3 Special Stocks With Tremendous Long Term Upside Potential

An interview with

Robert F. Zagunis

Chairman, Jensen Investment Management, Co-Portfolio Manager of the Jensen Quality Growth Fund

This article is more than 2 years old.

Robert Zagunis: Our approach is a very fundamental approach to investing that has resulted in good long-term numbers and a very nice return to our shareholders. We start with reviewing all the public companies that are available through the U.S. exchanges -- roughly 4,000 companies -- and screen for those that are $1 billion in market cap or greater.

Our focus is on those companies that can have a consistent creation of shareholder value, day in, day out. This implies a strong competitive advantage, which we see as companies that can have a high return on invested capital consistently, year in, year out, irrespective of what's going on in the economy. The required minimum Return on Equity (ROE) is 15% per year for each of the last 10 years. The average ROE in the Portfolio is currently over 25%. This translates to a high return on invested capital at a rate that's always higher than what is the cost of capital -- ensuring that the gap between cost of equity and capital, and return on cost of equity and capital is always positive.

These companies are special. They have been able to execute this fundamental approach for at least ten years and, many times, for decades on end and they mature into companies that generate a tremendous amount of free cash flow. Then, it's part of our job to determine how management is making the decisions on those resources -- the free cash and how they invest it for the future.

So, we have discreet expectations for each of these companies going forward for the next ten years. It's pretty easy for us to determine if they're going to be heading off the business track or not. Obviously, there's a lot of work with evaluation on the companies, followed by portfolio construction. Consequently, we have what we think is a portfolio of remarkable companies to be held for a long, long time. Currently the ‘I’ shares of the Jensen Quality Growth Fund (JENIX) are outperforming the S&P 500 Index for each of the 1, 3, 5 10, and 15 year time frames.

Wally Forbes: About how many companies do you have in your portfolio? Does it vary or what range is it in?

Zagunis: It varies a little bit, in terms of how many companies we have. Currently, we own 25 companies in the portfolio -- rarely more than 30, rarely less than 25 -- so that obviously implies, at some times, large positions. We think nothing of having three, four, five, or six positions over 5% each.

One of those is a company that I'd like to talk about, and that is Becton Dickenson (NYSE: BDX), which has been one of our biggest positions for a while.

It is a medical technology company that's focused on devices and diagnostic systems. But their primary business is what we would consider low-tech products, including needles, syringes, and basic diagnostic tests. What we like about Becton Dickenson, is its strong, competitive advantages -- especially in syringes. It's almost mind boggling, but they produce in excess of 29 billion syringes per year, and a lot of their products are disposable in nature.

So, BDX is remarkably well positioned in the consolidating medical field, driven by the strength of some important mergers and acquisitions. In our view, Becton Dickenson is poised to accelerate their earnings per share over the next five to ten years. Consequently, we like it very much. It meets all our criteria across the board.

Forbes: I hear you.

Zagunis: Another company that we like a lot is a company most people have heard about. That's 3M (NYSE: MMM). This is a diversified industrial conglomerate, which focuses on products in the core material sciences and manufacturing expertise. What we like about the company is that it's been very consistent with its performance. Net margins are double digits with some expectation that this margin may actually improve over time as the leadership moves the company forward into becoming more effective and focusing on new products -- what they call new product vitality.

Vitality basically means to have about 40% of the products sold at 3M having been introduced in the last five years. So, 3M is one of those remarkable companies. They've been around for a long time and their free cash conversion -- in other words the profit to cash -- is almost 100%. On top of that they've been paying a dividend for close to 100 years, which is pretty remarkable, and they have been increasing the dividend for almost 60 years now. They're a great quality company and included in our portfolio for a while.

Forbes: And they are staying with the times?

Zagunis: Yes, they are not sitting still. It's clear that under the direction of their CEO, Inge Thulin, they are very focused on even improving what is, in our opinion, a very good operating performance already with the expectation of improving margins, improving the top line, and the general operating efficiency for the company going forward.

Forbes: Sounds good.

Zagunis: There's one more company that I'd like to talk about that’s been fairly visible and that one is Oracle (NYSE: ORCL). It's an enterprise software company, which engages in the development and manufacturing of databases and middleware and application software worldwide. What we like about Oracle is its scale for starters. It has a broad product portfolio and they have a solid market presence within an area that requires a high switching cost to change.

Oracle is also remarkably well positioned right now to take advantage of the cloud conversion. And there is a huge emphasis on the company to continue to improve their cloud market share, which we think bodes well for the future. It is going through a bit of a transition. But we think, given the type of profit and cash flow that it generates and the continued proper reinvestment of that cash flow, Oracle will continue to be a good investment for the long term -- especially given today's prices, which we think are quite low given what we think will likely happen in the next five to ten years.

Forbes: Sounds very strong, Robert, and major companies indeed.

Zagunis: Yes, Wally, and very, very good companies. Sometimes the general investing public might see these names as sort of staid names. But if one analyzes the management and the competitive advantages, and the remarkable financial strength that these companies have, they are really well positioned to create shareholder value. And that's what we're focusing on.

