The third step is identifying growth drivers. Sanders carries with him words from an old mentor – ‘always understand what drives top-line revenue’. For example, when Sanders first invested in Amazon back in 2003, when it was $17 a share, online penetration of retail sales in the U.S. was only 3%, but he believed that number was going to grow substantially over time. He met with Jeff Bezos who explained his competitive advantages – widest selection, lowest prices and convenience – completed his analysis and bought the stock. Sanders said: “That’s an example of a company that had a clear growth driver – penetration of its end market with offline retail going online.”
The fourth step is a financial statement analysis, getting into the nitty gritty of the balance sheets from a cash-flow perspective, while the fifth step is a management team assessment. Sanders is not interested in a company’s latest shiny product but instead wants to understand the key assumptions that go into his team’s investment process. ESG factors are also analysed at this stage, including how the board is made up and the compensation model.
Step six is critical and involves Sanders laying out four scenarios – best case, base case, bear, and worst, which are all five-year minimum discounted cash-flow models. The base case is what he thinks the stock is worth today, an estimate of cents on the dollar or intrinsic value. If Sanders believes a stock is worth $100 and it’s trading at $70, it’s 70 cents. He said: “We have this list of companies we’re following, and it’s ranked by cents on the dollar every morning. When stocks get to 70 cents, we recheck the analysis and we buy, and when stocks get up to 100 cents, we sell. That, in a nutshell, is our process.”
Every quarter these values are updated, in step seven, so it’s a moving target, underpinned by deep fundamental research that involves a 10-person team looking at one stock at a time before presenting it the team for debate.
While many investors focus on what is happening that quarter, Sanders told WP he thinks longer term, an approach illustrated by the crash of March 2020. He saw a health crisis, not an issue with the consumer, who ultimately drives the economy. Now in his third market cycle of managing money, the portfolio manager recognized that many elements were actually in good health, from millennials with no mortgages, a housing market at steady levels in the U.S. as it continued its recovery from the 2008 Global Financial Crisis, and a banking system that was doing well after 10 years of Federal Reserve stress tests.
