PORTFOLIO PERFORMANCE
Second quarter 2008
MANAGEMENT
Richard Skeppstrom II
Managing Director, Portfolio Co-manager
- Joined Eagle in 2001
- 17 years of investment experience, including 15 years as a portfolio manager
- Covers consumer staples, communications, financials and leisure
- B.A. in mathematics (1985) and M.B.A. (1990), University of Virginia
LARGE CAP CORE
GROWTH at a REASONABLE PRICE
Eagle's Large Cap Core program strives to provide long-term capital growth by investing in established companies that are expected to exhibit consistent earnings growth. The program employs a "growth-at-a-reasonable-price," or GARP, style, which means that portfolios are constructed with securities that appear poised for above-market growth rates at price-to-earnings multiples that are in line with the S&P 500 Index.
INVESTMENT PROCESS
Eagle's Large Cap Core program is managed by a team of co-managers, each with industry-specific responsibilities and buy-and-sell authority. The group's combined effort is team management at its best.
In selecting portfolio holdings, the team initially picks stocks from the 500 largest names by market capitalization. They immediately eliminate deeply
cyclical stocks, high multiple stocks, companies with unproven business models and businesses without competitive advantage.
Portfolio co-managers use intensive fundamental analysis to develop proprietary earnings and valuation models for each company they follow.
- An understanding of key drivers helps develop proprietary earnings estimates and growth rates for each company.
- Explicit five-year earnings and terminal-relative P/E ratios form the basis for discounted cash flow (DCF) analysis.
- Market- and company-specific historical levels, modified for estimates of the future risk in the business, help develop relative P/E ratios.
The initial screening leaves about 150 names, which the group divides roughly along
sector lines.
Know What You Know
A co-manager then develops a proprietary earnings model for each company. The co-managers believe they need to have a clear understanding of a company — what it does, how it does it, who is buying its products, how it plans to grow and whether those growth expectations are realistic — to make prudent investment decisions. This is the heart of the Large Cap Core team's process. They do not rely on a company's earnings projections or consensus estimates. Instead, each co-manager develops his own earnings estimates based on historical data and current comparables. It is not uncommon for a co-manager to spend months meticulously reviewing company financial reports and projections, reading about industry trends and developing best- and worst-case scenarios before coming to a conclusion about what he thinks is a reasonable growth rate for a company. Then, team members enter the data they have developed into their quantitative valuation system that assigns rankings for each stock. The top third is comprised of those stocks that are relatively undervalued and are candidates for purchase. The middle third is made up of what the team considers fair-valued stocks. Finally, the bottom third is comprised of those stocks deemed to be overvalued. A holding that falls into the bottom third of the list is likely to be sold.
Sell Discipline
The relative valuation model drives the sell discipline: a name becomes a potential candidate for sale when it begins to drop below the median in the rankings.
- If the company has a relatively full valuation but still has good fundamentals, a co-manager will put it on a watch list for sale if its valuation rises further;
- If the company has a relatively full valuation and its fundamentals begin to deteriorate, the team generally sells it;
- The team sells any company that falls into bottom third of the rankings;
- Due to the co-managers’ reliance on proprietary growth estimates, a company becomes an immediate candidate for sale if the team loses its confidence in the management team or the scope or veracity of disclosure from a company.
Accountability
The last point is key. Disappointments happen in the stock market, but Eagle's Large Cap Core team will not hold on to a security whose fundamentals are no longer explicable to the responsible co-manager. Further, the team's structure — the person who decides whether to buy or sell a stock is the same person who has analyzed the company — ensures accountability because each co-manager is responsible to the others for his holdings' performance.
The Large Cap Core team believes it can reward long-term investors by delivering above-market returns at below-market risk by investing in businesses it understands; by buying established, but growing, companies; and by paying reasonable prices for those companies.
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