Plant your seeds where they will grow

• Perceptions in publicly traded companies
• The value of a bottom-up approach
• Understanding drivers of profit

With the first signs of spring in Calgary, we’ve been busy preparing our garden for the summer. In what’s become a ritual the past few years, my eight-year-old daughter and her friends were helping us plant various seedlings. While doing so, we heard the kids discussing if tomato seedlings should be planted among the fruits or vegetables.

This tomato debate is more than a growing concern. The Government of Canada stakes its ground on the matter clearly: “a tomato is a fruit, not a vegetable”. Opinions vary, however, in the U.S. tomatoes are the state vegetable of New Jersey, while Tennessee and Ohio have proclaimed them to be their state fruit. By now, you’re likely wondering what any of this has to do with investing.

Perceptions in publicly traded companies

Perceptions sit at the core of this deep-seated debate, and there are parallels to the world of investing. Just as tomatoes are perceived as fruits by some due to their botanical properties and vegetables by others due to their culinary use, many publicly traded companies are perceived differently by various market participants. For example, are MasterCard and Visa best understood as technology, financial services or consumer discretionary companies? Depending on one’s perception of these companies, they may choose to own these stocks or not.

Public companies are classified into a particular sector or industry based on their business by various index providers. Market participants take these categories very seriously, with portfolio managers managing funds partly based on these classifications. For instance, if you’re bullish on oil prices you’ll want to be overweight the energy sector relative to the weight in an index such as the S&P 500. If you’re bearish, you’ll want to be underweight.

In most cases, the way these companies are classified aligns with what ultimately drives their business. But the lines can get blurred. Consider companies such as Dollar General and Dollar Tree. On the surface, they may seem to be discretionary businesses and not staples like grocery stores. In reality, these businesses have proved to be anything but discretionary, especially in times of distress as consumers shift to dollar stores for their purchases.

Similar dichotomy exists in MasterCard and Visa. Are they technology companies that provide technology infrastructure to allow seamless financial transactions, or are they financial services companies that enable payments across various channels? Extending it a step further, are they consumer discretionary businesses that thrive on consumer spending? The latter is extremely relevant, as a large part of MasterCard and Visa’s earnings are driven by consumer spending on things like travel and e-commerce.

The value of a bottom-up approach

This varied perception amongst market participants allows bottom-up investors, like us, to add value for our clients. We can do this by understanding what really drives the profitability of a business rather than being distracted by a pre-assigned sector or label.

In our U.S. portfolios, we’ve long held Dollar General and Dollar Tree, as well as MasterCard and Visa. While the Dollar stores were classified as consumer discretionary businesses by various index providers, we understood them to be extremely defensive and resilient businesses. During COVID-19, when market participants fled to the safety of defensive business (including consumer staples companies), we added value for our clients by owning these outperforming businesses at much cheaper valuations than by investing in businesses traditionally considered defensive at much higher valuations.

Understanding drivers of profit

Our approach to MasterCard and Visa also unlocks value. By truly understanding the drivers of their profits, we not only maintained but allocated incremental capital to these businesses irrespective of how they were categorized by index providers.

Increasing our holdings in these firms meant that we benefitted from the global recovery in travel, while avoiding the pain of decline in technology stocks as interest rates began rising in 2021. Our view was that even though MasterCard and Visa were classified as technology companies, their profits are driven more by consumer spending. This differentiated view benefitted our portfolios and thereby our clients. Figure 1 shows the returns of our holdings versus the technology heavy NASDAQ since interest rates started rising in 2021.

Figure 1: Returns on holdings vs NASDAQ



Source: FactSet

In what feels like a validation of our bottom-up process of understanding businesses, the companies shown in figure 2 were reclassified into different sectors to reflect their businesses more accurately.

Figure 2: Recently reclassified companies

Source: S&P Dow Jones Indices

We strive to evaluate all investment opportunities with a clean slate, without prejudice or bias. While it’s impossible to overcome all biases, our investment process constantly steers us towards “seeking the truth” and evaluating each opportunity on its merits. When done consistently and accurately, this adds value for our portfolios and clients.

I can’t resist comparing our investment process to the advice my wife gave to the kids with regards to planting their tomatoes: “Plant them wherever they will grow.” If the kids had gone with their preconceived beliefs about tomatoes being either fruits or vegetables, that would have dictated where they planted them. However, much like our investment process, they disregarded those notions and simply planted them in areas with maximum exposure to sunlight. That is, they based their decision on what made sense and what would benefit the plants most – not on labels.

Sources: FactSet, Government of Canada

Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of CWB Wealth or its affiliates. CWB Wealth does not assume any duty to update any of the information. Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk. Nothing in this content should be considered to be legal or tax advice and you are encouraged to consult your own lawyer, accountant or other advisor before making any financial decision. Quoted yields should not be construed as an amount an investor would receive from the Fund and are subject to change. Investors should consult their financial advisor before making a decision as to whether mutual funds are a suitable investment for them. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments.

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