| Philosophy and Process
Franklin Street Partners attempts to invest in companies that possess an open-ended market opportunity, defensible market position, above-average operating margins and strong returns on capital. These characteristics enable companies to sustain a high and accelerating growth rate over a multi-year period. We focus on sustainable as well as absolute levels of growth, believing that the ability to sustain current levels of above-market growth is a critical variable in valuing equity securities. Our valuation methodology and competitive edge focus on determining four factors:
- Return on invested capital
- Cost of capital
- Earnings growth rate
- Duration of the growth rate
We believe the duration of the growth rate is the most important of these four factors. We estimate the duration by analyzing the size of the market opportunity, potential for market share gains, margin expansion opportunities, product life cycles and cash needs. The duration varies with our confidence in projecting a company’s future earnings and cash flow streams.
About two-thirds of our holdings are sourced from identifying themes that can enable sustainable revenue and earnings growth. These themes are identified through observing news events, leveraging ideas from business leaders and academics in the Research Triangle area of North Carolina, and monitoring opportunities created by price volatility in the markets. The other one-third of our holdings is composed of stocks where we have identified a positive catalyst. We define a catalyst as an event—such as a new product development, unexpectedly positive earnings release or increase in operating leverage potential—that can cause a stock to be viewed by the market in a more positive light and valued accordingly. We employ a research process based on fundamental analysis. We conduct due diligence in advance of taking a position in a stock to include an analysis of a company’s operations, capital structure, management, customers, suppliers and competitors. All internal research takes place in our office in Chapel Hill, North Carolina.
Stocks are purchased if they possess a favorable risk/reward ratio as a function of the following three measures:
- Our 12-month price target
- Our downside risk target
- Our confidence level
Stocks are sold if valuations exceed the target warranted by our forecasted level and duration of earnings growth. Stocks will also be sold in anticipation of a negative marginal change in its fundamental outlook. Finally, stocks that decline 20% from their purchase price are re-evaluated by the entire investment team. |
