covering the names, the management of the company, and the supply chain that the companies are in. So we are intimately familiar with how the bottom-up picture is panning out for these companies, and we remain optimistic on their growth potential.”
Following this insight into Rostom’s contrarian views, we’d be remiss if we didn’t mention Sir John Templeton’s choice words about following the crowd. “Avoid the popular. When any method for selecting stocks becomes popular, then switch to unpopular methods.”
What are the Risks?
All investments involve risks, including the possible loss of principal. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size and lesser liquidity. These and other risk considerations are discussed in the fund’s prospectus.
1As of 12/31/11, the Franklin International Growth Fund held the following as a percentage of total net assets: Elekta (2.45%); MercadoLibre (2.16%); and Symrise (2.14%). Holdings are subject to change.