The Power of Concentration
We seek to own the few businesses that we believe are best able to create meaningful wealth over time.
What is the best way to build wealth? We think the answer is straightforward: Identify the few truly exceptional businesses with the capacity to generate sustainable, above-average earnings growth, own them in large weights in a concentrated, conviction- weighted portfolio, and accept short-term market volatility in order to benefit from the long-term compounding of growth. If the stock prices reflect the earnings power and growth of these businesses over time as we expect, we will be successful.
It’s a simple, prudent approach—but that doesn’t mean it’s easy. Our research shows that only a small number of businesses can create significant wealth for investors. In fact, over the past 30 years through December 31, 2019, less than one percent of businesses accounted for 40 percent of all wealth creation.1 That’s why our investment philosophy and process focus on identifying the select few businesses around the world that we’re convinced are best able to create meaningful wealth over time. And when we find these businesses, we tend to own them in large weights over an investment horizon of five years or more.
“I have always felt concentration is just common sense,” says Chairman and Founder Frank Sands Sr. “If you have too many companies, you have to embrace mediocrity. Is that doing your clients a favor?”
The Advantages of Concentration
Special businesses are, by definition, exceptions. Owning relatively few companies enables us to put all our effort into seeking those opportunities for our clients.
Holding concentrated positions allows us to:
- Know each of our businesses intimately
As of August 31, 2020, Sands Capital strategies collectively owned shares of about 140 public businesses, and we have a staff of over 48 investment professionals. Each research analyst leads coverage on about five companies, allowing them to become true authorities on each one.
“[Chief Executive Officer and Chief Investment Officer] Frank Sands stresses the value of taking the time to read everything we can get our hands on to understand our businesses and the markets we’re evaluating,” says President and Director of Research Perry Williams.
This commitment to deep research is embodied in our firm’s analyst-first culture. Most portfolio managers hold the dual title of “analyst,” and every member of the investment team has fundamental analysis included in their job description.
- Capitalize on our convictions
We believe that owning only the businesses in which we have the greatest confidence best enables us to add value and enhance the wealth of our clients with prudence over time.
Many investors take a different approach, holding many stocks in order to protect against price volatility or the possibility of trailing the market over the short term. That approach inevitably dilutes the long-term impact of owning the highest-conviction businesses. We view ourselves as business owners, rather than stock investors. Therefore, we don’t define risk as short-term volatility or short-term underperformance, which we believe are natural and essential parts of growth investing and long-term wealth creation. Instead, we define risk as an impairment to a business that compromises the sustainability of its earnings growth and results in a permanent loss of capital.
We try to mitigate that risk by performing intense, methodical research, and by owning only companies in which we have the highest conviction.
Each of our companies must meet our six investment criteria. They also must stand up to our rigorous investment process, through which a team of Sands Capital professionals conducts fundamental research, conducts competitive audits, interviews company management teams, and makes site visits. The thoroughness of this process gives us confidence in the durability of our companies’ earnings growth.
History in part bears out that confidence. Consider the chart below, which shows the earnings growth of the businesses in our Select Growth strategy compared with the companies in the Russell 1000 Growth Index during and after the Great Recession of 2008–2009.
A Committed Team and Culture
Developing the kind of conviction that is needed to build concentrated positions requires that the investment team have a deep understanding of its businesses and a steadfast commitment to our selective, team-based investment process.
Deep domain experience is critical. Our analyst-first culture requires our investment professionals to be deeply knowledgeable in specific businesses, industries, and/or geographic regions. To build this experience, members of our investment team conduct in-depth, continuous research, read voraciously, attend conferences, and spend time on the ground at the businesses and in the countries where we invest. “We see ourselves very much like investigative journalists,” says Williams.
This conviction can’t be rushed. It’s common for our team to spend six months or longer researching companies before deciding to own a business. “The goal of investing is to create long-term wealth, not to produce short-term efficiency,” says Senior Portfolio Manager Sunil Thakor. “We will take as long as necessary to make the best decision.”
We have aligned our team’s incentives with the goal of building wealth for clients. For example, we compensate team members based on long-term wealth creation, not on the short-term performance of companies they recommend. As a result, they have no incentive to recommend a greater number of lower-conviction opportunities or to advocate for their business over a better one discovered by another analyst. “Sometimes deciding not to invest is just as important as deciding to invest,” notes Thakor.
Our team’s strong commitment is critical because holding concentrated positions is not easy. It takes hard work and substantial time and resources to develop and maintain true conviction in the businesses we own—or to be confident that a business doesn’t merit our conviction.
But our mission isn’t to avoid hard work or look for quick, unsustainable gains. Our mission is to add value and enhance the wealth of our clients with prudence over time. We’re confident that the best way to achieve the mission is to concentrate our efforts in the select few businesses that we believe can produce durable, above-average earnings growth, and then to own them over many years while their growth compounds.
1 Bessembinder, Hendrik (Hank), Wealth Creation in the U.S. Public Stock Markets 1926 to 2019 (February 13, 2020). Available at SSRN: https://ssrn.com/abstract=3537838
The views expressed are the opinion of Sands Capital Management and are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. The views expressed were current as of the date indicated and are subject to change. This material may contain forward-looking statements, which are subject to uncertainty and contingencies outside of Sands Capital’s control. Readers should not place undue reliance upon these forward-looking statements. There is no guarantee that Sands Capital will meet its stated goals. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. GIPS®-compliant presentations and additional disclosures for the related composites may be found at Sands Capital Disclosure Presentation.
Select Growth calculations in the chart are based on the Tax-Exempt Institutional Equity Composite (TEIEC). The performance shown is compared to the Russell 1000® Growth Index (R1000G), a broad-based securities market index. The Russell 1000® Growth Index is a subset of the Russell 1000® Index, a capitalization-weighted, price-only index which is made up of 1000 of the largest capitalized U.S.-domiciled companies and are included in the Russell 3000® Index. The Russell 1000® Growth Index measures the performance of those Russell 1000® Index companies with higher price-to-book ratios and higher forecasted growth values. Performance results prior to January 1, 2002, were measured against the S&P 500 Index. The benchmark was changed to be more representative of the composite strategy, however, information regarding the comparison to the S&P 500 is available upon request. Broad-based securities indexes are unmanaged and are not subject to fees and expenses typically associated with managed accounts or investment funds. Investments cannot be made directly in a broad-based securities index. Sands Capital Management may invest in securities not covered by the Russell 1000® Growth Index.