Interview With David Rolfe of Wedgewood Partners

David Rolfe is the chief investment officer and portfolio manager at Wedgewood Partners. Under his leadership, Wedgewood was named a separately managed account (SMA) manager of the year in both 2011 and 2013. He writes some of the most thorough quarterly investing letters I'm aware of and those letters (and Wedgewood's investment performance) are included in the Investment Masters Class website. Wedgewood letters have also been honored by Professor Lawrence Cunningham in his journal article "Lessons from Quality Shareholders." David has been a featured guest on CNBC and Barron's, and he will be presenting at the Guru Investing Conference in Omaha this May.

What follows is a recent interview I conducted with David over email.

John Rotonti: Tell us about Wedgewood Partners. (David, here you can keep it high level into things like where you are located, whether you are a value or growth investing firm, whether you manage a concentrated or diverse portfolio, assets under management [AUM] if you want, when you were founded, anything else you want.)

David Rolfe: Wedgewood Partners was founded in 1988 by our chairman, Tony Guerrerio. Our strategy was incepted 30 years ago in 1992 when I joined Wedgewood as chief investment officer. I am also the architect of our strategy that I started at my previous firm of employ back in 1988. In addition to our large-cap focused-growth strategy, we also offer a focused SMID strategy we stared in the summer of 2018. We currently manage $1.2 billion.

Our firm's leaders, on both the investment and business front, have spent many years, if not decades in the investment management industry. Our investment team is also quite rare in the industry in that our three-decade-long track record is not a compilation of different CIOs and different senior investment professionals or different investment teams. Our investment team includes Tony Guerrerio, Michael Quigley, and Chris Jersan. With Wedgewood, you invest with the key people who actually built the firm's leading 30 year-track record.

Rotonti: What is your investing philosophy? What types of businesses do you try to buy stock in?

Rolfe: Our firm's large-cap focused-growth strategy is based on what we call "The Competitive Advantage of Focus." Our 30-plus years of peer and index outperformance is due to the competitive advantage of our focused strategy. We believe that focus is our edge. And that edge is repeatable.

The powerful combination of a disciplined culture of investing for the true long term in best-of-breed businesses, combined with the synthesis of the time-tested, classic tenets of both growth company investing and intelligent value investing is a recipe for long-term wealth creation, as well as peer and index outperformance.

Rotonti: What is Wedgewood's investment process?

Rolfe: Our investment philosophy begins where so many other non-focused managers finish. Our investment universe is the Russell 1000 Growth index. There are currently 519 stocks in that Index. We also include the best businesses in the S&P 500 index. We begin our investment process by identifying best-in-class business models. In that search, we look to measures of past excellence, in terms of both profitability and growth. At this point, the first question the team collectively asks is, "Can we understand the business model's past drivers of that profitability, growth, and management's capital allocation?" Going through this process typically reduces our universe by about 80%. Once we get to this point on about 100 companies, we ask ourselves a second question: "Can we understand the business model's competitive advantages well enough to be confident on what the business model will look like over the next 5-10 years?" This second question cuts our universe in half down to around 40 business models. The third question we ask ourselves are actually a series of questions on portfolio management. These involve matters of catalysts, valuation, risk management and actual portfolio construction. 

The key to our investment philosophy and strategy of building a focused, 20-stock portfolio, in order to beat our benchmark and peers, is risk management. I can't emphasize this enough -- risk management pervades our entire strategy, from security analysis to portfolio construction to portfolio management. 

There are five steps that synthesize our philosophy and process, all in accordance with prudent risk management. One: Profitability is the mother's milk of growth. Best-in-class profitability is our process North Star. Better businesses typically perform better in tough times and emerge even stronger after industry downturns or general recessions. Two: We believe the best way to generate wealth is through the long-term ownership of exceptional growth companies, where intrinsic value growth compounds at least at double-digit rates over time. Three: Businesses that require the least amount of capital to maintain their competitive position and support future growth are inherently better businesses. Four: We earnestly believe and practice the maxim, "Price is what you pay; value is what you get." We endeavor to invest in a select few, best-of-breed businesses when the stocks of such businesses are either misunderstood by the market and/or undervalued by the market relative to their long-term growth prospects. Five: We build our 20-stock portfolio by overweighting our highest-conviction ideas, all the while adhering to prudent diversification through limited business model overlap.

Rotonti: What is your portfolio management philosophy? How many stocks do you own? How do you determine weightings? What percentage of your portfolio is in cash?

Rolfe: "Invest like an owner" may be an overused cliché, but we practice exactly this at Wedgewood. Such a mentality becomes very powerful when so many of our active management peers profess such, but their portfolio turnover stats tell another, much different tale. For example, during calendar 2022, we sold just two stocks and bought just one. We typically own 20. We weight each holding on two scores. First, we weight what we consider our best risk-reward stocks the highest. Second, we also take care to make sure that every stock weighting in our portfolio is weighted higher than its respective constituent weighting in the benchmark. The only exception to No. 2 has been the huge weightings of a few megatech stocks. Our cash weighting is typically around 2%-4%. We aren't market timers. We want to own great businesses, not hold cash.

Rotonti: How do you think about risk management and portfolio diversity?

Rolfe: We think of risk management within the confines a 20-stock portfolio. Competitively advantaged businesses are best suited to ward off competitors throughout both industry cycles and economic cycles. Buying expensive stocks is a recipe for sustained underperformance -- no matter how great the underlying business may be. Again, price is what you pay; value is what you get. We are the antithesis of momentum investing, which is a staple in large-cap growth investing. Diversifying by business model, rather than industry sectors, is key to investing in just 20 stocks. While we are extremely focused relative to our benchmark and most active managers, that said, we won't let any position exceed 10% of the portfolio. Lastly, being an independent firm protects our unique investment strategy from the performance ruination of institutional imperatives, which so many other active managers suffer.

On the matter of portfolio diversity, we believe "business model" diversity trumps the more common "Noah's Ark" model of diversity whereby most portfolio managers buy a couple of stocks in too many industries to "diversify." Here's how we think about business model diversity -- consider our technology holdings. Motorola Solutions (MSI 0.27%) couldn't be a more different business model than, say, Microsoft (MSFT -4.20%), while Microsoft's business model couldn't be more different than Taiwan Semiconductor (TSM -1.94%). Business model diversification has been a staple of our risk management since our strategy's inception.

As a proof statement of our portfolio risk management, again in the context of a portfolio of just 20 stocks, consider that since our strategy's inception 1992, there have been 28 3-year rolling time periods. We have generated positive returns in 26 of those periods, or 93%. There have been 26 5-year rolling periods. We have generated positive returns in 25 of those periods, or 96%. Both percentages greater than broad stock market indexes.

Rotonti: How do you measure management quality, and can you please give us an example of a CEO (either in your portfolio or not) that you think does it right?

Rolfe: Quality is a mosaic. High-quality managements demonstrate capital allocation excellence over product, service, industry, and economic cycles. Quality managements treat all shareholders as partners. Quality managements deliver bad news quick. Quality managements are honest, humble, and transparent. High-quality managements understand that growth without profits is rarely a long-term plan.

We think that all of our invested company CEOs are paragons of quality, but I'd like to call out CEO Greg Brown of Motorola Solutions. Starting in 2015, Brown has spent over $5 billion acquiring 22 companies that span public and private safety, from land mobile radio communications to video security and building access control, combined with command center software. In all, Brown has transformed Motorola Solutions into a near-monopoly platform company with 50% recurring revenues. In 1987, Harvard Business School presented a case study on retiring CEO Bob Galvin, who was the son of the founder of Motorola. HBS needs to do the same with Brown.

Rotonti: Do you have any performance metrics that you prefer management compensation be based on?

Rolfe: We prefer compensation to be largely based on some form of return on capital metrics.

Rotonti: How long does it typically take for a brand-new idea to make it into the portfolio from the first day of research to the day you hit the buy button?

Rolfe: It typically takes more than a few months, sometimes years if the stock's valuation doesn't come in enough. That said, over the past 30 years, we have found that if we identify a great business that we endeavor to own, the market usually will serve it up on the valuations terms we demand.

Rotonti: What financial data tools does your team use such as Bloomberg, FactSet, New Constructs, HOLT, or others?

Rolfe: Mostly FactSet.

Rotonti: What is your definition of an investment thesis?

Rolfe: An investment thesis is a set of overlapping understandings and facts of what made a company outstanding in the past, and our assumptions of a continued entrenched competitive advantages that will allow said company to continue to prosper and grow at industry-leading rates so that it will be great over the ensuing years.

Rotonti: How important is valuation to your process?

Rolfe: Critical. We are buying a share in a business, but that share must be valued at a reasonable discount to what we believe that business is worth today, tomorrow, and in the future.

Rotonti: What valuation tools and metrics does your team use? Do you build discounted cash flow models? Do you look at P/E ratios and free cash flow yields? Something else?

Rolfe: We incorporate a myriad of valuation measures. Critically, we are always inverting the traditional DDM by asking ourselves, "What's in the stock price?" Oftentimes, our earnings estimates may not differ much from consensus, but what the market prices in on earnings expectations can vary greatly. That shorter-term valuation discrepancy, coupled with our time arbitrage as longer-term investors perfectly illustrates the maxim, as mentioned earlier, "Price is what you pay; value is what you get."

Rotonti: When picking stocks, do you consider an upside potential-to-downside potential ratio? If so, what do you look for?

Rolfe: Yes, we do. We don't employ a hard, fast ratio, but we look for a multiple of upside versus potential downside risk. It is a mixture of quantitative and qualitative. This embodies what John Train called, "The Craft of Investing."

Rotonti: Do you incorporate a macro view into your stock picking and portfolio management? If so, what is your current macro outlook?

Rolfe: Macro view, not so much at all. Industry economic views, absolutely. 

Rotonti: How do you factor interest rates into your stock picking and portfolio management?

Rolfe: No, not too much. In the extreme, yes. For example, during the zero-interest rates borne of quantitative easing, for years we avoided reducing the required return rate of our stock selections to absurdly low levels, which propelled far too many "growth companies" to absurdly ridiculous valuations. We all know what happened starting in early 2021, when Fed Chairman Powell began whispering a change to a tighter monetary policy.

Rotonti: Do you read Wall Street research and do you find it helpful?

Rolfe: Sure. There are many excellent Street analysts, particularly those analysts who have proven a high level of industry knowledge. That said, we don't pay much attention to Wall Street price targets and such.

Rotonti: When do you trim and when do you sell out of a stock completely?

Rolfe: Sales and/or trims are made due to the following: Full valuation. Recognizing mistakes. New and better risk-adjusted opportunities. Resizing positions due to industry concentration and other position-size considerations.

Rotonti: In your opinion, is the S&P 500 undervalued and are you finding cheap stocks to invest in?

Rolfe: The beauty of being invested in just 20 stocks is that you don't need to have an opinion on the valuation of the stock market. It is quite rare if some terrific company's stock isn't "on sale." Warren Buffett has been quite clear over the decades admonishing investors that the "stock market is there to serve you, not instruct you." If any investor, lay or professional, can figure out Buffett's admonishment (plus understand and practice chapters 8 and 20 in Benjamin Graham's The Intelligent Investor), they will be miles ahead of the investing game.

Rotonti: What is one company you'd love to own stock in at the right price?

Rolfe: Ha! I'd tell you, but then I'd have to charge you a client fee! Let's just say there a just a couple of extraordinary high-end retailers and semiconductor companies that are beyond compare in their own respective ways.

Rotonti: Your largest position is Motorola Solutions. Please tell us why this deserves to be your largest position.

Rolfe: Motorola is the dominant market leader in its core land mobile radio (LMR) business: providing infrastructure, handsets, and related software and services for customized, highly resilient, secure networks for global police and emergency services, a variety of government and military applications, and other commercial and public safety applications where security and reliability are of the utmost importance. The company has continued to find success in using its entrenched position in these mission-critical networks to layer in faster-growing and higher-margin software, service, and video products. It is the only player capable of fully integrating the entire service offering with its core LMR network backbone.

Motorola has assembled this stable of complementary products and services largely through acquisition, using the steady, recurring cash flows the LMR business has provided. These purchases not only have been attractive strategically; they have been extremely attractive financially, as well. 

The U.S. federal government has been creating (and continues to create) massive stimulus funding for state and local governments, as well as other Motorola customers such as FEMA, school districts, and airport and transit operators. Although this funding typically does not appear immediately and may take some time to find its way from a news headline to an actual customer's budget, the company has highlighted funding already available to customers in the region of $350 billion for state and local governments, $170 billion for education, and $38 billion for airport and transit. The company expects to see the benefit of this funding through 2024, when the current rounds of stimulus expire. 

Rotonti: What is your investment thesis in Meta (META -14.97%)?

Rolfe: If you build it, they will come. With apologies to W.P. Kinsella, CEO Mark Zuckerberg has built it. And they did come. And they have stayed. By the billions. The metaverse will be the next evolutionary chapter by Meta Platforms. And speaking of billions: Meta Platforms' family of apps (FoA: Facebook, Instagram, WhatsApp, and Messenger) currently has over 3.7 billion monthly active users -- this includes almost 3 billion daily active users. If baseball is sports' national pastime, family of apps is the social national pastime. The International Telecommunications Network (ITU) estimates that of the 8 billion in world population, nearly 3 billion are without an internet connection. If you exclude China's population (where U.S. social media companies are largely banned), Meta Platforms' family of apps are used monthly by a staggering 90% of the world's connected population and by 70% on a daily basis. This level of user engagement and density across the company's FoAs would seem to be an impenetrable fortress. It surely has been in the continued growth and stickiness in terms of users. 

It seemed that everything that could go wrong for the company in 2022 did go wrong: A post-pandemic growth hangover, the multibillion revenue hit from Apple's (AAPL 0.55%) infamous iOS 14.5 update that introduced the company's App Tracking Transparency (ATT), a cyclical slowdown in online advertising spending, poor capital allocation timing of stock buybacks, and Zuckerberg's unchecked spending of billions on both new hirings and massive billions to be spent on artificial intelligence and the metaverse. Even renaming the company from Facebook to Meta Platforms seems premature. In short (from that long list), Zuckerberg has lost the confidence of shareholders. In the coin of the realm circa-2022/2023, Meta Platforms had lost "the narrative" -- despite its still intact family of apps profit and cash generation machinery.

We have long applauded companies that invest for the long term. Companies, regardless of their particular industry, must adapt, or evolve, or they will slowly die. That's why for years we have emphasized in our research the importance of capital allocation. This is critical to our investment process. We endeavor to hold our investments for many years, not just for a few quarters, which is the typical fare on Wall Street. Our portfolio of best-of-breed businesses generates substantial retained earnings. The deployment of this largesse into a myriad of capital allocation decisions (R&D, capex, M&A, stock buybacks) is arguably the most critical function of the C-suite.

We've owned Apple since 2005. Apple is a very different company than it was 15 years ago -- much different still from the company's founding in Steve Jobs parents' garage in 1975. At the time of our first purchase, the iPhone was little more than a twinkle in Steve Job' eyes. In fact, early on in those years, the iPad was slated to be launched before the iPhone.

In our view, Zuckerberg has built and navigated the company quite well as technology and user behavior has changed. He has built it. They have come. He continues to build. His "vision thing" has be good, too, considering his early critics on mobile, Stories, and Reels. The jury is still out on his megaspending on the metaverse -- no, check that -- the jury is in on this score. By Wall Street's reaction, Zuckerberg's metaverse vision and spending is a near-unanimous flop. We don't share this view. We remain bulls on Zuckerberg and Meta Platforms.

In fact, in the general internet economy, which is to say any enterprise or institution whereby the internet today is in any way relevant, expect future digital disruption. These countless entities are already planning for the next evolution of the internet (call it what you will). And they collectively are already planning for it in size -- whether Zuckerberg builds his vision of a metaverse platform or not.

The stock at 2022 lows had priced in zero growth in FoA users and little rebound in profitability. This is fat-pitch territory. Valuations at current levels need to assume a long secular decline in the company's family of apps business and continued billions dumped into the assumed metaverse landfill. Both extremes in the negative, in our view. If the combination of favorable 2023 catalysts emerge, along with unduly cheap valuations, we may well swing again at the shares. The stock has currently staged one of the most remarkable turnarounds I have witnessed since entering the investment business way back in 1986.   

Rotonti: What is your thesis in Pool Corp. (POOL -3.81%)?

Rolfe: Those of you who own a backyard pool already know the Pool Corp. story quite well. ("Honey, why is the pool water green?") Those who don't own a pool, well, we recommend a little rent-seeking on your neighbor's pool by owning these shares. The Pool Corp. strategy is beautifully simple: build a pool and become its customer for life. Once the major discretionary expenditure of building a pool is made, that high-maintenance asset becomes an annual annuity for your local pool service company. Increasingly, that local pool service company could well be owned by Pool Corp. 

Those who own older pools know quite well that pool maintenance is much more involved (read: expensive) than just annual chemicals in the early years. Once a pool reaches its early teen years (often sooner), maintenance reaches a very different level (read: expensive) when every part of the pool's filtration system wears out. As the years progress, the pool/backyard rebuild kicks off. Well, that original pool becomes a brand-new second pool. Rinse and repeat. Your local pool-service company is assuredly not the lonely Maytag repairman.

A decade or so ago, most backyard pools were simply pools surrounded by some type of hard coping. Fast-forward to today, and our backyards have turned into major entertainment centers. We are spending much more time outdoors, and the backyard is now a focal point of our homes. Healthier outdoor living is now ingrained in our lifestyles and budgets. According to Zillow (Z -2.90%) (ZG -2.71%) Research Surveys, respondents asked of the importance of a house with a pool (or spa) jumped to 35% in 2021, from 25% in just 2019. Pools are now surrounded by decking and patios, outdoor fireplaces and kitchens, majestic fireplaces and waterfalls, outdoor lighting, weatherproof speakers, hardscapes, landscapes, and irrigation -- much of it connected to apps controlled by smartphones. Indeed, significant technological advancements are found across the entire spectrum of a modern pool, dominated by automation; sanitizing systems (salt systems, UV systems, and ozone systems); heat pumps (which cool water, too); robotic cleaners; whisper-quiet, variable speed pumps, and LED lighting. Pool Corp. distributed all this backyard evolution.

Today, the company is the world's largest wholesale distributor of swimming pool and related outdoor living products, operating over 410 sales centers in 12 countries across North America, Europe, and Australia, and distributing more than 200,000 national brand and private-label products from over 2,200 vendors to roughly 120,000 wholesale customers. 

Notable, too, is the company's November 2021 acquisition of Largo, Florida-based Porpoise Pool & Patio, including its main operating subsidiaries, Sun Wholesale Supply and Pinch A Penny. Sun Wholesale Supply is a wholesale distributor of swimming pool and outdoor-living products, including a key, state-of-the-art (chlorine) specialty chemical packaging operation, which until now only sold to Pinch A Penny franchisees. Pinch A Penny is the largest franchiser of pool and outdoor living-related specialty retail stores in the U.S., with approximately 260 independently owned and operated franchised stores in Florida, Texas, Louisiana, Alabama, and Georgia, and brings Pool Corp. substantial opportunities for expansion.

Sixty percent of the company's business revolves around the installed base of pools (and spas). Pool renovations and upgrades are 20%, and new pool construction is 20%, as well. Its typical customer, 80%-plus, are local maintenance contractors and professional builders. Local backyard-related retailers make up 12% and the rest is a small mixture of do-it-yourself customers and commercial customers (hotels, theme parks, and universities).   

The company estimates its U.S. share of the pool industry to be around 38% in the $10 billion wholesale market ($22 billion retail), based on the U.S. installed base of 5.4 million pools. The company is about four times larger than its only national competitor (Heritage Pool Supply, a division of SRS Distribution). Horizon (Green), the fourth-largest landscape distributor in the U.S., with 81 locations largely in the Sun Belt, services a $14 billion national Green addressable market.

Pool Corp. has been a growth and profitability powerhouse for years. The company reminds us of another powerhouse, Old Dominion Freight Line (ODFL -0.62%). Both share a long-ingrained culture of organic growth by nonstop capacity additions. Both, too, have surely benefited by strategic acquisitions, but at the end of the day, the consistent ability to serve more customers from existing locations is the seed-corn of organic growth. Such growth, on top of the long crawl of operating leverage is the mother's milk of ever-increasing profitability.

While 2023 has started quite well for the company, our growth expectations for late-2022/early 2023 encompass a material decline in 2020-2021 growth rates. Namely, for calendar double-digit growth in revenues and low 20%-plus growth in earnings per share -- and back to high-single-digit growth in each during 2023. The current bear market has corrected the once-excessive valuation in the stock.

Rotonti: What do you like about Edwards Lifesciences (EW -1.87%)?

Rolfe: Edwards Lifesciences has been in portfolios since 2017. The company is a leader in treating structural heart diseases and providing critical care technologies to surgical and intensive care centers. Edwards' flagship franchise is its Transcatheter Aortic Valve Replacement (TAVR) SAPIEN family of aortic heart valves. The company's TAVR products began revolutionizing aortic valve replacement clinics around 15 years ago. Prior to TAVR, patients who were too sick to undergo open-heart surgery often went untreated. After a long history of surgical valve development, Edwards came to develop a prosthetic aortic valve that could be inserted into place with a minimally invasive procedure, often via a small opening in the femoral artery (or less frequently, through a small incision in the ribs). Since then, Edwards has provided these life-saving valves for over 800,000 patients.

Edwards' revenue rose over 40%-plus from 2016 through 2021 driven by TAVR revenues that more than doubled. More recently, the company's TAVR performance has been volatile, especially when compared to the pre-pandemic trend line. The large swings in growth have been due to random regional shutdowns from the pandemic in addition to hospital staffing shortages. The pandemic societal shutdowns are almost impossible to predict, but we assume those will eventually subside, as they have in the U.S.

On the latter point of hospital staffing shortages, it is most acute in the U.S. Even though TAVR is minimally invasive to the body of the patient, it seems TAVR is "moderately invasive" to the administrative efforts of hospitals in the U.S., at least in the early part of this post-pandemic world. We will admit, surprisingly, that cracking open a patient's ribs in to expose their beating heart for an aortic valve replacement is more streamlined from an administrative perspective than minimally invasive TAVR. TAVR, on the other hand, requires several non-invasive, pre-operational steps in order to make a clinically safe decision about if and how the body can handle the procedure. 

But Edwards, and the rest of the structural heart technology industry, have an excellent incentive to help hospitals alleviate the administrative bottleneck that emerged during the pandemic. We estimate Edwards' addressable market for TAVR grows by about $1 billion per year in the U.S. alone, based on demographics and compared to the company's 2021 TAVR revenues that approached $3.5 billion. Severe aortic stenosis (SAS), which is the disease that TAVR is most often used to treat, is most prevalent in those approaching their mid-70s and beyond. Only 12 out of 100 patients with SAS have had valve replacement therapy, with over 1 million patients estimated to be in need of the therapy in the U.S. alone. We estimate U.S. valves to cost anywhere from $20k to $30k per device. Further, Edwards is enrolling a study to treat patients with moderate aortic stenosis (MAS). MAS has been shown to be nearly as lethal as "severe" cases, but with a population that is twice the size.

The good news about Edwards' treatable population is they are living longer, not only once they reach 70 years of age but also once they reach 80 years and beyond. As people are living longer, they are more susceptible to moderate and severe forms of aortic stenosis. So there's no shortage of patients in need of TAVR treatment. Given the recent bottlenecks in the U.S. healthcare system, those calls for gloom and doom are coming again. But as we can see, the untreated population for both severe and moderate aortic stenosis is clearly huge and underserved, so TAVR's demise continues to be greatly exaggerated.

We expect Edwards to be able to compound revenues at a double-digit rate over the next several years by driving higher adoption of TAVR, as well as through the launch of new platforms targeting other forms of structural heart disease (especially related to mitral valve). The company probably "under-earns" as they commit between 15%-20% of revenues to R&D, a multiple of larger medtech conglomerates (e.g., Medtronic (MDT -0.90%), Abbott Laboratories (ABT -0.07%), and Stryker (SYK -0.46%). Edwards' returns are still tremendous, even with this high level of reinvestment in future growth. 

Rotonti: What is your thesis in First Republic Bank (FRCB)?

Rolfe: First Republic Bank is one of the most differentiated business models in our large-cap universe. What makes the company so different is not necessarily the activities that it does, but the activities it does not do. These trade-offs are an incredibly important strategic decision that every company must make. However, in our experience, rarely are these forgone activities lauded or even recognized as critical differentiators.

When we consider the financial industry, especially banking, is fraught with competition, simply being better than any of the other massive money-center banks is not enough to sustain many decades or even years of superior performance. Rather than try to outcompete every bank in the country, First Republic's competitive strategy of doing only a handful of things well results in a superior value proposition to its customers. These trade-offs are easy to understand, but difficult to copy, given widespread competitive and institutional imperatives that pressure management teams to revert to the mean. 

First Republic organizes its entire business around keeping long-term relationships with its bankers and clients. This strategic decision contrasts with competitors that have underlying strategic goals to drive as much client activity as possible. As a result, client development activities at First Republic look very different from those of its competitors. First Republic has outgrown its peers over the past several years. The company compounded revenues at an 18%-plus rate from 2016 to 2021 and is now one of largest single-family mortgage lenders in the U.S. 

And more recently, the dramatic rise in long-term interest rates has caused mortgage industry underwriting volumes to plummet, mostly due to a decline in refinance activity. Despite this, and admittedly to our surprise, First Republic turned in an astonishing 23%-plus growth rate in mortgage originations during the second quarter of 2022. That is not to say things won't slow from here, given the continued rise in rates, but it was another important, contrasting data point of how the company's business model differs from most large money-center peers. Competitors' overwhelming reliance on the securitization markets, as well as mortgage correspondent mass-market focus was in no small part to blame for the industry slowdown. As First Republic keeps these functions in-house and focuses mostly on jumbo mortgage financing, there were no third parties or vendor partner upheavals that the company had to contend with to continue providing its customers with reliable mortgage underwriting service.

In conclusion, while being the most profitable or fastest-growing business are certainly the goals most businesses strive for, we are steadfast in our view those goals must be byproducts of a differentiated competitive strategy. In the highly competitive industry of personal banking, First Republic has made a concerted effort to focus on only a handful of activities to excel at while actively avoiding many others, even when those activities might seem to be industry-standard offerings. First Republic's prudent and deliberate approach to trade-offs offers competitive differentiation that should continue to drive exceptional growth over the long term.

Rotonti: What is your thesis in Taiwan Semiconductor and how do you think about its valuation?

Rolfe: Taiwan Semiconductor Manufacturing is arguably the most important corporation on the planet. TSM is the leading -- by far -- semiconductor manufacturer in size, scale, scope, and advanced nodes. Indeed, if Samsung falters rolling out their next-gen 3-nanometer (3N) technology, TSM could enjoy a near-monopoly post-2022 at 3N. Technology companies such as Apple, Advanced Micro Devices (AMD -0.96%), Nvidia (NVDA -0.27%), Qualcomm (QCOM -0.39%), and Intel (INTC 0.38%) would not exist in their current form without TSM. 

Since TSM's stock trades as an ADR, few institutions own the stock in size and the stock is not owned by the gigantic passive crowd (both index funds and index ETFs), unlike, say, Intel and Texas Instruments (TXN 0.31%). The only owners of note are the relatively small emerging market funds and ETFs. As such, TSM is one of our largest portfolio positions on an "index attribution, active share" measurement.

In fact, Berkshire Hathaway's (BRK.A -0.32%) (BRK.B -0.35%) most recent reported stake of 60,000,000 shares would arguably make Berkshire TSM's most significant "large" U.S.-based shareholder. Furthermore, we suspect that Berkshire has continued to build their TSM position after the Sept. 30 13-F reporting deadline. If Buffett is indeed the buyer (and not one of his portfolio manager lieutenants), Buffett, in our opinion, would likely be still swinging a fat bat at TSM given its fat-pitch cheap valuation. We can't help but think that TSM is akin to how Buffett views the railroad industry -- few rational competitors, with massive legacy and capex barriers to entry.