In a world where market trends can sway investor sentiment, our Concentrated Dividend Equity Strategy takes a different path. At the heart of this Strategy is a belief that behavioral biases lead to mispriced stocks.
Portfolio Manager Mike Alkhazov explains how a contrarian viewpoint, a rigorous focus on margin of safety and business quality, and a flexible investment mandate allow the Strategy to capitalize on mispriced stocks.
Q: What informs your stock selection process?
Mike: It might be helpful to start at a high level with our value-oriented approach before drilling down to stock selection.
We typically begin with the fundamental question: "Why does a stock mispricing exist?"
The explanation that makes most sense to me is founded in behavioral finance. After years of a trend being in place for a company or industry, whether it's positive or negative, investors often bias themselves to thinking the trend will continue indefinitely. Once they make up their minds about this, they tend to underreact to new, contradictory information rather than admit they made a mistake. This behavioral bias leads to mispricing in the market, and it naturally pushes us toward a contrarian mindset. We look for opportunities to take advantage of mispriced stocks by investing on the other side of trends. Taking the opposite view of a prevailing trend can be uncomfortable but rewarding.
Q: How does your view on risk affect your investment decisions?
Mike: A general observation that has shaped my investment approach is that there are a lot of people who seem more confident about everything than I am about most things. I believe if you’re not clairvoyant and aren’t absolutely certain you can overcome the randomness of the market over the three, five, or 10 years that you plan to hold a stock, your investment process should include a margin of safety. This leads me to build a margin of safety into my approach.
Q: How do you define and implement a margin of safety?
Mike: Unlike many traditional value investors, our margin of safety is not determined solely by stock price. More important to us is the quality of a business. Naturally, we also consider stock price, making sure we’re not paying too much for a company or buying a business that’s cheap but also broken.
We also analyze the quality of earnings, balance sheet strength, regulatory risks, and the durability of a company's competitive advantages—all of which help us identify businesses we believe can weather various challenges and continue to perform well. Through this process, we end up with a basket of stocks we have the highest conviction in.
Q: Will you elaborate on your approach to analyzing individual businesses?
Mike: Our goal is to truly understand a business and its competitive advantages—everything from brand strength, scale, and financial power to unique assets that competitors can’t easily replicate and potential regulatory advantages.
We also evaluate whether these competitive advantages are sustainable. This involves looking at the industry dynamics and the quality of the management team, assessing whether they’ve been good allocators of capital and are incentivized to align with shareholders' interests. We also consider whether the runway for growth is long enough so that there is an opportunity for compounding.
We focus primarily on mature businesses because they often generate excess cash flow, enabling them to pay and increase dividends. However, our flexible mandate allows us to invest in companies even if they don't currently pay dividends. Ultimately, our objective is to estimate a company's structural earnings power, normalized earnings power, and the normalized growth rate of those earnings over the next five years.
Q: How does the Strategy’s flexible investment mandate benefit investors?
Mike: Our process emphasizes managing dividend yield at the portfolio level rather than the stock level. This flexibility enables us to diversify by investing in stocks that conventional dividend equity strategies typically overlook, including non-dividend-paying stocks.
If a company's business model, profitability, cash flow, and earnings meet our criteria, and the company returns capital to shareholders through share repurchases or debt reduction, it can still be a candidate for investment—even without paying dividends. In fact, we've seen several instances where non-dividend-paying stocks in our portfolio have transitioned to paying dividends, demonstrating the effectiveness of our flexible strategy. This flexibility not only broadens our investment universe but also positions us to capitalize on companies' evolving capital allocation policies.
Q: What role does concentration play in your portfolio management?
Mike: When we find businesses that we have high conviction in, we want to make those investments count. This naturally leads to a more concentrated portfolio, as we allocate more capital to our best ideas. Our thorough analysis and demand for a margin of safety mean that we can confidently hold larger positions in fewer stocks, which we believe will generate superior long-term returns for our investors.
Check out this recorded interview with Portfolio Manager Mike Alkhazov to learn more about our Concentrated Dividend Equity Strategy.
