Hennessy Cornerstone Growth Fund picks its holdings just once
a year, so the managers know they better get it right.
They do that by choosing 50 stocks that have the wherewithal
to perform well the whole year.
Research has shown Hennessy that if you get that right, the
frenetic trading that's done by most other managers isn't
Cornerstone Growth was the top small-cap blend portfolio so
far this year going into Monday. Its 29.32% gain is nearly triple
its peer group's 10.79%. It more than doubled the S&P 500's
In an industry filled with managers who trade -- sometimes
frenetically -- daily, weekly and monthly, managers Neil Hennessy
and Brian Peery stand in contrast to their peers. They decide
once a year what to hold, then buy those 50 names from October
through February. They don't trade any more until it's time for
them to replenish their portfolio a year later.
Hennessy, who is 56 years old and chief investment officer of
Hennessy Advisors, and Peery, 44, talked shop from their offices
north of San Francisco.
This is a fund that Mr. Spock, the highly logical character in
the "Star Trek" series, would have loved.
This is a quantitative fund rather than qualitative. Qualitative
lets managers' emotions drive the stock-buying decision-making
process. Do they like a company's management? Do they like the
economy? We don't let emotions dictate how we accumulate
positions. That's the secret behind our sauce.
You buy during a single period of the year. What do you do with
inflows the rest of the year?
We start by putting 2% into each of 50 companies. The rest of the
year, we allocate inflows based on a holding's weight. If a stock
is 3% of our portfolio, for instance, it gets 3% of inflows. We
do the same for redemptions.
What are some of your buy criteria?
We start with a universe of about 10,000 companies. The first
thing we do is make sure a company's market cap is at least $125
million, so we don't get caught in microcaps.
Second, we make sure its price-to-sales ratio is 1.5 or less,
so we don't pay more than $1.50 for every $1 of revenue.
Third, we make sure earnings are higher than the previous year
on a rolling 12-month basis.
The companies that come through those filters go through
additional screens. One is that we look for relative strength
over three to six months. That's essentially price momentum.
Then we pick the 50 companies with the best relative strength
over 12 months. Essentially, we use GARP (growth at a reasonable
price) by using price-to-sales, then add in momentum.
What's unique about your tack?
Most managers have some formula like that. But then they put in
qualitative overlays. We're strictly quant.
But not all of your funds are run this way, right?
We have six quant funds that have a buying (window) like this
We just acquired FBR funds, adding another 10 funds to our
lineup. Three are quant, the rest actively run. And we have funds
managed by subadvisers. The ones that are subadvised can buy and
sell whenever they want. It's all explained on our Website.
So in Cornerstone Growth, you are not making bets based on any
Look at today's portfolio. Consumer discretionary and consumer
staples are about 55% of the portfolio. The portfolio is saying
...we are in a slow growth economy and people are trying to get
more for fewer dollars. We're inDollar General (
),Ross Stores (
),Domino's Pizza (
),Tractor Supply (
But doesn't Tractor Supply cater to affluent weekend farmers?
When the economy slows, you might have to cut your gardener, who
brings his lawn mower. So you buy a lawn mower, do your own lawn,
and you get satisfaction out of it too. That satisfaction keeps
you from going back in the opposite direction even once the
Sally Beauty (
) is fighting back from a rough patch. What's the appeal?
It met our criteria last year. Even today, you're looking at a
1.2 price-to-sales ratio. Here's a company earning about $1.30 a
share, and doesn't pay dividends.
Until we get clarity from Washington on health care, taxes,
regulations, companies won't hire, but they keep making money.
They can do five things with it: initiate a dividend, raise a
dividend, make buybacks, put the money into internal
infrastructure or make acquisitions. All of those are good for
companies but not good for (lowering) unemployment.
So when we look at Sally Beauty, we see a company that could
initiate a dividend.
Not that you assessed that when you bought. You bought because it
came through your screens.
Right. It's one of several companies in the portfolio that are
doing well on top-line sales growth and beating GDP numbers
pretty handily. We use rolling 12-month looks at earnings per
share on a quarter-to-quarter basis, so we see how they grow
Why are many of your holdings not household names?
I've been in this business 33 years. Every time I rebalance, I
go, "I never heard of this or that!" With our emphasis on value,
you find that most value plays are overlooked because they are
not sexy stories.
You go toPool Corp. (POOL) for chlorine. How sexy is that?Papa
John's (PZZA) is pizza.W.R. Grace (GRA) is can coatings. Not
sexy. But that's what the portfolio picks up.
Is Papa John's a play on today's consumer cost-cutting?
Right. In a slow economy, people don't have a lot of money. Dad
wants to take the family out, but he can't afford something
fancy. So he goes to Papa John's, rents a movie, gives the family
a change of pace without spending too much.
This is one of those companies that makes a lot of money but
isn't spending a lot because it doesn't have the clarity it wants
from Washington. Yet it could initiate a dividend at some point.
And at some point when the economy gets better, it will grow
Explain why W.R. Grace works for you.
They're very large, but not well understood. Most people have a
product from them in their house. They make sealants for cans,
food cans. In a tough economy, people might cut back from fresh
vegetables to canned. Without Grace's coating, your veggies will
taste like they came from a can. Their coatings are in soda,
beer, vegetables. They do other things too, but sealants are a
tremendous business for them.
What makes American Vanguard, another non-household name,
Today, their price-to-sales ratio is 2.9, so they would not fit
into the portfolio going forward. But just because something
rises past 1.5, we don't sell until it's time to rebalance. This
stock had a good run. It doesn't mean their run is over. They
just won't fit into our new portfolio when we rebalance.
Cambrex (CBM), which makes pharmaceutical ingredients, was up
roughly 100% for the year in mid-October. What is its recent
Its price-to-sales is 1.3. The recent downtrend is because people
are getting nervous, coming into earnings season. It still meets
our criteria. If you look at it over the longer term, the stock
has done exceptionally well.
Arctic Cat (ACAT) also nearly doubled before downtrending. Is
this maker of all-terrain vehicles showing sensitivity to a soft
On price, you'd pay 80 cents for $1 of revenue. That's within our
limit. But based on momentum, this would not make it into the
portfolio now. Still, typically their Q2 and Q3 earnings are
their best of the year, so you may be seeing some
LeapFrog Enterprises (LF) has pulled back and is trading below
10. They're in educational entertainment for kids. Are they
another victim of investor worries about slow economic
Its price-to-sales ratio is within our realm at 1.2. They (expect
to) earn 68 to 70 cents per share (in 2012 compared to 30 cents
per share in 2011). They don't pay a dividend. So there are a lot
of things that could go right for them. But this is Brian's.
Brian, what can you add?
They've done exceptionally well with execution. It's a company
that people kind of know. But everyone has taken a myopic view
and is looking at earnings on too-short of a basis. Everyone is
acting like a trader. We're investors. We don't worry about
Lithia Motors, which runs car dealerships and sells parts in
rural areas, has bounced back from an Oct. 25 sell-off, right
after reporting earnings per share rose 48% after rising 41% the
prior quarter. It was its highest quarterly EPS ever.
Auto sales have picked up. People feel more comfortable buying a
car. In the go-go days of 2007-08, car sales went through the
roof, hitting 16 million. Now they're just 11 million. And people
are shedding leverage. So they want less expensive cars.
Why did the stock hiccup?
It was due to their 2013 guidance, with Q1 earnings roughly in
line with Q4's. The 2013 projections were for roughly 5% to 10%
increase. So some analysts may have had higher growth targets
than what Lithia announced.
Do you make your buys and sells all at once or throughout the
We buy and sell over time, but it doesn't take the entire period
to complete the rebalance.
What do you do the rest of the year when you're not
We constantly monitor and document corporate data on each stock
Do you have any re-do rules that let you bail out of a stock in,
say, midyear if a disaster destroys it before it's time to
If a restatement has been made to the data that were used to
select a stock, our team determines if the restated data would
have met our screening criteria. If not, then the stock would be
replaced with the next stock in line. But we've never needed to
replace a stock that way.
Any other exceptions?
We would sell a company as soon as it files for bankruptcy
What are the risks with this portfolio? Lagging the S&P 500
in the past six years has played havoc with your average annual
returns for three, five and 10 years.
We don't expect our portfolios to outperform in every single time
period. Rather, our formulas were developed to maximize long-term
risk-adjusted returns, and we are proud of our longstanding
Neil, who was your mentor?
My father. That's who taught me how to invest. He died in 1974,
when I was a senior in high school. He was a position broker who
bought equity for clients.
Did your dad teach you to buy and reshuffle just once a year?
No, he taught me about investing by taking all of my paper route
money and (money from) other jobs and investing it in mutual
funds. I got very little to spend, but it turned out for the
I'm sure you were thrilled!
Actually, it taught me a lot. This business is in my blood. (My
career) would not have been possible had my dad not sensed that
this business was for me. Making money for others is very
gratifying to say the least!