Last week I sat down with Philip Tasho of TAMRO Capital Partners, one of the few mutual-fund managers to beat his benchmark index over the last decade. I asked Tasho about his due-diligence process, and he brought up a technique he uses to sort investment ideas out using three categories: leaders, laggards, and innovators.
Here's what he had to say about the process, including three examples (transcript follows):
Morgan Housel: We were talking earlier about how you break up companies into three different buckets: You have leaders, laggards, and innovators. Can you tell me a little more about that?
Philip Tasho: It really helps to put everything in perspective, because companies are in different stages of their operating cycle. Some are just starting out, some are very well far along, so we use that as an opportunity for us. It also helps to balance out the growth and value-type characteristics that we're looking at, too.
So leaders are really the best-of-class companies -- the cream rises to the top over the long term ... relative to their peer group. So it has everything we're really looking for. And the near-term miscues really provide us with that opportunity in terms of valuation for the security.
Laggards are companies that have a lot of the characteristics that we're looking for in terms of competitive advantages -- great core business, they're allocating capital pretty well -- but maybe not all the drivers are what we want to see. So we find that a change of management potentially could take the company which we consider a laggard, because they've lagged their peers, into the leadership category. And that can create a successful restructuring, so that's why we look for that as a potential opportunity.
And then innovators are short-cycle businesses, mostly technology, very short-tail in focus, and parts of health care. These are companies that really innovate through either internal R&D, they can license a product from another company, or they can just go out and buy a company and expand their suite of products. Those would be considered to be innovators.
Morgan: So what would be a good example of each? What would be a good example of a leader?
Philip: A company I mentioned earlier, which is The Advisory Board (NASDAQ:ABCO). They've really built a huge moat. They were really the first ones to do this; to duplicate what they have would be extremely expensive for any company. So we see them as a leader, a very focused company that's operated very well throughout their history.
Morgan: And one example of a laggard?
Philip: One restructuring that we kind of focus on -- and with a restructuring or a laggard, you want to make sure there is a tailwind behind you, because you want to make sure that the fundamentals are improving in the category they're serving. That's in the consumer area, in retail, and here we have Chico's (NYSE:CHS), which is a fashion retailer for the more mature women. We brought in a new management team several years ago to kind of right the ship. They closed some stores, and they really started to innovate to try to broaden out their demographics, too. It's been a very successful restructuring. Same-store sales have grown double-digits now for the past two years. So that's an example of a very good, successful laggard that we think will eventually turn into a leader in that category.
Morgan: We were talking earlier, one example of an innovator you said was Apple (NASDAQ:AAPL).
Philip: Definitely. Short cycle -- what have you done for me lately? So that's a great example of an innovator. Most of technology is really focused on innovation.
Morgan: Do companies evolve and devolve between the categories? Could Apple eventually be a laggard some day?
Philip: It could very well, yes.
Morgan: So, are companies constantly moving through those three groups, or do they stay stationary most of the time?
Philip: It's really difficult for a lot of companies to maintain that type of growth in terms of both top line and bottom line and managing cash flow. So everybody runs through certain bumps. Sometimes it's a tailwind, sometimes it's a headwind and things get really tough for them and they lag their peers.
Morgan: With the pullback in Apple's shares over the last six weeks and people talking about more competition from Google's Android and Samsung, is Apple losing its title as an innovator?
Philip: No. Long-term, that cream still rises to the top, and Apple has been one of the most successful companies out there, period. The pullback here is simply a potential opportunity. You don't want to color them as a laggard anytime soon.
Morgan: In your portfolio, do you try to have an equal weight of the three categories -- some leaders, some laggards, some innovators?
Philip: That's a great question. We're bottom-up, so it's simply the output of the research that we see. Historically, leaders have comprised up to two-thirds of the portfolio. They're currently down to around 50%. Laggards have been as low as 20%; I think currently they're around a third of the portfolio. And innovators on average have been roughly 10%; they're at the higher end now, roughly about 20%. That's in part because, with the downdraft in 2008, it provided us an opportunity to buy these innovators that historically have been very highly valued at more reasonable valuations. So we were able to use that opportunity in the downdraft to move into more of those names.
Morgan: Do you expect equal stock performance from the categories, or is it a situation where the leaders will always perform better than the laggards, and innovators perform best of them all?
Philip: You can have a very successful laggard that can go from not just the value play but the growth play, too. So the best-case scenario is having a laggard turning into a leader, and it can just do phenomenal work in your portfolio. But leaders in general really do provide a lot of the return.
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