www.WellingonWallSt.com

VOLUME 10 ISSUE 15 listeningin NOVEMBER 20, 2020 Bargain Hunting Isn’t Us INSIDE Polen Capital’s Big-Cap Mavens Talk Long-Term Compounding Magic Listening In Amid, dare I say, the Growing Client chaos of the last few Assets By Staying weeks — with the mar- Strictly In Quality kets tossed to and fro by Growth Stocks alternating news of stun- ning vaccine advances Guest Perspectives and heretofore unimagin- Dunne & Henwood able record numbers of Life Depends On It Covid-19 infections and John Hussman deaths all across this na- Pushing Extremes tion and the globe — not Dave Rosenberg to mention the sorry spec- Looking Across Gap tacle of an electorally de- Greg Swenson feated President trying to FAANGless Growth prolong his hold on the Gail Dudack White House by hook or Priced For Perfection by increasingly desperate crook, it seemed important Chart Sightings to find interviewees thor- Michael Belkin oughly grounded in incon- Dan Davidowitz Damon Ficklin Last Shall Be First trovertible fundamentals;

Blaze Tankersley their process rooted in principles that have stood the test only the best quality growth stocks with, of all things, a A FortuneWaiting? of time — and who have delivered extraordinary invest- Thomas Peterson margin of safety. They were kind enough to fill me in on ment returns through some pretty horrible markets. all the details when we chatted last week. Listen in, and China Miners Crater Andrew Addison learn. Meet Dan Davidowitz and Damon Ficklin, who are pic- — KMW Fall Follow-Ups tured, shoulder-to-shoulder, above. The pair are the co-

Deep Dives heads of the research efforts of Polen Capital’s Large How did a couple of evidently nice guys, like Save People First Company Growth Team. Dan is also the lead PM of you, end up in money management? Was it Ode to Comfy Cushion Polen’s Focus Growth strategy, while Damon handles something in your upbringing, perhaps? Pandemic Relief Impact that chore for its Global Growth strategy. Concentrated Poverty DAMON FICKLIN: [Laughter.]

Deaths Of Despair DAN DAVIDOWITZ: I like that question as a start — Polen Capital, which now oversees $56-plus billion of Middle Class Angst AUM placed under its stewardship by institutions and Just saying, it’s always mom’s fault! Acute Observations individuals, is a Boca Raton, FL-based growth man- DAN: Well, my mom always wanted me to be a doc- Comic Skews ager that has been practicing and refining its highly tor, so apparently, I’m the one that did something Hot Links concentrated, quality growth investing methodology for wrong, not her. better than 30 years, with admirable results. In large ALL ON WEBSITE measure, they say, because they strictly insist on buying You still haven’t figured out what?

RESEARCH SEE DISCLOSURES P. 20 -2 1 WELLINGONWALLST. November 20, 2020 PAGE 1 DAN: My career actually started out in health care, DAN: Well, I’m not a millennial, let’s just put it that so, I wasn’t far off from what my mother wanted me to way. In my case, a Value Line alum was Director of do, but on the finance side of it. I went to college in- Research at a Osprey Partners Investment Manage- Published exclusively tending to be a pre-med, but didn’t end up going that ment, a firm in New Jersey that was doing large- for professional and/or route, though I was a public health major. Now, it and small-cap value, long-only, equities, and he avid investors who are seems kind of funny, in the light of the Covid-19 hired me. Those were really my formative years, paid-up subscribers by pandemic, but I took only one epidemiology class. learning how to do research and understand busi- I’m not at all qualified to opine on anything Covid-19. nesses. I spent five years there before coming to Welling ON Wall St. LLC ISSN 2332-161X understand that their style, which is low p/e, low Would that many others were so punctilious! price-to-book and contrarian, wasn’t really resonat- DAN: Still, while studying public health, I did real- ing with me. I much prefer finding great companies ize that I liked the financial stuff. That’s how I that should compound earnings for long periods, Kathryn M. Welling ended up working at and decided to try to Editor, Publisher & Principal [email protected] Sloan Kettering Cancer concentrate on that. Office. (631)315-5076 Center for five years “We can’t stress Cell. (973)650-2722 after I graduated from And that’s when you Rutgers. Mostly in ana- enough that we found Polen Capital? lytical and finance-re- DAN: Right. I looked

Donald R. Boyle lated jobs. But I also actually know what around to find firms that Chief Financial Officer went back to school at did that, and lo and be- Chief Marketing Officer night to get my MBA at has been driving our hold, Polen Capital was [email protected] City University of New one of them. I coinciden- Office. (631)315-5077 York’s Baruch College in outperformance — and tally had a friend who Cell. (201)394-1548 Manhattan. had just interviewed at it’s a very different Polen Capital at the As soon as I graduated, I time, who ended up not Distributed biweekly, mentality than waking usually on Fridays, decided I really wanted going through with the 16 times a year, by to pursue finance — it up on January 1 and whole interview process. Welling ON Wall St. LLC was during the dot.com But he told me, “This is PO Box 620 bubble in the late ‘90s a firm that you should be Mattituck, NY 11952 trying to pick what — exciting for the wrong looking at.” So I begged Office:(631)315-5076 reasons, right? stocks are going and pleaded and inter- Fax. (631)315-5077 viewed with Stan Moss, www.wellingonwallst.com Exactly. to rise the most who’s now our CEO, and

DAN: But I didn’t have our founder, David the background to get a in the next 12 months. Polen, and lucky for me,

Copyright Warning and Notice. job at any of the signifi- I ended up here. It is a violation of cant firms. Value Line This is a marathon, federal copyright law to repro- was the only place that I I took a bit of a circu- duce all or part of this publica- not a sprint” tion or its contents could get a job as a re- itous route, from Public by any means. The Copyright search analyst, basically, Health major, to hospital Act imposes liability of up to $150,000 per issue for but it was a great place administration, to a value such infringement. for me to learn how to do research. It was a place shop and finally to here, but thank goodness, I had Welling ON Wall St. LLC does not license or authorize where you learned to fly on your own, so to speak. those experiences and ended up in the right spot. redistribution in any form by They didn’t really have a lot of formal training. But clients or anyone else. Ho- that’s where I got very interested in understanding Does that also explain why I actually saw wever, clients may print one personal copy and limited re- businesses and really understanding what made the phrase “margin of safety’ in Polen’s print/republication permission them tick. And there’s a huge network of Value Line description of its growth strategy? may be made available, in writ- DAN: ing, upon specific request. alums out there, as you’d imagine, because turnover Yes, the value influence is really just under- is so high. standing the concept of margin of safety in invest- ing. We really look to have a margin of safety in the It was actually renowned as a training ground way that we invest in growth companies, and we’re Copyright 2020 in years gone by. I don’t know if it’s still — always looking for that. But our methodology is a K.M. Welling and DAN: I’m not as young as you’re implying. little bit different than just saying, “I know this Welling on Wall St. LLC All rights reserved and company is worth X, and I’m buying it at a discount vigorously enforced. That depends on your perspective. to X.”

WELLINGONWALLST. November 20, 2020 PAGE 2 How so? DAN: That’s not the whole margin of safety for us. I mean, our margin of safety is really in the per- manence of a business, its compet- itive advantage, the strength of the balance sheet, its long-term earn- ings growth. It’s a little bit more robust, I think. But it does come out of the concept that Ben Gra- ham made famous. In The Intelli- gent Investor, he talks about margin of safety and growth stocks. There’s just a tiny little part of The Intelligent Investor about investing in growth stocks. But that’s what David Polen latched onto, and we’ve built our whole investment philosophy around it.

It’s a very tiny part in a very weighty book — DAN: Yes, I had to read it a sec- We Have PROOF, by Pat Byrnes, Politi- ond time to find it. vesting. Plus, I was just always fascinated by the calCartoons.com miracle of compounding. I was a little bit of a Which may say a lot more about when he Warren Buffett junkie, even as a student — when I was writing that book than anything else. came to understand what he achieved over time DAN: I think you’re right about that. with Berkshire and the role this seventh wonder of the world, compounding, played in it. That drew me Damon, I take it your road to Wall Street in. It is just kind of unbelievable what can be done, South was a bit more direct. if you’re disciplined, to produce great results for a DAMON FICKLIN: Yes, I was chewing on how to very, very long period of time. And I decided I blame my mom. I can’t really find a way — wanted to be an investor when I was pretty young, so yes, my route was a little more direct than Dan’s. DAN: Damon’s mom is really nice. I hear a “but” coming — Speaking as a mom, she’ll be happy to read DAMON: Well, my first idea was to become a broker that. on Wall Street, because, growing up in Florida, I DAMON: Yes. The only thread I could find is that really had no idea how the investment business is we’re a competitive family. My mom would never let structured, about all the roles in money manage- me win at anything just because I was a kid. I ment. I just knew I wanted to invest, so I studied played racquetball and different sports with her accounting, getting a B.S. from the University of when I was growing up, and obviously, eventually South Florida, and an M.S. in accounting from Ap- grew to a point where I could actually beat her. But palachian State University, before going to the Uni- she never let me win. versity of Chicago to earn my MBA.

Anyway, I was always intent on competing, and You’re not one of those guys who bought there’s something exciting and interesting to me his first stock at age six, are you? Subscriptions to about the investing. There’s a scoreboard, there’s a DAMON: [Laughter] No, I wasn’t. I did start invest- WellingonWallSt. long-term outcome, it’s all measured, and you get to ing after reading books about Warren Buffett, and Welcome! apply yourself and see if you can outperform over I’m embarrassed to say the first stock I invested in Payable in research time. was Gannett, the newspaper chain. votes or hard dollars.

contact: So, while I’m also very patient and very long-term Warren Buffett very much has The Wash- Don Boyle in my outlook, I think the competitive aspect of my ington Post on his investment resume. [email protected] personality is one of the things that draws me to in- DAMON: I know. The newspapers have all died as businesses — 631-315-5077

WELLINGONWALLST. November 20, 2020 PAGE 3 publish. I covered health care companies, oddly Subscriptions to Please, you’re talking to a journalist who enough — it’s a weird connection I have with Dan. WellingonWallSt. took the newspaper track at Northwest- Pretty much everything except pharmaceutical Welcome! ern’s Medill School. And they haven’t all companies was my baliwick. So, I covered phar- Payable in research died. A few have evolved. DAMON: macy benefits managers, medical tech, hospitals, votes or hard dollars. True, but the industry, once upon a time, drug distributors, the whole lot, which was great. contact: was comprised of many outstanding businesses. It

Don Boyle was an interesting lesson to watch that transition. I had worked at Morningstar for about a year when [email protected] our late founder, David Polen, posted a job opportu- 631-315-5077 No argument there. Especially from the inside. DAMON: I studied accounting because I thought nity at Booth, and one of my friends from there, who that was a good base of knowledge and then went was continuing to search for a new job, saw the on to get a Master’s in it before going to work for posting. He called me and said, “This is exactly Price Waterhouse as an international tax account- what you’ve told me you wanted to do for the last ant, and earning my CPA license. I didn’t aspire to three years. It’s a Florida-based firm, looks like it be a tax accountant for the long-term, but I thought, does concentrated quality growth investing for the again, it was a good base. long-term, and it has a strong track record.”

Finally, when I went to the University of Chicago, I said, “You’re right.” I applied and was fortunate intending to use my MBA as a stepping stone into enough to get the job — and the rest is history. the money management business, I double-majored in Finance and Economics. But my timing wasn’t Gee, wasn’t it hard to leave the Windy City great. I graduated from Chicago in 2002, while the for Sunny Florida — as a relative youngster? markets were still reeling in the aftermath of the DAMON: Remember, I grew up here. Now, I’m in my technology bubble blowing up. 18th year at Polen Capital. I came in with relatively limited experience, but a very clear philosophy At least that was better than a year or and view and vision of how I wanted to invest — two earlier — in retrospect. which was well-aligned with the firm’s. I’ve been DAMON: Still, not an ideal time to try to move into lucky enough to become an analyst and then a money management. Nevertheless, at that moment, portfolio manager and then co-head of team and am because of regulatory changes, the brokerage in- happy to be part of the success that we’ve achieved dustry had started moving toward a model using in- at Polen Capital. dependent, as opposed to in-house, research. And Morningstar was building its Equity Research De- You both boast long tenures at Polen — partment to try to meet that demand. I became one DAN: Yes, Damon was really the first analyst that of the early members of that department. It was David Polen brought in. Until then, David had, for perhaps a little more structured than Value Line, about 20 years, invested basically by himself. the way Dan describes it, but not a whole lot more. You really had to figure it out on your own and then He was definitely a one-man band, way back when I met him in the 1980s, as I recall. Polen’s Flagship Focus Growth Strategy DAN: Damon was the first hired, basically, into what has become our large company growth research team. He was co-portfolio man- ager of the firm’s flag- ship Focus Growth strategy with me from 2012 through 2019, when he took the PM reins at our offshoot Global Growth strategy. And he remains co-head of our large company growth team.

WELLINGONWALLST. November 20, 2020 PAGE 4 run the business, who we are and how we work as Focus Growth was Polen’s sole strategy Subscriptions to teams. And it is manifest in our commitment to “go for years, wasn’t it? WellingonWallSt. DAN: beyond” in everything we do, for our clients, our Yes, we didn’t start our second product, the Welcome! communities and our teams. Global Growth Strategy, until about six years ago. Payable in research

votes or hard dollars. I see Polen now offers not only your Tell me about today’s Polen Cap. Your contact: strategies, Focus Growth and Global AUM has grown tremendously — Don Boyle DAN: Growth, but also complementary ones in in- Yes, and a lot of that is because — if you [email protected] ternational, small-, mid-cap, and emerging look at our investment results across our portfolios 631-315-5077 — or even if you just look at our Focus Growth market flavors. Yet all of your research strategy, which has the longest track record — you’ll teams employ the same methodology; share see very consistent results. It’s amazing, actually, your style? that all of the portfolio statistics you can look at — DAMON: Yes, all of the teams are essentially ex- the returns, all of the risk statistics — at Focus ecuting philosophies based on the same core tenets, Growth look the same, whether you look at the period — concentration with high conviction, quality, and when David Polen was running the portfolio, or when growth with a business owner’s mindset. So you see Damon and I ran the portfolio, or at now, with Bran- all of those features across all of the products. The don [Ladoff] and me running the portfolio. The in- large company growth team that Dan and I co-head vestment results are indistinguishable. [Graphics, supports the flagship Focused Growth strategy, the pages 4 & 5] Global Growth strategy, and also the International Growth strategy, which is ex-U.S. Then, we have Then what’s changed? two other autonomous research teams: small com- DAN: What’s changed, really, is that we were not an pany growth based in Boston, and emerging mar- easy firm to do business with when David Polen was kets growth, run out of London. Each team adheres wearing all the hats — the portfolio manager as well to our core tenets — concentration, quality, and as the CEO. We needed to have, let’s say, a real deal growth with a business owner’s mindset — but ex- CEO. Luckily, we had him here the whole time. ecutes their disciplines autonomously. After David Polen passed away in 2012, Stan Moss, who had been our COO, became the CEO — and he Another advantage we have at Polen is that our fully has created this amazing business and culture — integrated global management enables our distinct around what was already a great investment philoso- investment teams to focus solely on what they do phy that’s now proven itself for over 30 years. best — investing and research — without being saddled with additional management or operating It’s all about having the right people in the responsibilities. We can leave all the compliance, right roles. But that’s easier said than done. trading, distribution, marketing and tech headaches DAN: Absolutely. At the risk of sounding like a to the centralized teams that Stan has created to marketing brochure, what we’ve built at Polen Cap- support both our investment process and the indi- ital under Stan is very much a purpose-driven firm vidual and institutional investors that we work for. — we are passionate about making a meaningful difference in the lives of investors entrusting us So all of your investment teams all follow the with their financial well- being — and we’ve been Focus Growth doing that by investing their (and our) assets in concentrated portfolios of the highest-quality growth companies for more than three decades. We think our results speak for themselves. But we’ve succeeded be- cause we’ve built a cul- ture of results, rooted in quality, that permeates not only how we run the portfolios, but how we

WELLINGONWALLST. November 20, 2020 PAGE 5 same basic concentrated high-quality growth given the environment, management teams have principles, but operate independently? been relatively open to it. It’s also easier for them. DAMON: Yes, each team executes with sole decision- DAN: I haven’t noticed any negative impacts on our making authority for security selection in pursuit of team’s ability to connect if we want to. If anything, true alpha. Still, we do have shared research drives. maybe a marginal positive. Maybe not for all inves- So if anyone on our Global Growth team publishes a tors. But you have to remember what type of inves- note on, say, Alibaba, then of course, the Emerging tors we are. Management teams typically are open to Market Growth team can see and read that note — meeting with us. After all, we tell them that we only and vice versa. But we execute independently. study the best businesses in the world, so if we’re asking to meet with you, we think you’re among that Then, for instance, you two, as the long-ten- group. What’s more, if we end up taking a position, ured large-cap PMs don’t lean on your emerg- it’s going to be a significant one. In the case of Fo- ing markets team to do the heavy lifting for cused Growth, probably a billion-dollar-plus invest- you if a stock like Alibaba catches your eyes? ment, at a minimum. DAMON: No, we’re doing all of our own research from the bottom up on the large company growth And we typically stick around for five-plus years. team. If it’s a candidate for our portfolio and we end That’s music to managements’ ears. Not to mention up owning it, we want it to be because of our own that we’re also not asking about what the next research, or own thought process — and the same quarter is going look like; we’re talking about the goes for them, right? next three - five years, their strategy, their long-term objectives. If I were on the other side of the table, How challenging is it, even just physically, that’s a meeting I’d rather have. A higher-quality to keep your concentration focused amid conversation. the pandemic, while mostly working — I as- sume — from home? True, albeit less multi-dimensional than a per- DAMON: There are a couple of threads worth pulling, sonal visit — though I guess you pay more at- or connecting to, that question. One, as Dan men- tention to metrics than personalities. tioned, we’ve for many years now operated within a DAN: Right, and remember, we’re dealing with very results-only work environment, or what we refer to as large, very competitively-advantaged companies. As our ROWE. One upshot is that we’re not really con- Buffett has said, you want to own a business that cerned where people do their work or how they get can succeed almost despite management. I’m sure their work done. It actually is about the results only. I’m butchering that quote. But quality of the busi- Nothing was nice, when the pandemic started up- ness is more important than the management. ending the world. But it was — gratifying, I guess — to see how our ROWE culture had already created a Really? We’ve all seen bad managements firm that didn’t have to scramble to operate from ruin good assets — wherever our people are, globally. DAN: Unfortunately. But again, remember, we focus only on the best of the best companies. We ob- For instance, our Large Company Growth team in viously want managements that think like long-term Boca Raton operates very autonomously and inde- business owners — as we do. We try to evaluate that pendently. But at the same time, we have structured the best we can — and set very stringent hurdles meetings multiple times a week, and while we al- the companies have to clear to become portfolio ways come together on Fridays to review companies candidates. What we’re looking for, invariably, are and share thoughts, I’d say that almost all the time companies — anywhere around the globe — with — even before the pandemic — half of the team exceptional earnings growth, that are driven by a was not physically present. So we’ve really been sustainable competitive advantage, possess superior able to execute without any hiccups. financial strength, proven management teams and powerful products or services. And we firmly be- Subscriptions to I assume your research process typically lieve owning them will prove far more rewarding WellingonWallSt. involved company visits to “kick the tires” than hugging any index. Welcome! before Covid-19. And presumably that’s Payable in research stopped, for now — Then I won’t find you looking at turnaround votes or hard dollars. DAMON: Yes. Normally, we do go visit management situations, or fallen angels, either? contact: teams; that was part of the process. But what we’ve DAN: No, because only investing in what we believe Don Boyle found is that it might actually be easier to do it via a to be the best companies — growing ones, with [email protected] video conference. It’s certainly much more efficient long-term staying power — is what creates our abil- 631-315-5077 than it is to fly all over for one-hour meetings. And, ity to deliver, and to compound, outsized returns.

WELLLINGONWALLST. November 20, 2020 PAGE 6 And it minimizes risk. but it’s a little more of the cherry on top of our re- Subscriptions to search than a very integral component. It’s nice to WellingonWallSt. Quality isn’t often on the bargain counter — know that people running the business are good Welcome! DAN: No. Our approach is “to not buy low and to stewards of capital and think like a long-term Payable in research sell high” — meaning that bargain-hunting isn’t us. oriented owner would. But we can usually see that votes or hard dollars. We really mean it when we say we are looking for through their actions. contact: great companies. Because we fervently believe con- Don Boyle sistent earnings growth is the primary driver of in- Or in their compensation packages. [email protected] trinsic value and long-term stock appreciation. DAN: Right, there’s a lot of information out there. 631-315-5077 That’s why our efforts focus on identifying and then We don’t need to shake hands to figure out if they’re building concentrated portfolios of companies that good stewards of investors’ capital. we believe are capable of delivering sustainable, above-average earnings growth — and whose val- You mentioned that all of your strategies uations don’t fully reflect that potential. It’s actually employ the same rigorous quality criteria? not as hard as it sounds, given our focus on holding DAN: Yes. That’s really important, because if you positions for the long-term. start looking at average companies, it’s very hard to know what earnings are going to look like over any How so? time horizon. They are subject to so many different DAN: You’ve probably noticed that people’s time factors that are out of their control. That difficulty horizons tend to be quite short in the investment led to David Polen’s masterstroke, his key insight. world today — Don’t keep me in suspense. Vanishingly so — DAN: David realized that if he just concentrated his DAN: And patience is also in short supply. Which portfolio holdings in the best, most financially super- tends to set up opportunities for us to acquire great ior, competitively advantaged companies that he businesses at prices we feel are attractive — rel- could find — and in nothing more, or nothing less ative to their prospects for growing their earnings — over time, he would not only preserve his clients’ several years out. The kind of high-quality growth capital but compound it. We’ve never strayed from companies we buy can compound their earnings at that investment philosophy; we’ve been quite consis- rates that are higher than the GDP’s growth rate — tent in employing our highly repeatable methodology often for decades — even if legions of analysts’ div- for going on 32 years now. idend discount models can’t compute that. Concentrated portfolios are über contrary in Essentially, we do try to buy companies at a dis- this age of indexing. count to their intrinsic values — though it some- DAN: That’s true. Only a very few companies qual- times does not appear like that, when we’re paying ify for inclusion in our portfolios. Roughly 10% of 20 - 30 times the next year’s projected earnings. But the global large-cap universe survives our screens. we achieve our results on the strength and staying But quality growth works, so we stick to our guard- power of that earnings growth. rails, which is how we refer to our stringent invest- ment criteria. And you commit to long-term relation- ships, so you’re actually around to reap How about describing what goes into that the rewards of that compounding growth? secret sauce? DAN: Yes, our long-term holding strategy is under- DAN: In essence, we set very high hurdles in our pinned by a belief that the return on the share price screening to find companies that rise to the top in will ultimately match the growth of the earnings. We terms of not just one or two, but all five of what we also believe that superior earnings stability and finan- call our pillars of strong growth: cash-rich balance cial strength serve as a “Margin of Safety” that typically sheets, abundant free cash flow, sustainably high results in less volatility during market declines. returns on capital, stable or increasing profit mar- gins, and, finally, real organic revenue growth. The upshot is that, for the most part, once we iden- tify a company’s competitive advantages, and or- So you’re not drawn to a Tesla, say, or a ganic growth prospects, as well as its balance sheet “fast-growing” highly leveraged roll-up? strength and the sustainability of its high returns on DAN: In a word, no. Most of the companies we own capital and profit margins, the management is are growing their earnings at double-digits, but that usually a lesser consideration. It’s something that means somewhere between 10% and 30% for the we always want to understand the best that we can, most part. What we really want to see are massive

WELLINGONWALLST. November 20, 2020 PAGE 7 competitive moats that should allow their earnings for us to own to get the whole portfolio’s earnings Subscriptions to growth to continue without a lot of risk. It might growth where we need it to be. That’s the thought WellingonWallSt. sound a little contrary, but we’re looking for growth process behind the growth. Welcome! with a margin of safety. So we don’t focus on just Payable in research the fastest-growing companies we can find, but on Makes sense. votes or hard dollars. quality growth, across that spectrum. DAMON: If you think about it, when we screen contact: down, using all of our guardrails and then look for Don Boyle The companies that we tend to invest in are competitive advantages — Visa and Mastercard are [email protected] usually, themselves, driving long-term, secular dy- great examples, as Dan described — but we’re 631-315-5077 namics that are — I wouldn’t say they’re easy to playing within that zone within almost everything quantify —but likely to be forecastable, within a we’re seriously analyzing as a portfolio candidate. range. So, if you think about a Visa (V) or a Mas- While there’s always variability in the universe of tercard (MA) — I always tend to go back to them, companies available for equity investing, we stay in because they’re such good examples of typical that channel of higher certainty with everything we Polen Capital holdings. They share a global do. Which is how we’ve been able to produce such duopoly outside of China that has moved our world consistent results — and protect more on the down- from cash and checks to digital forms of payment. side when the unexpected happens. Because it al- ways does, at some point. This has been going on for 50 - 60 years. And what drives those companies and their growth is personal There’s always a surprise somewhere. Can consumption spending that tends to grow about 4% I assume you do things like cross-check every year, so people spend 4% more on their cards reported “earnings” against free cash flow than they spent last year. And then that digital shift and whatever capital investment the busi- adds another 4% on top of that. Which means that nesses require — Visa and Mastercard wake up with 8% revenue DAMON: Yes. We typically talk about earnings growth every single day. growth but underneath those earnings, there’s a nearly 100% conversion to cash flow across our A nice tailwind. portfolios. The terms could almost be used syn- DAN: Exactly. Then they have a little bit of pricing onymously. We do believe, at the end of the day, power on top of that; a little bit of mix shift to e- free cash flow is the underpinning for valuation. commerce that helps a little bit. You end up having low double-digit revenue growth, with very little in- I suspect that your holdings tend to be cremental expense on that revenue growth, so profit companies that aren’t terribly capital-in- margins expand. That generates pre-tax earnings tensive. growth in the, say, mid-teens range, and with a lit- DAN: Right. Even some of our businesses that do tle bit of help from buybacks and dividends, you deploy lots of capital because they choose to — say, get a total return in the high-teens, low-20s range Microsoft (MSFT) and Google (GOOG) and Facebook with a lot of consistency. (FB) with their infrastructure investments in data centers, which require pretty significant amounts of WOWS 2020 The upshot is that a Visa or a Mastercard is going to capital — still generate just enormous free cash flow grow 14% or 15% or 17% a year. It’s going to be in on top of that. Issue Dates that range. It’s not going to be 4%, and it’s not January 17 going to be 30%. There will be a relatively narrow What separates the companies that make February 14 range, and that’s what most of our companies are it into your portfolios from the ones that February 28 like. Because the dynamics driving them are so merely screen very well? March 20 DAMON: April 3 long-term in nature and very consistent, it’s not too The primary focus of our research after April 17 hard for us to have a pretty good idea of what they’ll we’ve screened out the majority of companies, May 8 look like not just next year but five years from now. using our guardrails, is debating and thinking about May 29 their competitive advantages. Are they sustainable, June 19 By respecting our guardrails we make sure that durable? We go through a very active research pro- July 24 things that could be very damaging or variable to cess to identify what’s special about each company. August 7 businesses don’t exist in the companies we own. So September 11 our portfolio companies can grow unfettered, tak- And if you can’t identify their edge? October 9 ing advantage of whatever long-term secular trend DAMON: The companies that don’t quite make the October 30 November 20 they are riding. We can have pretty good confidence cut are ones where we can’t put our finger clearly December 11 in that and just focus on which are the right ones enough on what, really, will make them sustainable.

WELLINGONWALLST. November 20, 2020 PAGE 8 Why can it not be competed away? When we do companies survive our winnowing process to even make an investment, we have pretty high conviction become candidates for inclusions in our portfolios. that all the right pieces are in place. And to stay in It saves us from wasting a lot of time and makes it that channel of greater certainty, we don’t waste our entirely possible for us to develop deep understand- time trying to apply our guardrails to a company ings of their special characteristics. that has maybe made it through our screens one year, so now we’re hoping it can do that for the next So your real universe is only 150 out of five. the thousands of listed large-cap com- panies around the world? Gee, you’re not trying to discover the next DAN: The entire universe is about 3,000 large-caps great moonshot? globally, but only about 150 fit through our guard- DAMON: No, the businesses that make it into our rails. Now, to your point on the sustainability of portfolios have typically been delivering exceptional businesses, if you think about companies like GE results for quite a while. They have been already and others once considered great companies that taking advantage of secular trends in motion, and have faltered — a lot of them wouldn’t have passed they’re serving large markets where we see plenty of our guardrails. GE, for most of its life, would not opportunities to expand their shares over time. have passed our guardrails because of leverage, among other issues. It was a massive conglomerate For instance, if you brought an idea to the team — and financial machine, but couldn’t make it a company that has grown earnings 5% per year for through our screens. We’re all about avoiding in- the last five years — saying that it’s suddenly going vestments in average, inferior, highly cyclical, or to grow 25% a year for the next five, you’d have a highly leveraged companies — that’s how risk infil- lot of work to do, to make your case. trates portfolios.

By contrast, if you bring a company to the team that Another point I’d like to stress is that we want to meets all of our guardrails, where we’ve done the stay invested in exceptional companies for as long deep research to understand exactly why we think as possible — as long as they continue to com- it’s advantaged and why it’s really hard to compete pound at great rates, we’ll continue as holders and with, or to knock them off their game, and that’s we hope that goes on for a long time. But we also been delivering, let’s say, 13% earnings growth for have the use of the capital markets, and we always five years or maybe a decade or longer, your task optimize our portfolios to own what we think are the would be easier. Once we had that whole equation 20 - 30 best companies at a given time. Remember, together, we’d just probe again, what was driving we run concentrated portfolios. We don’t just buy that growth and whether those conditions were both every stock that survives our screens. Focus Growth still in place and sustainable. Does the company usually holds only around 20 — no more than 30. still have a runway for taking more share? Is its market’s overall growth rate sustainable? So, if we decide that one of our great companies just is not going to be as great in the next five or In other words, there’s still work and analysis for 10 years, then we’re spending all of our time trying the research team to do; projections to be made. to find another one of our 150 or so portfolio candi- But we’re doing it within a zone of predictability dates that we think will be greater. Our whole pro- that’s much higher. These businesses have been in cess is more about making sure the whole portfolio motion for so long — and delivering such consis- is compounding than it is about any individual com- tent quality results — that it’s pretty obvious that pany compounding. their numbers are not mirages, right? By avoiding clinkers? I can’t help pointing out that lots of people DAN: What’s most important to us is that each com- once felt that way about, for instance Gen- pany in our portfolios has a massive competitive Subscriptions to eral Electric — albeit mostly without rigor- moat that allows for the compounding of growth to WellingonWallSt. ous analysis. Your quality obsession occur without a lot of risks. We’re not just going Welcome! pretty clearly keeps you out of deep trou- after the fastest-growth companies. We also want to Payable in research ble. But don’t you ever feel your winnowing own companies that we think have safety-like qual- votes or hard dollars. process a bit stifling — especially when ities. We want to protect capital, which for a growth contact: the market is chasing The Next Big Thing? manager, is not very common. Don Boyle DAMON: Mmm — no. Our screening and guardrails [email protected] are such that probably only 150 global large-cap I’ll say. How? 631-315-5077

WELLINGONWALLST. November 20, 2020 PAGE 9 DAN: We do that by investing across the growth performance, we’ve actually examined that. We wrote Subscriptions to spectrum. Typically, the vast majority of the com- a research white paper a few years back called, “The WellingonWallSt. panies we own grow their earnings at a double-digit 10,000 Portfolios Project.” The idea was to explore, Welcome! rate, so 10% or higher. But we have some com- “Are we actually good at what we do and if so, why? Payable in research panies growing between 10-11% and others grow- As well as, it possible for us to do better?” votes or hard dollars. ing at a 30% rate. The slower growers tend to be contact: our “safety” holdings, steady growers, even through And of course, you were impartial judges — Don Boyle recessions and challenging markets. DAN: We certainly tried — Let me explain. As I [email protected] said earlier, our Focus Growth strategy typically 631-315-5077 Your portfolio turnover is pretty low — holds around 20 companies at any particular time, DAN: Our hope is to keep it as low as possible. As and we hold all of them to our stringent criteria, long as the companies are compounding as we need and all that. So to answer those questions, we de- them to do, we’re very happy to not trade. We prefer cided to look back over 20 or 25 years of the his- not to trade. But the reality is, we rarely own com- torical data, saying, “Let’s figure out every panies for more than 15 years. There have been a combination of 20-stock portfolios we could have few, but our average holding period is five or six owned” out of the large-cap universe — meaning years — maybe a little bit longer for the global that the stocks just had to have market caps large strategy. We try to consistently take advantage of enough to be investable for us — and see how the our ability to shape the portfolio to make sure we long-term returns of those hypothetical portfolios are positioned well for the next five years. would have stacked up next our actual returns. What we wanted to know, after all that back-testing, Which is an eternity for most investors was where we would have ranked — and if we today. What would happen to your per- could have done better. formance, if you, say, eased up on just one of your guardrails? So all the hypothetical portfolios were DAN: We could do it, but it wouldn’t necessarily concentrated, but constructed randomly? make sense to do it! DAN: Yes, just 20 random large caps. But it turned out that it would have been quite computer-inten- DAMON: There’s a whole host of our competitors out sive and our partners doing the numbers-crunching there essentially doing that — managing growth suggested that testing 10,000 random large-cap portfolios not constructed with our guardrails. We portfolios against ours would give us plenty of re- think they’ve helped keep us out of trouble; helped sults, so that’s what we did — 10,000 iterations. keep us focused and kept the bar high. We try not to be tactical or activity-driven. We really try to I take it you liked the results? construct portfolios so that the businesses can drive DAN: What we found is that, on the basis of risk- the outcome from 30,000 feet. What we’re doing is adjusted return, or alpha, we were in the top, one- here is not rocket science. tenth of 1% or two-tenths of 1%. Even on the basis of just absolute return, we were in the top 6% or But I will say that even David Polen, our founder, 7%. So we beat almost every combination of 20- after coming up with our process and running it for stock portfolios you could come up with. And on a a couple of decades, was like, “What is going on, volatility-adjusted basis, we ranked very near the here? What are we actually doing? How are we de- tippy top. We feel that was no fluke, and that our livering these results by doing this basic set of ac- guardrails are a big reason for our outperformance. tivities — winnowing down the world to the best companies, buying them, holding them, owning Now, we’re trying to figure out some way to run the them, and letting them deliver compounding re- same type of simulation inside our guardrails. We turns. How is it possible that this produces top- would love to figure out how our performance would decile results? Well, that begs the question of what stack up against other portfolios we might possibly others are doing — have created while staying within our discipline.

Indeed, it does — That doesn’t seem impossible — you pre- DAMON: But we wouldn’t really want to do any- sumably already know what that universe thing else. was at any given time. DAN: There actually are some difficulties in doing DAN: But if you are asking if there’s something we that, because in our vetting process we make a lot of could be doing differently that would enhance our adjustments to companies’ accounting to put them

WELLINGONWALLST. November 20, 2020 PAGE 10 on a true economic look-through basis; we try to un- DAN: Right, but just an accounting entry, right? derstand the true economics of each business — There was no cash involved in the merger trans- something GAAP accounting statements don’t al- action; it was shares for shares. There was nothing ways reflect. To run that study, you’d have to make that made it an economically relevant number. And those adjustments for every company, and that’d be it didn’t take a rocket scientist to figure it out. If difficult because there’s some subjectivity to it. you took that $19 billion out of your return calcula- tions, Visa’s return on capital was more like 40% - In any event, we haven’t been able to run that test, 50% at the time of the IPO. but we still strongly believe that our highly selec- tive process and its stringent guardrails results in My point is that we do make adjustments like that, concentrated portfolios that put us in a uniquely when the accounting numbers are obscuring the advantaged place. So, could we change it? Sure, but true economics of a business. Most of them are chances are, if we did, we’d do worse. much smaller than $19 billion, though!

When our team gathered (all four of us at the time) Let’s hope! But let me switch back to your after David Polen passed away — and Damon re- highly concentrated portfolios. If 150 or so members this — the first that I said was, “Going global companies pass your screens, why forward, we don’t do anything different. We’re not not diversify your holdings more broadly going to change anything about our investment phi- across them? Received wisdom says that losophy or process because it works, and if we would be less risky. tinker with it, we’re going to make it worse. So, let’s DAMON: True, but that’s not our experience, or what make sure that we’re still executing it the right way, our record shows. We actually believe that our con- the way we’ve always done it. It works, let’s keep centrated portfolios, of just the best of the best of doing it.” those companies, are one of our huge competitive advantages — and what really distinguishes us and That’s telling. Yet the economic, business the team from our peers. In fact, portfolio concen- and certainly accounting landscapes have all tration tops the list of our competitive advantages. shifted, sometimes dramatically, since ’12. DAN: Well, the accounting has changed a bit, but Because? it’s easy for us to see through — see what is truly DAMON: Portfolio concentration really drives our economic and what’s not. We don’t make massive ability to outperform, produce excess returns over adjustments unless it makes economic sense. time. It’s really driven by everything we’ve been talking about — owning only the highest-quality For instance? growth companies, growing faster than the market, DAN: When Visa came public — I always go back and letting them compound their investment results to Visa and Mastercard because they make such over time. That’s pretty intuitive. good examples. When Visa came public, it was re- porting only a 9% return on capital and a 9% return The less intuitive side of it is that we believe con- on equity. But we knew very clearly that the eco- centration is also a big advantage in terms of pro- nomics of Visa’s business were much, much better tecting capital — than those reported numbers. We had studied American Express and owned it for many years at You must get a lot of questions from in- that point; we also already owned Mastercard by vestors worried that idiosyncratic risk — that time. So, why did Visa’s returns look so low? one of your holdings stumbling badly — could take a wrecking all to your returns. They were just executing poorly? DAMON: At times, but we’ve learned to lean on DAN: That was a possibility, but when we went Focus Growth’s 30-plus year track record. The through the accounting we could see that Visa was strategy’s returns have been a lot less volatile than an amalgam of a bunch of geographically separated, our peers’ and the indices’. And we’ve captured just Subscriptions to formerly not-for-profit entities that had been owned a fraction of our benchmark’s downside; only about WellingonWallSt. by different member banks in those different geog- 60% downside capture since inception in Focus Welcome! raphies. Prior to the IPO, member banks had basi- Growth. That lands us in the top decile — actually, Payable in research cally done a non-cash merger of all those entities in the top 1% of our peer group. votes or hard dollars. into the one new Visa. And in that merger process, contact: they created $19 billion of goodwill. And keeping the bar very high for inclusion in the Don Boyle portfolio has been really key — critical to produc- [email protected] That’s a huge slug of intangible assets — ing that result. 631-315-5077

WELLINGONWALLST. November 20, 2020 PAGE 11 Polen Global Growth Strategy was up almost 3% Now, this year has been quite interesting, to say the least —

Is that what you’re calling it? I tend not to be that polite. DAMON: It’s not been easy. While the markets have rebounded and we’ve captured more than 100% of the recov- ery from the bottom, the Still, passive indexing has been adopted first quarter was exceptional in all the wrong ways. Subscriptions to with quasi-religious fever by so many in- But even then, our Global Growth strategy partici- WellingonWallSt. vestors these days; adoration of the index- pated in only about 60% of the downside. In other Welcome! ing gods passes for received wisdom. words, our performance has been very similar to the Payable in research DAMON: You’re right that there are some religious patterns obvious in Focus Growth’s long, long votes or hard dollars. beliefs around concentration versus diversification. record — capturing more of the upside and less of contact: So you can’t convert everybody. But our big advan- the downside, over the long term. And our Inter- Don Boyle tage is that we have our 30-plus-year track record national Growth strategy, I might add, exhibits the [email protected] demonstrating the superiority of our concentrated same patterns over the last four years. 631-315-5077 Focus Growth strategy. It’s not just a thesis, or a back-tested portfolio simulation. It’s actually a But just because this has been such an unusual working result. And beyond that, we launched year, I did write a little looking back at shorter term Global Growth almost six years ago now; we performance in our September commentary. launched International Growth almost 4 years ago, and our other products, more recently. But you can Refresh my memory — see the same, exact patterns emerging in their port- DAMON: What’s really stood out to us is how dispro- folio return statistics already (Global Growth portionate the winners and losers have been as the graphics, this page). market has rebounded from its lows. Even with economies reopening, the shift of business online is I think you’d have to agree that the past six years persisting. The relative stability of subscription and have certainly been an interesting environment for recurring business models has also been recognized global investors. But, for instance, our Global in the markets. These highly recurring revenues Growth strategy, in 2015, when its benchmark, the contrast favorably with the severe disruptions that MSCI ACWI, was down for the year, was up nearly many brick-and-mortar and more discretionary 10%. And in 2018, when the benchmark was down businesses experienced, at least temporarily. And nearly 10%, our Global Growth strategy the net result has been that a relatively narrow group of companies has Polen Global Growth Strategy been driving market per- formance this year.

Not usually a healthy sign. But you seem to be hold- ing a lot of winners. DAMON: Fortunately, we do. Through the third quarter, the index was up less than 2%, with its top-30 holdings chipping in nearly 8% of its re- turn. Meaning the vast majority of its 3,000 con- stituents detracted from

WELLINGONWALLST. November 20, 2020 PAGE 12 its performance. This lopsided outcome is so clear years, and that informs what we invest in. Subscriptions to and the narrative so strong that the likes of Netflix, We’re investing in secular, not cyclical, businesses WellingonWallSt. Apple, Zoom and Spotify have left the rest of the with true competitive advantage, true differentia- Welcome! market in the dust. But we own none of them. tion, true durability and sustainability. We know Payable in research that, in the next five years, there will be a recession, votes or hard dollars. Too hot to handle? a crisis, an event. We know we’ll own our portfolios contact: DAMON: For various reasons. While we agree those through those drawdowns. That makes us really Don Boyle businesses are increasing in value, their extraordi- think through how durable and sustainable our [email protected] nary increases in valuation this year make us ques- business are — really pushes us into quality — 631-315-5077 tion how much is being driven by fundamentals as prepares us for rough patches. opposed to speculative expectations and multiple expansion. Remember, we want to concentrate in our In any event, concentration versus “diworsification” portfolios the quality growth businesses with funda- isn’t really as challenging of a conversation, from our mentals that best support their values. point of view, as you might imagine. Because we can offer overwhelming evidence that we’ve been suc- And our performance so far this year demonstrates to cessfully running concentrated portfolios for so long. us that we’re by and large on the right track. While our highly discretionary businesses (less than 15% of If only rationality weren’t so rare these days. the portfolio at the end of September) have seen and DAN: You’re right, obviously, that there’s a strong will see a significant short-term hit to earnings in move toward passive investing, especially in the 2020, we expect their earnings to rebound in 2021 U.S. large-cap space. But one of things we see quite and deliver positive growth — from 2019 to 2021— clearly on the institutional side is that most of the on a portfolio-weighted basis. And, on a whole port- big asset allocators don’t seem to go 100% passive. folio basis, those headwinds this year will be largely Instead, they want to go heavily passive but then offset by strong continuing earnings growth from most also have high-active around the edges, for some of our IT and communications services holdings, alpha generation. And we’re getting pulled into that which are more than 55% of holdings. conversation.

When you think about the magnitude of what hap- Even though your hypoactive — patient, pened in the first quarter and what’s going on, on a long-term — style likely throws many allo- global basis, to be able to say our portfolio’s earnings cators for a loop? are probably going to be about flat and still growing DAMON: Funny you should ask. As I’ve been saying, at a double-digit rate on a two-year basis, really it’s a huge competitive advantage that we’re not look- brings reinforces to us the value of concentrating our ing to put our portfolio assets to work for the next five portfolios in the most predictable and projectable or months, or even for 12 months. We’re investing for the sustainable businesses. next five-plus years. We firmly believe that it is un- derlying earnings growth that ultimately drives invest- You’re basically saying you prize resilience ment outcomes over time. And here, we are leaning over sex appeal? again on Focus Growth’s 30-plus year history. The DAMON: It works. Despite the market’s gyrations, we strategy has compounded at roughly 15% per year for believe our portfolio of quality growth companies an more than 30 years, and that return has been driven deliver double-digit earnings per share growth on a by the portfolio companies’ underlying mid-teens two-year basis. While this would be lower than the long-term earnings growth. mid-teens earnings per share growth that we target and have delivered in prior years, we would consider What’s more, because we’ve only owned a little this to be a strong result considering the environ- more than 130 companies, in total, over those 30- ment in the first quarter of this year, when busi- plus years, we could actually go back and decon- nesses were literally closing doors. And it implies struct what that earnings growth was, where it came we’ll get back to “normal” in a relatively short time, from. When we in fact went through that exercise, when you think in five-year increments, as we do. what it showed us was that the portfolio’s earnings growth has actually been incredibly stable. Even in It’s another proof point in terms of the resilience of unusual times, we’ve seen, pretty consistently, the portfolios — and it’s not because we predicted growth — even if it was more modest growth, dur- what’s happened this year. Nobody did. So we’ve ing downturns. And in most “normal” years, we’ve only done as well as we have because of our overall seen steady, double-digit to mid-teens growth, approach. We’re always thinking about the next five through and through, for decades. That’s pretty convincing —

WELLINGONWALLST. November 20, 2020 PAGE 13 DAMON: I can’t stress enough that we actually know kind of opportunity cost is a big mistake for us. And what has been driving our outperformance — and we’ve had situations like that. Fastenal comes to it’s a very different mentality than waking up on mind. That’s exactly what we did there, unfor- January 1 and trying to pick what stocks are going tunately, during a stretch when our benchmark rose to rise the most in the next 12 months. This is a significantly. marathon, not a sprint. That isn’t something that happens a lot, but it was a DAN: Let me interject here. I have to reiterate that lesson reminding us to be conservative on our our argument does seem to be striking a chord on growth estimates, especially when there’s a cyclical the institutional side — perhaps despite our “hypo- aspect to one of our companies. It was a reminder Subscribe active” turnover. Our Focus Growth strategy is win- that we don’t really need cyclical businesses in our ning allocations to be that high-active satellite that portfolios. Many of big asset allocators seem to want to have arrayed around their passive core investments these days. More often, though, our bigger mistakes in the past our clients So it’s interesting. have been errors of omission. Especially when our investment team was just Damon and me, we did of every The money management businesses that are defi- miss some companies along the way. But now our nitely being eaten away in this environment are the team has grown from 2 of us to 10, while our inves- imaginable closet indexers, the advisors who are fake active, or table universe has only swelled from about 100 size low active share. Those are going away. Those are companies to 150. So while we may still decide not definitely being replaced by passive indexes. But to own some company that turns out to be great, it’s and asset on the high active side, there are still believers. not going to be because we didn’t get a chance to research it in depth. I mean, we’re only human, but class Against all odds. we try to learn from all of our mistakes. DAN: Honestly, I think what’s going on is a great tell us they thing. Not just because we benefit from it, but be- Where have I heard that before? cause for a long time there have been so many ac- DAN: We don’t just say that. It’s part of Polen’s cul- subscribe to tive managers out there that didn’t earn their fees. ture. We train on communication within the team, and as a firm, we train on radical candor. What we on Too often, it was the only thing they were mean is, we want everybody to be able to speak the Welling WallSt consistent about. truth to each other. You have to first care deeply DAN: And that business model is kind of criminal, I about your teammates, right? You can’t just be an because it think, at the end of the day. Charging a fee to not asshole, you have and give them honest feedback. give your clients even an indexed return. Those makes them pools of capital should be indexed. That is the good What, no snark? side of passive investing. This winnowing of the DAN: The point is to avoid mistakes by being can- think. Others ranks is Darwinian. That’s the way it should be. did with each other and saying, “Hey, are we sure find the ideas we got this right? Constructively picking it apart all What has all your introspection told you of our decisions. So our research process now in- priceless. about your biggest mistakes over the last cludes a pre-mortem. 30 years. There must have been a few — If your cu- DAN: Certainly, we’ve had a few. I think the biggest Sounds depressing — have occurred when we have overestimated the DAN: No, it’s basically thinking through, “If this riosity is growth profile of the business and watched its mul- turns out to be an awful investment, what would’ve tiple compress, instead of expand. But we’re not been the reason?” Reverse engineering the invest- piqued, call often off by a lot. Earnings growth is usually quite ment decision. It’s not just listing a bunch of risks. Don Boyle predictable for our high-quality companies. Mean- It’s the whole team evaluating what could go so hor- ing, if we predict, say, 15% compounded earnings ribly wrong it would sink the position. (631)315-5077 growth over the next five years and we’re “way off,” the earnings will still be compounding, but only at If you identify that up front in the pre-mortem pro- 10%. That’s a pretty big miss for us. cess and still decide to make that investment, it sets up a situation where, if any pre-mortem risks start The pain comes if we paid 30 times for that com- to come true, you’re going to have the 10 other pany and because its growth rate slows, the multiple people on your team — trained in radical candor — compresses to 20 times. That translates into about a pointing it out and asking, Should we still continue zero return of us within a five year window. That to own it?”

WELLINGONWALLST. November 20, 2020 PAGE 14 cause of the internet, but environmental technol- So you’ve turned your whole research ogies, renewable energy, fintech — they are going team into devil’s advocates? to fall apart overnight, but those are big headwinds. DAN: It’s more that everybody’s on the alert to iden- What’s more, if you take out of the S&P 500 just a tify changes, rather than playing devil’s advocate, few of its biggest cap constituents, you find that the per se. I don’t believe in someone arguing just for index hasn’t grown earnings at all for 10 years. the sake of arguing. And I’ve told my team that I think any problems we have tend to be that we Sad but true. don’t dimensionalize the upside as much as we DAN: So my question is, if you’re investing in that should. We’re all human and wired to focus on the “growth index,” what’s going to actually drive re- downside. So we don’t necessarily need a devil’s ad- turns on those companies in it that don’t grow? Are vocate. What we need is honesty, to be open with their valuations just going to grow for no fundamen- each other, be vulnerable and candid with each tal reasons? Maybe, but that’s not going to last very other, which is not always an easy thing to do with long, right? very bright people, but I think we’ve reached that level and we keep training on it continuously. And, as someone who spent five years in deep value investing before coming here, I would tell you that DAMON: It’s also about diverse perspectives. We value/growth cycles are not a thing. At the end of are very unified around one investment philosophy, the day, it’s individual companies that are either process and belief system. But we all bring in dif- growing or not growing and paying dividends or not ferent life experiences, styles and ways of thinking. paying dividends that drive returns even if interest So our research team now includes, for instance, an rates play into it from time to time. ex-Top Gun pilot, an ex-private equity attorney, an ex-midshipman in the Navy — people with very di- That’s why we feel like we’re always in a really good verse backgrounds in finance and elsewhere. And spot. The S&P 500 earnings growth has been 6% or we operate very much as a collaborative, cohesive 7% forever. The Russell 1000 Growth, may be a little team. All of those different points of view are bit faster. But our portfolios have been growing very thrown on the table, which is so critical to getting to consistently in the mid-teens range. It’s not too hard a good outcome. for us to do that, and we don’t see any reason why our return should be wildly different going forward. Granted, this is a totally short-term query, but half of the Street is abuzz at this mo- Can you be more specific about the met- ment about a massive secular rotation to rics that make you comfortable you have a value from growth — on the basis of a few margin of safety built into your expecta- days’ trading. Are you? tions for your portfolios? DAN: All because Pfizer had good vaccine data. DAMON: Sure, it really comes down to analyzing the This is too short term a move for us, for sure, even if individual businesses, understanding their advan- it were to go on for months. What we always come tages, how durable, defensible, sustainable they back to is the reality that earnings growth, and div- are. It’s not until we get to the very end of that pro- idends drive returns. That’s it. cess, assuming all those conditions are in place and we really believe this is solid, a somewhat pre- As long as we can continue to find companies that dictable, sustainable business, that we think can grow earnings at the rates that we are looking through the valuation lens — about what’s a reason- for — that mid-teens earnings growth rate — over able estimate of earnings, five years from now; the long-term, our portfolio returns are going to what’s a reasonable valuation five years from now? pretty closely track that. Granted, if the starting point for the multiple on that growth is a little bit As long as we’re getting a double-digit investment too high, our return may be a little bit lower for a return, out of that equation, we’re good. We talked while. But at the end of the day, it’s going to com- a little about wanting our portfolios to span the Subscriptions to pound with our companies’ earnings growth. growth spectrum, from 10% growers to 30% WellingonWallSt. growers. And we fully expect that, over a five-year Welcome! And I really don’t like to think in growth versus holding period or longer, the p/e multiples on many Payable in research value terms. Face it, the companies that fall into of our businesses will probably come down, as their votes or hard dollars. the value indexes typically don’t grow earnings very growth rates mature. contact: much, if at all. And many are seeing real secular But we think that if the underlying earnings growth Don Boyle disruption of their business models, not just be- rate is strong enough — if they’re growing earnings [email protected] 631-315-5077

WELLINGONWALLST. November 20, 2020 PAGE 15 20%, 25%, 30% or higher — that will overcome a IPO at Ant doesn’t give you pause? Subscriptions to little bit of multiple compression — or even a lo, in DAMON: Actually, Alibaba owns roughly a third of WellingonWallSt. some instances. That’s kind of dynamic, forward Ant Group, which we also see as an incredible op- Welcome! looking expected return exercise we go through. portunity over time. Payable in research And we have to constantly keep checking our as- votes or hard dollars. sumptions. Sometimes, the market being the mar- Why? contact: ket, a valuation runs away from the fundamentals. DAMON: Think about PayPal (PYPL), which we ac- Don Boyle And that’s a flag to trim it or to sell it outright. tually own in both the Focus and the Global [email protected] While we’re long-term investors, we’re not married strategies. Well, Ant is actually multiple times 631-315-5077 to any of our holdings. larger, in terms of the total payment volume that they’re processing, than PayPal. It’s an incredibly How about giving me some idea of how all scaled and strong fintech business that we think will we’ve been talking about works in reality — get even stronger over time. putting some flesh on the bones of how you’ve decided to invest in a stock or two — Chairman Xi seems to have qualms about DAMON: I’ll throw out one example that is unique to that prospect — Global — Alibaba (BABA) is one of our larger hold- DAMON: Essentially, the IPO was delayed because ings. We see the opportunity as not only as an e- regulations are still fluid — being formed — in commerce disrupter — Alibaba is essentially the China. So in the final hours before Ant was planning Amazon of China — but as a whole-economy en- to come public, there were new regulations pro- abler. China’s brick and mortar infrastructure hasn’t posed that meant Ant might have to retain more of been nearly as developed as that in the U.S. or Eu- the loans it extends on its balance sheets — rather rope, where Amazon typically is the disrupter, offer- than just acting as a connector, creating a loan and ing an e-commerce alternative. then offloading it to a bank to provide the funding. These regulatory changes aren’t finalized, but would Alibaba is essentially allowing much of China to have amounted to a material change that needed to simply skip over that whole stage of brick and mor- be disclosed before going public, so they ended up tar commercial development, especially in the hin- deferring the IPO. terlands. So Alibaba is very much aligned with the Chinese government’s long-term interest in creating You don’t think Ant’s model will be wrecked? a more consumer-driven economy. When you look at DAMON: There clearly are short term impacts, and Alibaba’s new user growth, you see that roughly two- if they do increase the portion of loans that need to thirds of them are coming in from tier four, tier five reside on Ant’s balance sheet, that could affect the cities. They’re literally bringing peasants in rural valuation, maybe even growth profile. So, I wouldn’t China into the modern economy as consumers. say there’s no impact, but from Alibaba’s point of view, it’s still an incredibly valuable asset, one that Plus, Alibaba is completely dominant in the Chi- we think will grow over time. And it is not impact- nese market — having close to 800 million annual ing what we see as Alibaba’s tremendous compet- users and still growing — they’re basically serving itive advantages in China. almost everyone in China who’s buying online. They’re just miles ahead of anyone else. It’s just Could they perhaps be too great? Xi has kind of an unstoppable ecosystem. Alibaba is also also started looking at the antitrust impli- the leader in cloud services in China, which is still cations, of all things, of its internet dom- early in its growth, but they dominate China’s digital ination in China. Challenging the Party world. We think it’s a great growth profile. isn’t welcome there.

And it is profitable enough for you? DAMON: We are still comfortable. It’s an incredibly DAMON: Alibaba has much higher margins, in fact, dominant business model, clearly, but we actually than Amazon, because they’re predominantly a think that at the highest level, Alibaba’s interests third-party marketplace. They don’t buy as many and the Chinese government’s are largely aligned. It goods, hold them, and then resell them, as Amazon is driving the development of more consumer- does. And it trades at a reasonable valuation, ac- oriented modern economy. tually, despite all the great things I just said, less than 30 times forward earnings. We think that’s just We’re no strangers to regulation or antitrust issues; a tremendous opportunity. it comes with the territory when you own the best, most dominant businesses, as we do. Alibaba adds a Perhaps, but what China just did to the lot of value in a lot of ways. I can’t see how it would

WELLINGONWALLST. November 20, 2020 PAGE 16 be in the interests of the government to disable it. meaning the number of times they use PayPal per month — is accelerating as well. Maybe, but even in China there are unin- In fact, we’re seeing what Charlie Munger would tended consequences. And Xi does have a call a Lollapalooza effect on PayPal’s business. It thing for control. And you don’t actually was already compounding fast because of great hold Alibaba shares, right? It’s only pieces long-term secular trends and its own great compet- of paper called VIEs that trade in the West. itive advantages, but it’s all been kicked into a DAMON: Yes, it is a VIE structure, a variable inter- higher gear and started to accelerate even more. est entity. It’s not like directly owning shares of Al- phabet, for example. The VIE is a contract, I understand the pandemic has forced a lot essentially, provides a connection to equity own- of things online, but why PayPal? ership of the company. DAN: Part of what makes it exciting is how the busi- ness has changed. They also have Venmo, and both A derivative, in essence. platforms are enjoying very, very high engagement DAMON: It is not ideal. But it is a contract. The way with users. They are actively trying to bring in a we’ve thought about it is that it would be very dam- broader array of funding sources, so users don’t nec- aging or difficult for the Chinese government to do essarily just have to use their bank accounts, or anything untowards in regard to the investors in debit or credit cards, to fund transactions. Their these structures. users can tap cryptocurrencies, reward points, a lot of different “currencies,” which makes it even more In essence, they’ve blessed them, by virtue of allow- attractive to more people as a transaction platform. ing them to exist for quite a while — because their goal is to become more of a global hegemon; to be Then too, merchants increasingly want to have Pay- able to attract capital globally. It couldn’t blow up Pal or Venmo buttons on their websites because that all the international investment dollars in such large tends to make their sales conversion rates so much and visible asset as Alibaba or Tencent without higher. major ramifications. While there’s always going to be some saber rattling around these issues, it Why is that? doesn’t seem likely to us that the Chinese govern- DAN: If someone goes to buy something online and ment would do something that really impinged the gets to that payment landing page planning to use a rights of foreign investors. Foreign investment dol- credit card, about 50% of the time, they don’t go lars would then flee China, which is not what through with that transaction. Either they get they’re trying to accomplish. buyer’s remorse or just find putting in all the nec- essary information too much of a hassle. True enough. But what China has been up to in Hong Kong lately doesn’t exactly With a feature that PayPal has developed called comport with their long-term interest in One Touch, however, the websites’ conversion rate is attracting Western capital. about 90%. Merchants really like that, of course. DAN: That’s a fair point. They hate abandoned carts. So they really want that PayPal button on their website. So let’s talk about your domestic portfolio. DAN: On Focus Growth side, maybe one of our Hmm. Does the demographic of their users more interesting holdings at the moment is PayPal. skew a lot younger than the credit card companies’? Explain the attraction, please. DAN: On Venmo, for sure, yes. Venmo is definitely a DAN: Well, PayPal already was benefiting from e- much younger, more Millennial type user base, al- commerce long before the pandemic, right? It has so though that’s broadening out. About the PayPal user many secular growth opportunities in digitizing pay- base, I’m not entirely sure. My guess would be a lit- ments, e-commerce, cross-border trade that have tle bit younger. I mean, the average credit card user Subscriptions to been driving it for years already. It is already the is definitely an older, more affluent user. If you add WellingonWallSt. dominant digital wallet, outside of China. In short, in debit cards, PayPal’s average demographic is Welcome! it’s been a great growth business for many years. But probably similar. Payable in research with the pandemic, we’ve seen an acceleration of al- votes or hard dollars. most all of those things. And we are seeing a big ac- DAMON: One thing to add there, though, that’s impor- contact: celeration in the growth of PayPal’s users. They’re tant — PayPal has actually called out the growth in Don Boyle adding so many more users than they’ve ever added their users among what they call the “silver tech” de- [email protected] before. And the engagement of those users — mographic, which is essentially the 55 and older crowd. 631-315-5077

WELLINGONWALLST. November 20, 2020 PAGE 17 able to compound. With eBay taken out, the rest of Subscriptions to DAN: Tech-savvy older people — PayPal’s business is growing at 25% to 30% per WellingonWallSt. DAMON: Right, given the pandemic, the cohort at annum. Very, very fast. Welcome! higher risk for Coronavirus has really been forced to Payable in research embrace PayPal and other touchless technologies. Losing eBay won’t create a big divot in votes or hard dollars. And PayPal says that if someone tries their services PayPal’s revenues next year? contact: three times in their first 10 days, it’s a really good DAN: eBay is not totally going away. About half of Don Boyle sign that they’re a lifelong user. And that is the most the eBay business will go away. It’s been slowly [email protected] wealthy cohort, the biggest spenders. moving in that direction and it’ll create an incre- 631-315-5077 mental headwind for 2021, but we’re talking about DAN: It’s also significant that PayPal has been get- just a couple of percentage points off of growth. The ting much, much better at making its services just loss of that revenue is not going to be too material. really easy to use — which will help broaden out the user demographic. Anything else you’d like to mention? DAN: Well, Damon talked about having higher I must say, I’m not a big fan. Any time I growth companies and also more safety-like growth was forced to use it — maybe to make in- companies in our portfolios. Typically, over the ternational travel arrangements (re- years, our “safety” companies have grown a mite member those days?) — I found it a pain. slower than our mid-teens average, though they are DAN: Exactly. They still have work to do on their still good growers — often in sectors like consumer user experience, but it’s far better than it used to be. staples. We still own a couple of those today, but in- And the easier they make it, the more we’ve seen creasingly we’re finding that some of our faster-grow- their user engagement numbers increase. ing software businesses, especially the cloud, SaaS, recurring revenue business models, have real It used to be, as you imply that people would use “safety” characteristics — even though they’re faster PayPal only when they had to, but that’s changing. growing. We are referring to them as our new safetys. The latest statistics we’ve seen show that their most- engaged users do 30 or 40 transactions a year on Why are they safe in your eyes? PayPal. They want to get that number up to, first, DAN: Because they’ve locked in recurring revenue credit-card-like penetration, which is 10 times a streams. If you were a buyer of, say, Adobe (ADBE) month, and then to debit-card-like penetration, which or Autodesk software 10 years ago, 7 years ago — is once a day. That’s still a lot of growth ahead. you bought a license to use a specific program as long as you wanted. Then, when the company came I guess I’ll have to take another look. out with a new and improved version a few years DAN: Then you can use Venmo like the cool kids — later, you’d probably have to buy the upgraded ver- sion. But in between, you weren’t paying anything to Oh, no. Been there, done that, when my the software developer. kids were in college. I’m not that cool. DAN: Well, now they are compounding very, very But now most of the software developers have trans- quickly — even though they are up against some formed into cloud-based subscription businesses, headwinds in their business. and their customers pay ratably every month, every quarter, every year. Or they can’t use the software Such as? anymore. It’s a much better business model for the DAN: As larger merchants become a bigger percent- software companies. And what we’re finding is that age of their total dollar volume, the amount PayPal even though these are some of the faster growing can charge them shrinks, so their revenue per dollar companies in our portfolios, they’re actually also the of spend statistic is trending lower. But they’re still most resilient ones now. compounding at a high-teens, or 20% rate on a sus- tainable basis. Companies like Adobe and Autodesk used to have somewhat cyclical earnings profiles 10 years ago. Another headwind for them is eBay, which was a Today, not at all. And of course, the pandemic has huge part of their business for a long time. Not only made cloud-based software indispensable for work- is eBay itself shrinking, but eBay is planning to ing remotely. If you’re a creative person, you have move all of its transactions off of PayPal’s payments Adobe Creative software. If you’re in the architec- system next year. The thing about that is that eBay tural, engineering, or construction business, you has been growing so slowly that losing its business have Autodesk. And everyone is using Microsoft Of- will actually remove a drag on how fast PayPal is fice 365. We’re all in the cloud today.

WELLINGONWALLST. November 20, 2020 PAGE 18 As a result, the SaaS businesses have now become Any final words? far more resilient and stable and almost safety-like. DAN: Just to tie it all together a little bit. Polen Even though they come with relatively high multi- Capital has invested one way or over three decades ples, we think they’re well-deserved. with a tremendous amount of consistency. Even though the markets seem to have only gotten more Interesting. Has anything besides SaaS be- efficient over the years, we still seem to be able to come more safety-like? do what we’ve always been able to do — in a very DAMON: I can talk a little bit about another stock efficient part of very efficient markets. Now, we’ve we’ve added to both portfolios in the past year or so, entered different segments of the market with our Abbott Laboratories (ABT). But it falls more into our newer teams, and they’re executing, as Damon said, traditional definition of a safety as a diversified almost exactly the same way in their particular health care company. We owned Abbott many years areas of expertise. All backed by a tremendous cul- ago when it was an integrated pharmaceutical com- ture and investment philosophy. pany, before they spun out the pharma unit as AbbVie. Anyway, the Abbott Labs of today is a DAMON: Just elaborating on Dan’s point, what we do leader in nutritionals, both infant and adult, and in is very teachable, very repeatable. We’re executing diagnostics, as well as in branded generic drugs and it across many different products. We’ve built out a in medical devices. People may be more aware of it strong team of people with diverse perspectives, life lately for its success in developing COVID-19 tests. experience, all unified around a core philosophy But they’ve been a leader in all their businesses for and process. We’ve built a very vibrant culture all years. It’s an incredibly resilient business and about delivering for our clients at Polen Capital there’s a lot of growth across their product portfolio. under Stan Moss’ leadership, and that’s attracted a talent not just to the investment teams, but across Which are its real strengths? the firm. DAMON: One of their more exciting businesses op- portunities is in diabetes. Abbott’s FreeStyle Libre We’ve proven what we do for over three decades — continuous glucose monitor is not nearly as expen- and we’re excited to keep doing it for the next 20 sive as Dexcom’s, which was the market leader his- years and beyond to deliver more value to more torically. Abbott has quite quickly surpassed them clients — by staying very rooted and grounded in with a device that has similar efficacy and a much fundamentals and common sense and discipline. cheaper price, which is key. Unfortunately, diabetes is an epidemic and there’s been a big opportunity to And now you’ve just explained why most serve the long tail of under-treated people with type PMs don’t do it your way. Thanks, gen- 2 diabetics — if they had a cheap enough solution. tlemen. Abbott has come onto the scene and provided just that and it’s driving great growth. Abbott also has other very innovative products that are big suc- cesses, like MitraClip for mitral valve repair.

What’s more, despite the pandemic, demand for most of the products in Abbott’s portfolio have been incredibly stable. There have been temporary pockets of weakness when medical procedures were deferred or delayed. But if you needed a stent or a cardiac synchronization device and deferred the procedure in March, you probably went back and had it in June or July. So we’ve already seen a 90% plus recovery in the run rate on their medical de- vices. Their nutritionals business just kind of pow- Subscriptions to ered through. Diagnostics showed some impact, but WellingonWallSt. the success of their Covid-19 test is really helping Welcome! there. And their branded pharmaceuticals business Payable in research is doing okay. So Abbott is seeing strong growth de- votes or hard dollars. spite the environment. They’ll see it again next year. contact: It is a great example of one of our traditional type Don Boyle safetys delivering roughly double-digit earnings [email protected] growth through any and all types of environments. 631-315-5077

WELLINGONWALLST. November 20, 2020 PAGE 19 WellingonWallSt. Research Disclosure Welling on Wall St. LLC believes that its reputation for journalistic enterprise, intellectual indepen- dence and absolute integrity are essential to its mission. Our readers must be able to assume that Many of our clients of every imaginable size and asset class we have no hidden agendas; that our facts are thoroughly researched and fairly presented and that when published our analyses and opinions tell us they subscribe to WellingonWallSt. reflect our best judgments - and not the vested pocketbook interests of our sources, our col- leagues, our clients or ourselves. WOWS’s mission is to provide our readers with because it makes them think. thoroughly independent research, trenchant anal- ysis and opinions that are as considered as they are provocative. We work tirelessly to fulfill that If your curiosity is piqued, drop a line directly to mission. 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In other words, found it in my fifty-plus we don’t give investment advice. Don’t mistake anything you read in WOWS for investment advice. This publication does not provide sufficient infor- years in the financial in- mation upon which to base an investment deci- sion. WOWS does advise all readers to consult their brokers or other financial advisors or pro- dustry. It teaches you fessionals as appropriate to verify pricing and all other information. WOWS, its affiliates, officers, owners and associates do not assume any liability most of the techniques for losses that may result if anyone, despite our warnings, relies on any information, analysis, or opinions in the publication. And, of course, past performance of securities or any financial instru- needed to do deals.” ments is not indicative of future performance. Confidentiality and Trading Disclosure: All infor- mation gathered by WOWS staff or affiliates in — Mario Gabelli connection with her/his job is strictly the prop- erty of WOWS It is never to be disclosed prior to publication to anyone outside of WOWS and is never to be used, prior to publication-and for two week thereafter-as the basis for any personal in- vestment decision by staff, affiliates and/or members of their immediate households. All staff and affiliates of WOWS will avoid not only specula- Now in bookstores! tion but the appearance of speculation and may not engage in short-term trading, the short sell- ing of securities, or the purchase or sale of op- tions, futures, or other derivatives, including ETFs Welling on Wall St. Interviewee disclosure: Dan Davidowitz and Damon Ficklin are the co-heads of Polen Capital’s Large Company Growth Team research effort. Polen Capital, with $56-plus billion of reliant on derivatives. Any equity or fixed-income investments entered into by WOWS staff or affili- AUM placed under its stewardship by individuals and institutions, is a Boca Raton, FL-based growth manager that has been practicing and refining its concentrated quality growth investing meth- ates will be held for a minimum of six months un- odology for better than 30 years, with admirable results. less dispensation is received, under extraordinary circumstances, from WOWS’s legal counsel. Any Dan, who joined Polen in 2005 is also the lead portfolio manager of the firm’s flagship Focus Growth strategy. Prior to joining Polen Capital, Dan spent five years as Vice President and Research Ana- pre-existing direct investment interest in any lyst at Osprey Partners Investment Management. Before joining Osprey Partners, he spent one year as a Research Analyst at Value Line, Inc. and five years in the health care sector, holding various stock, mutual fund, ETF or partnership portfolio analytical positions at Memorial Sloan-Kettering Cancer Center. covered in an issue of WOWS will be specifically disclosed in that edition and that position will be

frozen for at least a month. Internet disclosure: Damon joined Polen Capital in 2003, the first analyst hired by the firm’s founder, the late David Polen. Besides co-heading the Large-Cap Growth research effort, Damon is the lead portfolio manager Electronic Communications Disclosure: The web- of the firm’s Global Growth strategy. From 2012 through June 30, 2019, Damon was a co-portfolio manager on the Focus Growth strategy. Prior to joining Polen Capital, he spent one year working sites and WOWS’ electronic communications can, as an equity analyst with Morningstar and four years as a tax consultant to Fortune 500 companies with Price Waterhouse. alas, fall prey of all manner of malicious activity. While WOWS takes reasonable and prudent steps For more information and important disclosures about Polen Capital, its strategies and investment offerings, please see:: www.polencapital.com to try to prevent its website, journals and com- munications from interception, corruption, infec- tion, contamination and other electronic This interview was initiated by Welling on Wall St. and contains the current opinions of the interviewee but not necessarily those of Polen Capital. Such opinions are subject to change without no- malefactors, there are even fewer guarantees in tice. This interview and all information and opinions discussed herein is being distributed for informational purposes only and should not be considered as investment advice of any sort. Infor- the realms of software and the web than in fi- mation contained herein has been obtained from sources believed to be reliable, but is not guaranteed. Certain information contained herein may be based upon proprietary research and should nance—where there are none. WOWS disclaims and not, in any way shape or form, be considered an offer or solicitation for the purchase or sale of any financial instrument. The price and value of investments may rise or fall. There are no guaran- cannot accept liability for any damages to com- tees in investment, in economics, iin research, or in life. puter systems as a result of downloading or opening contaminated versions its website, jour- nals or communications. No part of this copyrighted interview may be reproduced in any form, without express written permission of Welling on Wall St. and Kathryn M. Welling. © 2020 Welling on Wall St. LLC

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