Interview With Howard Rothman, Chief Investment
Officer of Vision Investment Advisors
What is your investment philosophy?
Howard Rothman: We are an investment management firm focused on helping our clients create and preserve wealth by allocating capital to large and mid-cap stocks in a prudent fashion. Our focus is on well managed companies that tend to be market leaders in their industries and we like to buy them when we believe they are attractively priced.
Apart from the ability to generate cash, we examine a company's prospects for growth searching for companies which we believe have sustainable attractive returns on capital. We also analyze the competitive landscape a company operates in to determine if it is a market leader. We favor companies that have more stable, steady growth, rather than cyclical growth. We prefer sectors including financial services/banking and mature technology because of their generally stable growth characteristics. Within sectors we tend to favor brand names. In general, we avoid capital intensive businesses because they often do not generate free cash flow and a steady return on capital on a consistent basis.
We attempt to create wealth for our clients by selecting companies with growing revenues and earnings. Investing in these companies at attractive prices should enhance that process and we are very conscious of not paying too high a price. If you pay 50 times earnings for a company, and at the end of the investment period, it is worth only 20 times earnings, then you haven't really done yourself a favor unless the company has experienced phenomenal growth, which is difficult to sustain over long periods of time as the sales base gets larger.
How do you select stocks in Vision Investment Advisor's E-Portfolio?
Howard Rothman: There are over 10,000 publicly traded companies in the Standard & Poor's Compustat Database. The first cut we make is based on market capitalization. We focus on large and mid-cap companies, so we are generally running market caps over $2 billion. We also want strong balance sheets. We are looking for companies whose credit is investment grade rated because of our conservative nature. Then we screen for companies with the ability to sustain high returns on equity. We believe a high return on equity is important because it indicates that the company can provide a handsome return on its base capital.
We attempt to measure the predictability of earnings using various data sources such as The Value Line Investment Survey. Earnings predictability coupled with an examination of a company's history helps us to determine whether the company has been able to grow its earnings in a consistent fashion over time. When all is said and done, our selection process reduces the universe of stocks down to between 30 and 50 companies.
We then analyze the fundamentals of each target portfolio selection including sales growth, return on equity, balance sheet strength, competitive position and cash flow generation. If the company generates a reasonably stable stream of free cash flow over time and if we have a good idea what it is going to be doing in the future, then company is one that we want to own.
What kind of sales and earnings growth rate do you seek in companies you select?
Howard Rothman: Our optimum sales growth rate is between 6%-10% annually. We don't feel a 20% annual sales growth rate is sustainable over the long term. Companies with significant cash flow can usually pull out a little bit more in earnings growth because they can either buy back stock (which reduces their share count and increases earnings per share), pay down debt (which reduces their interest expense and increases profit), or make acquisitions, which may enhance sales and earnings growth.
We are looking for annual earnings growth in the range of 8%-15% for companies in our E-Portfolio. Long term, the S&P 500 companies have grown earnings around 6%-7% annually. So, if you can put together a portfolio that you think has a stable opportunity of growing earnings 8% -11% annually, then you have outpaced the S&P 500. A potential 10% annual growth rate should double the earnings of the company every seven years. Investors can create wealth if they can stick to their program and allow earnings of these companies to compound.
What research sources do you use to augment your own internal research?
Howard Rothman: Generally speaking, we use independent research that is generated from sources outside of traditional large brokerage firm research departments. We find this research to be unbiased and objective. We look at sources such as Value Line, Bloomberg and Ford Institutional Research. These research sources provide us with the quantitative analysis for us to select the few quality stocks that we are seeking and gives us an ability to see important company factors over a five or ten year span.
Is all of your research fundamentally based or do you utilize technical analysis?
Howard Rothman: Our process to select stocks is done through primarily fundamental research, but the timing of entering or exiting a given position may take advantage of technical research.
Do you invest only in domestic stocks or do you also purchase international stocks?
Howard Rothman: First, many of our domestic stocks operate 50% or more of their business internationally, so we believe that our U.S. companies give us a broad international exposure. Second, from time to time, we will select some international stocks (utilizing American Depositary Receipts) and potentially select some Exchange Traded Funds that may invest in various regions around the world.
What is the typical turnover in the E-Portfolio and what is your feeling on turnover?
Howard Rothman: Our turnover in comparison to most mutual funds is low. Our belief is that when we find the right stock position, it should be good for a period from two to five years, not six months to a year. We typically change only a small percentage of stocks in the portfolio per year.
Vision Investment Advisors is not a trading shop. We have relatively low portfolio turnover, and we patiently wait for buying opportunities. Much of that is driven by our philosophy that once we purchase a company that is, or has tendency to be a market leader, and it has good growth prospects, we want to let it run. The valuation enhances the compound power of the business; however, valuation is not the only driver of wealth creation. We give the compound process a chance to bear fruit. We also strive to be tax efficient. Turnover and capital gains taxes can seriously impair an investor's total return.
Given our aversion to trading as a background, there are two situations where we would generally sell: one is a ridiculous valuation. If our clients are fortunate enough to hold a stock that appreciates to the point that it becomes clearly overvalued, we would likely sell in that circumstance. The second reason is deterioration in business fundamentals such as competitive position, balance sheet quality or growth prospects. A major risk in owning a stock is that it does not grow as contemplated because the fundamentals deteriorate.
How do you react to extreme volatility in the market?
Howard Rothman: We look at extreme volatility, especially volatility that has negatively impacted the value of stocks, as a great buying opportunity for those stocks. We recognize that the marketplace sometimes undervalues a stock and sometimes overvalues a given stock (as evidenced through the stock's share price) and is therefore not always operating efficiently. Those undervalued stocks are what we believe are good opportunities to buy or add to existing positions. Generally speaking, we do not use those opportunities to exit out on weakness, we generally exit out of positions when they become fully or overvalued.
What are your thoughts regarding dividend paying stocks?
Howard Rothman: We are pleased when we can find a growth stock that meets our criteria and also has a quality dividend or a dividend that has been rising steadily over the past several years. While it is not our first criteria in selecting a stock, a good paying dividend is something that we are happy to have and it certainly can add to the overall return.
When would you employ a strategy of writing (selling) covered calls on an existing position?*
Howard Rothman: We believe a sound and prudent way to add income and gain a limited measure of downside protection in a client's portfolio is to strategically write (sell) covered call options. Unlike writing naked calls, where risk can be unlimited, writing covered calls limits one's risk by virtue of owning the underlying stock itself. In writing covered calls, the option writer (seller) receives cash (premium) for selling the call but, in exchange for the premium, forfeits any increase in the stock price above the option's strike price.
Certain market conditions are conducive to covered call strategies. For example, in a consolidating, mildly bullish, or even in a slightly receding market environment, the option premium can typically provide additional return to investors, without a significant risk of the stock being "called away." The major negative factor in writing covered calls occurs if a stock rallies above the strike price. Investors keep the premium received from selling the options, but then sacrifice additional gains on the underlying stock above the strike price. It is an issue of opportunity risk.
In a challenging rate environment, what advantage do you think that Vision Investment Advisors can offer investors who participate in the I-Portfolio?
Howard Rothman: Generally speaking, we seek the highest rate of return for our I-Portfolio by identifying high quality issues of preferred stocks. The preferred stocks trade every day on the New York Stock Exchange and offer us excellent liquidity. Furthermore, because of the need for companies to issue preferred stocks instead of diluting their common stock, these issues tend to provide a quality return. A portfolio of preferred stocks can offer our clients better returns than investing in other interest bearing securities.
In addition, we are regularly monitoring the overall quality of the underlying stocks from a credit standpoint. Any deterioration that we perceive in these credit issues would give us signals to get out of specific investments or the market as a whole. We are not just trying to maximize yields; we are also attempting to protect the principal.
How do you maximize income when investing in preferred stocks?
Howard Rothman: Generally speaking, we seek preferred stocks that have the highest rate of return, usually defined as yield to call or yield to maturity, without compromising or subjecting the account to any undue level of risk. We tend to utilize only investment grade preferred stocks. While rates will vary from time to time, we have been able to establish portfolios of preferred stocks currently yielding between 6.0% and 7.5% per year.
Do you consider yourself a bullish or bearish investor?
Howard Rothman: A bullish investor! We believe that in the long term, the specific companies in our E-Portfolio are growing their earnings an average of 8% to 15% per year and in turn, that growth of earnings will over time be reflected in the price of the underlying stocks. Therefore, we believe that over time the market will continue to head higher as our specific stocks tend to move in the same direction as the overall market.
There are obviously times when the market will be bearish, either briefly or on an extended basis, but we feel that there can still be attractive opportunities to invest in.
What are your thoughts regarding asset allocation and diversification?
Howard Rothman: One should not keep all their eggs in one basket. Whether its stocks, bonds or U.S. Treasury instruments, money should be allocated to different arenas based on each individual investor's unique investment objectives, risk tolerance, time horizon and liquidity needs. It is both prudent and necessary to utilize an asset allocation strategy. Once a target allocation is established, it is critical to properly diversify each asset class. However, one must be careful not to be over diversified and therefore diluted because that does not add value to the portfolio. It also causes unnecessary trading and can be a distraction because you need to monitor more stocks on an ongoing basis. We generally are diversified, but certainly less diversified than a given stock mutual fund. Our general philosophy is that there are great stocks out there, but not an unlimited number of great stocks.
What is your typical time horizon when purchasing a stock?
Howard Rothman: Generally speaking, we look at a two to five year time horizon to own a stock. It can be longer and will likely only be less if a negative event happens occurs to the specific stock, its market sector or the market as a whole.
Do you employ tax-advantaged investing strategies on behalf of your clients?
Howard Rothman: Absolutely! One of the key advantages of an individual account that we oversee is that we are able to manage and seek to build quality and profitable stock positions that will last for over a year so that they qualify for long term capital gains treatment. In addition, from time to time, we will re-position our portfolio to take advantage of netting out gains and losses during a given tax year.
Does each client get a "cookie cutter" portfolio or do you tailor each client's specific portfolio?
Howard Rothman: The great advantage of Vision Investment Advisors is that each client gets their own individual portfolio. While many portfolios will include some of the same common or preferred stocks, we look for the best specific investments that are at the most attractive prices when a client's specific portfolio is being created. We also take into account each client's specific investment objectives and the target asset allocation between fixed income and stocks for that specific client.
We also take a holistic view of the client's entire portfolio - not just their holdings with Vision Investment Advisors. If they own have a large position in a specific security something elsewhere, we will take that into account when constructing their Vision Investment Advisors portfolio. So you see, there is no "one size fits all" approach when it comes to our clients.
What differentiates Vision Investment Advisors from other investment advisors?
Howard Rothman: Several factors. One, as discussed earlier, we are not a cookie cutter "one size fits all" shop. Two, we are very cognizant of taxes and resulting costs of taxation on a portfolio. Three, we take a complete approach where not only the representative speaks to the client, but the investment advisor gets involved with client consultations both before the account is opened and ongoing while the relationship exists with Vision Investment Advisors. We have been hard pressed to find other investment advisors who have the same level and frequency of direct communication with their investors.
How would you describe your relationship with the clients that are a part of Vision Investment Advisors?
Howard Rothman: As discussed earlier, it is a much more active and long term approach where the clients have a direct relationship with us as investment advisors and specifically with me as the Chief Investment Officer. Generally, we speak to our clients regularly not only about the management of their accounts, but on other matters such as taxes, estate planning and other lifetime needs. We are not tax advisors or lawyers, but as investment advisors there are many opportunities for us to add value to a client's overall situation and that is what we try to do. We also get involved in consultation with our client's other trusted advisors such their accountants and/or their lawyers. At the end of the day, we are all on the same team trying to help the client.
The interview transcribed above took place on September 26, 2007.
