Methodologies, Valuation

Interview with Ronald Canakaris of Montag & Caldwell

I was reading an excellent interview with Ronald Canakaris of Montag & Caldwell, in the Wizards of Wall Street book  by Kazanjian. Its pretty consistent with the process we have arrived with thus far. Here’s a quick summary of his investment methodology:

  • Screen for companies with 10+% growth.
  • Shows strong earning growth over the intermediate term (+- from current point in time) in relationship to the earnings growth of other companies. That’s the timing device.
  • Best measure of value is the present worth of a future stream of income, which is the present value of each year’s dividend, if there is a dividend, and the present value of the projected price we hope to receive 10 years out. That projected price would be the tenth year’s earnings times the reciprocal of the discount rate. If the hurdle rate is 10%, we put a 10 multiple on earnings 10 years out and then discount it back to the present; if the hurdle rate was 6%, we’d use a 16.7 multiple. Remember you have two income streams for all dividend-paying stocks — dividends and the projected price.
  • The hurdle rate is related to the level of bond yields and the financial characteristics of the company. Because stocks have a higher standard deviation in relationship to bonds, they always require a higher rate of return. A company whose earnings variability is low, whose financial characteristics are very attractive, and whose stock trades well will have a lower hurdle rate than a company whose earnings are more variable or whose financial strength and financial profitability ratios are less favorable. We have an array of discount rates for different companies.
  • You need 4 ingredients to determine present value:
    1. Normalized earnings (at the starting point), i.e. earnings that can be earned in good and bad times. Figure that out by analysing historical ROE and historical profit margins and determine what a good mean is. For cyclical companies, you want to pick mid-cycle earnings, or the kind that are sustainable on the company’s equity.
    2. Payout ratio. Look at historical data and what management suggests the payout will be going forward.
    3. Growth rate of dividends and earnings.
    4. Hurdle rate, i.e. your required rate of return.
  • Want to buy stocks at about 20% discount to present value
  • Minimum market cap of $3 billion
  • Typically hold 30 to 40 stocks
  • Bottoms-up process with a top-down perspective. Look into the industry trends, demand for the company’s products, the company’s market share position, how much opportunity they have to increase market share. Go through the income statement and balance sheet analysis from top to bottom, looking at sales, the potential for sales growth, global opportunities, how well management controls costs, the nature of the accounting, whether it is conservative or liberal, the strength of the balance sheet, and the potential for financing.
  • 30 to 50% turnover
  • Sell discipline
    1. When a stock gets to a 20% premium to fair value, either cut back or sell. This is because when a company develops momentum in its core product line, that momentum is usually stronger than expected and lasts longer than investors expect. Having this 20% rule keeps us from selling too early
    2. When a company has an earnings disappointment, we analyze the situation. If we’re not willing to add to our position, we sell the stock. This will keep us from freezing up and hoping and praying things will get better and wind up spending much of your time in meetings discussing one stock that may be 2% of the portfolio. If we’re not willing to add to positions when a company has an earnings disappointment, we go on to something else.


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