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Welcome to Soundbites – weekly insights on market trends, and investment strategies, brought to you by Investment Executive, and powered by Canada Life.

For today’s soundbite, we discuss analyzing opportunities with Lauren DeMore, assistant portfolio manager for Putnam Investments. We talk about corporate analysis, giving stocks time in the portfolio, and knowing when to sell. We started by asking what she looks for in the companies she invests in.

Lauren DeMore (LD): What we focus on the most really is the cash flows the company is generating and how they’re going to deploy it, and then looking at whether we think the multiple they trade at reflects the value that they’re contributing. And so, we’re looking for companies that are maybe trading cheap relative to peers despite having similar prospects, or even ones that are trading in line with peers but have much better prospects. So, we’re always looking to harness our valuation relative to something, and we tend to focus a lot on cash flow when we’re looking at those valuations.

Why getting cash out of the company is not always what investors should want.

LD: We don’t always want management teams to return the most cash to us as they possibly can. Sometimes we’re happy for them to keep that cash and reinvest it into the business in order to drive earnings for more cash in the future. And we don’t necessarily need cash returned to us in dividends if they have a more cyclical or capex cycle. And when that generates cash that can be deployed into growing the business or buying back shares, that’s another way to juice up earnings or cash flow per share.

Why she’s not one to turn stocks over very quickly.

LD: I think a lot of people say that they’re long-term investors but have turnover of 100%. Ours is really consistently 20% turnover or less, which means we hold shares for, on average, five years or longer. That’s really intentional, because we strongly believe that it takes time for value to matriculate. Often different parts of the thesis are firing at different times. And so, when we buy a name, we really intend to own it for a long time.

A few examples of stocks that have lived up to their promise.

LD: A good example of that would be Charter Communications [Charter Communications, Inc., based in Stamford, Conn.] the second largest broadband provider in the U.S. A few years ago, our analyst said the market thinks broadband subscriber growth is going to decelerate, and Charter had a weak quarter as they were integrating an acquisition, and when that completes their free cash flow is going to go up substantially. What happened over time was, the company proved to the market that broadband subscriber growth hadn’t decelerated and, you know, it took off again once they had integrated this acquisition. Free cash flow went up, and over the last few years they bought back about 25% of shares.

Also, Southwest [Southwest Airlines Co., headquartered in Dallas, Tex.] is the phenomenally run airline that is unique among peers in that it has very low to no leverage. It’s on its front foot, primed to benefit from the return to normal, at least for consumers. And they’re also gaining share in domestic leisure travel because they’re adding new routes as some of the weaker players give up slots at airports. Their shares have about recovered to where they were pre-Covid, but we don’t think that that truly values the opportunities that they have ahead of them.

And finally, what about sell discipline.

LD: While I’d like to say that, you know, our sell discipline is all based on stocks shooting through our price targets and us waving goodbye, you also have to be disciplined about selling stocks that have underperformed where the story has changed. And I think that can be really hard. We are very valuation focused and mindful of exiting a name when we think all of the good news is priced in and reflected in shares. So, one example of that would be Apple [Apple Inc., based in Cupertino, Calif.]. It’s a name we’ve owned for several years. It’s a great brand, they have great hardware, a very strong services business. But by the summer [of 2020], Apple shares were trading at 30 times, which is twice their historical average. And I think what might surprise some people is that Apple was actually barely growing earnings in the last several years. Its five-year earnings CAGR [compound annual growth rate] is about 2%. And, for us, we just felt like that was too rich. We had trimmed it earlier in the year, and we liquidated it in July. So, you really have to be very intellectually honest about whether the story has changed, whether this is really the best use of capital, and whether the range of outcomes is in your favour.

Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life. Our thanks again to Lauren DeMore of Putnam Investments.

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Thanks for listening.

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