Adam Zuercher (pictured at right) and his partner Tony Hixon (below Adam) are the principals at Hixon Zuercher Capital Management, based out of Findlay, Ohio. They recently launched a new Covestor model: Focused Equity.
Adam and Tony are value investors who, for this model, invest in 20 to 30 companies that are industry leaders with a clear competitive advantage.
Xavier Bremner from our editorial team had a chance to ask Adam a few questions about his background, Hixon Zuercher, and their approach to portfolio building.
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First of all, could you tell us a little about yourselves? Who are the big influences in your life and career? How did you two guys meet?
I grew up in a small town in Northwest Ohio. In college I studied accounting. After college, I went to work for a CPA firm and quickly gravitated towards investing. I had the opportunity to work with many wealthy clients who achieved financial success through investing in stocks. I began to read everything I could about investing. The more I learned, the more I knew that I wanted to become a successful investor myself and get into a career where I can help others do the same.
There have been many people who’ve influenced my life and career. One of the biggest influences on my investment career is Chris Davis, portfolio manager of the Davis New York Venture Fund and Selected American Shares. I have followed Chris’ work since my days at the CPA firm, listening to all his conference calls and reading his quarterly portfolio commentaries. His investment philosophy and way of thinking really resonate for me. I’m also inspired by the story of the Davis family, beginning with Chris’ grandfather, Shelby Cullom Davis, who started investing with an initial portfolio of $50,000 in 1947 and turned it into $900 million by 1994.
A couple of years ago I wrote a blog post about 5 of what I believe are the most important books on investing that I have read. Through those books some of the other big influencers on my investment philosophy have been Benjamin Graham, Warren Buffett, and Mohnish Pabrai.
Tony and I have known each other nearly our entire lives. We graduated high school in the same class. After that, we went to different universities. Four years later we wound up in the same community working for different accounting firms. We reconnected over many lunches and discovered that we had many of the same values as well as a mutual passion to help others build wealth.
Your Focused Equity model stresses a long-term outlook in largecap stocks - 85% of the portfolio will include stocks with a $1 billion-plus market cap. What are the advantages of this approach as you see it?
A long-term perspective helps you maintain control over your emotions. The greatest investors are able to control their emotions and avoid making mistakes based on today’s headlines. Much of what we see and hear in today’s media is designed to create fear. Fear, as I wrote about on our blog, is a very powerful emotion that can lead to negative investment behavior. To be successful you must embrace uncertainty, have patience, and avoid the temptation to follow the crowd.
We emphasize large-cap stocks in the Focused Equity Portfolio because larger companies are generally going to be more durable than smaller companies. This portfolio focuses on “all-weather” companies with fortress balance sheets, companies that can survive and thrive during all economic cycles.
What characteristics do you look for before deciding a stock is right for the portfolio? And what are the warning signs that tell you it is time to cut a stock loose?
One of my favorite quotes is from Warren Buffett: “If you’re not willing to own a stock for 10 years, do not even think about owning it for 10 minutes.” As investors, we want to think like an owner. When evaluating a company for potential investments we look for characteristics that foster long-term value creation including:
· products or services that do not become obsolete
· financial strength
· high returns on capital
· sustainable competitive advantages, and
· proven management.
We will sell a stock for any of the following reasons:
· Misinformation - If we discover new information that is detrimental to the company that was previously unavailable.
· Deteriorating Fundamentals - If a company's business fundamentals are substantially worse than they used to be with signs of continued deterioration.
· Detrimental change in management or focus of the company.
· Overvaluation - If a company's stock price has risen above our estimate of fair value.
· Better Opportunities - We may sell a stock if we determine that capital could be reallocated to a more attractive stock.
· Overconcentration - We may sell a portion of a position if it becomes overweighted in the portfolio.
Can you discuss some recent trades? You sold Home Depot (HD) and bought Lowes (LOW). Why?
This was simply a lateral trade in the portfolio. Occasionally, we will sell a stock when we feel a better opportunity has come along. At the time of the trade our view was that Home Depot’s stock price was fairly valued and Lowe’s was trading at a 20% discount to our assessment of fair value. We had a nice run in Home Depot since we owned it (74% total return), so we decided to take our gains and buy Lowe’s at a discount. We have each shopped at both retailers and from our experience we also feel that Lowe’s is a better run company.
Your model also sold Apple back in May at $570. It’s now trading at about $620. What was the rationale behind this trade?
This was a transition issue. When I transferred my account to Covestor it was concentrated in a few stocks. As we launched the model I sold these stocks and transitioned into our complete model. The reason I sold Apple back in May was to generate cash to purchase other stocks in our portfolio. We did not sell Apple for clients in our Focused Equity Portfolio in May.
However, AAPL is one of the stocks that we own on what we call a free ride. This occurs when a stock has appreciated 100% from the purchase price. At that point, generally we will sell half our shares thereby securing our cost basis and allowing the rest of the shares to continue to appreciate. We still may sell the shares at a later date based on our sell discipline described above. But in this circumstance, we’re enjoying more than a 300% return on this investment as of August 30, 2012.
You guys are long Wells Fargo (WFC) and Bank of New York Mellon (BK). What’s your outlook for these financials and the sector at large?
Our view is that the credit crisis has created some nice opportunities in the financial sector. However, investors should be selective about the financials they own. We have been underweight the sector.
With the purchase of Wachovia in 2008, Wells Fargo has become a nationwide bank and was catapulted into the top tier of U.S. banks. The bank has $1.3 trillion in assets and 6,600 offices across the nation. Competitive advantages in banking come through sustained low costs and consistent execution of strategy. Banking is a highly commoditized business, and product advantages are short-lived. Management discipline and scale therefore distinguish a top-tier bank from a mediocre one. Wells Fargo, quite rightly in our opinion, has one of the most admired management teams in banking. Additionally, the bank took advantage of the credit crisis to become a nationwide bank and now it’s time for shareholders to reap the rewards.
Bank of New York Mellon is not a traditional savings and loan bank. Instead, the bank provides a wide array of services to investors, governments, and corporations that tap capital markets. However, the bulk of the bank's profits come from two business segments: asset servicing (global custody) and issuer services. We like the bank's competitive position and its long-term growth prospects in both segments. BNY Mellon benefits from an unmatched market share in the global custody business. The bank provides asset administration and trust services to investment managers in multiple countries and markets. BNY Mellon is the largest provider of trust-related services to fixed-income and equity issuers around the world, with no contenders in sight. Most of the bank's competitors are small regional players that are usually limited to certain geography or market and cannot compete with BNY Mellon's global reach, product diversity, and sophistication. But perhaps the most amazing thing about this company is that it was founded 228 years ago and has endured all this time despite panics, depressions, and wars. Recently, the stock price has declined more than the business value and therefore we expect shareholders to be rewarded over the years ahead.
What was your biggest stock picking blunder and what lessons did you take away from it?
Chris Davis talks about how there are two types of mistakes that investors can make: errors of commission and errors of omission. An error of commission is one where the person responds or does something where they should not. This is compared to an error of omission, where the person fails to respond or do something when they should. Normally we think of mistakes as errors of commission… we bought or sold a stock when we should not have. However, I think it’s just as important to look at errors of omission. Occasionally we will ask ourselves, what are some stocks we missed, or failed to buy, that have done well?
I think one of our biggest blunders was an error of omission. A company that Tony and I are both very familiar with is Chipotle Mexican Grill (CMG). We should know that company well since we both eat there at least once a week! The stock has had an amazing run and we’ve missed out because we didn’t own it. We looked at buying it in back in August, 2009 when it was trading around $97 per share. Today, just three years later it’s trading around $293 per share. We missed out on a 202% gain. The stocks we owned instead performed well, but not too many outperformed Chipotle over the past 3 years.
The lesson learned: Don’t be afraid to sell a company producing mediocre results to buy a company producing great results. Chipotle has had a strong growth story and should have made it into the portfolio when it was trading for less than $100 per share.
Looking at the second half of 2012 and beyond, what do you think the biggest market moving themes will be?
I think the rest of the year investors will be focused on two topics: The election and the Fiscal Cliff.
Thinking longer-term, beyond 2012, we are big believers in the mobile theme. Our favorite stocks in the mobile theme include Apple, Google, and Qualcomm. Drilling down even further, we think the mobile payments theme will continue to explode, so additionally we like Ebay (Paypal) and Mastercard.
Thanks so much, Adam, and best of luck with your new Covestor model.