Commentary

Concentrated Strategy

June 30, 2020

THE MARKET ENVIRONMENT
Despite significant market volatility that carried forward from the first quarter, key U.S. indexes rebounded and finished higher for the second quarter. Notably, the S&P 500 Index logged its best quarterly performance in more than two decades. Investors took solace from incremental news that science and medicine continued to make headway developing coronavirus treatments and vaccines. At the same time, several states have seen record increases in coronavirus infections and some authorities have reinstated pandemic-related restrictions, which reignited a degree of investor anxiety. Businesses have been resuming operations in fits and starts and unemployment claims have appeared to stabilize, which points to a convalescing real economy. Even so, policymakers projected that the U.S. economy will likely shrink by 6.5% in 2020 and at year-end, the unemployment rate will be about 9.3% (compared with 11.1% today). Also, while the Federal Reserve pledged to implement extraordinary measures in the near term to support economic recovery, Chairman Jay Powell stated that key interest rates will probably remain near zero for two more years.

Simultaneously, heightened recognition of racial inequities and injustices prompted large-scale protests (and, in several cases, riots) to break out across the country and around the world. Surging protest activity that lasted weeks interrupted newly reopened businesses just emerging from pandemic-induced shutdowns, which led to further market volatility. The widespread call for change caused many organizations to publicly implement practices to fight racism, emphasize diversity, and eliminate offensive images, symbols and product brand names.

Although U.S. equity prices fluctuated throughout the second quarter, we contend that the long-term fundamentals of the companies we own held relatively steady. In fact, market upheaval presented us with a greater than average number of new investment candidates and we initiated positions in new holdings that met our investment criteria. In addition, we have been increasing shares of current holdings that became more discounted compared with our intrinsic value estimates. And we have trimmed share counts of holdings with prices that have gained a healthy amount of value. Our focus remains trained on using market circumstances advantageously to strengthen our clients’ portfolios, which has led to an elevated level of activity in recent months. However, we believe strategizing in this way can lead to meeting our goal of effectively positioning portfolios to benefit as the market improves.

THE PORTFOLIO
Top Performers:
Alphabet’s share priced tracked a general recovery in the U.S. equities market. In addition, the company delivered reassuring first-quarter results in April as exhibited by a 13% increase in total revenue. Both the YouTube and cloud segments grew 33% and 52%, respectively, as YouTube finished March at a high single-digit growth rate. CFO Ruth Porat also indicated the company is already seeing “very early signs of recovery” in search advertising. In our view, the return to more commercial behavior among users is a sign that things are moving in the right direction. Notably, Alphabet executed $8.5 billion in share repurchases in the first quarter versus $3.0 billion for the first quarter in 2019 and indicated it intends to maintain the increased pace of buybacks for the duration of the year.

Workday’s first-quarter earnings report proved encouraging to investors as revenue totaled $1.02 billion, which was in excess of analysts’ expectations ($1.00 billion), and amounted to a 23% increase year-over-year. Management guided for 19% revenue growth for the full-year period. In the enterprise software business, Workday signed deals with Fannie Mae, Okta and an unnamed large health care company with more than 50,000 employees. Management noted on its earnings call that the recent mandatory work-from-home environment across the world sparked increased interest in cloud-based financials. The company is cautiously optimistic that the trend toward cloud-based enterprise software business may accelerate once the world moves through this short-term uncertainty. In our view, Workday possesses an excellent competitive position with a long-term growth runway and a best-in-class management team.

Pinterest announced preliminary first-quarter results in April, including total revenue that exceeded consensus expectations set prior to the coronavirus. However, the company’s share price declined following the release of official results in May that lacked full-year guidance. Despite this, we appreciated the 35% increase in revenue on user growth that significantly exceeded consensus. Since mid-March, CEO Ben Silbermann noted a more than 60% increase year-over-year in search and a 60% increase in new board creations. Later, positive May internet traffic figures provided a boost for Pinterest in June. Minutes spent on mobile devices increased 11% year-over-year, with 87% of that time spent on mobile applications. In our estimation, the current pandemic has a smaller effect on Pinterest than on many other companies and it may even benefit from lockdowns as people devote more time to their hobbies. We believe the company is undervalued and that the investment can continue to provide value for our shareholders.

Bottom Performers:
Centennial Resource Development’s share price was negatively impacted by the decline in oil prices at the end of the first quarter. Considering the challenges facing the company, we opted to eliminate our position in Centennial in April in favor of other opportunities in which we have more conviction. Centennial was the only detractor during the second quarter.

During the quarter we initiated positions in Manpower and Workday. We eliminated Centennial Resource Development Group and General Motors during the quarter.

Past performance is no guarantee of future results.