The best money managers aren’t the ones who make no mistakes. They don’t exist. The best are ones who learn from their mistakes and improve as a result—and the only way to tell if you’ve found one is if a manager’s been around long enough to see the improvement.
Few managers are as long-tenured as Paul Hogan of the FAM Dividend Focus fund (FAMEX), and few have had as strong returns over the past five years, when he bested 99% of his peers in Morningstar’s Mid-Cap Blend category with an 11.7% annualized return. The fund’s record is a little less impressive over the past 15 years—it has lagged behind its benchmark, the Russell Mid Cap Index (.RMCC), by 1.4 percentage points annually—though it still has beaten its peers. Hogan, 55, has run the fund with his co-manager and Fenimore Asset Management’s founder, Thomas Putnam, 75, since its inception in 1996.
The fund’s stellar performance in recent years can partly be attributed to a valuable lesson Hogan learned: Don’t sell winning stocks too soon. In 2001, he purchased shares of department-store operator Ross Stores (ROST) for a split-adjusted $2.73 a share. Now they trade for $114. Excluding the dividend, that’s a return in excess of 4,000%. But FAM Dividend—which holds just 31 stocks and has Ross as its second-largest position—didn’t enjoy the full benefits of that investment. It sold some of its Ross shares in 2006 after they had more than doubled, to $5.94.
“At the time we were thinking, ‘Oh, that’s great. We got our double,’ not expecting we’d get [more than 4,000%],” Hogan says.
The problem was a lack of confidence in his own research into Ross’ competitive advantages. “Part of the secret sauce is you have to know how good the good ones really are,” he says. “When we bought Ross, we were worried about Walmart being a very tough competitor.” But Ross has a unique business model for its 1,500-plus stores: special deals each month on new merchandise. That creates a “treasure hunt” mentality among customers—something neither Walmart (WMT) nor Amazon. com (AMZN) has successfully emulated. Ross “can probably double the number of stores from here,” Hogan says. “They’re not even in the Northeast yet, so they have a long way to grow.”
The evolution of Hogan’s strategy somewhat mirrors that of Berkshire Hathaway’s Warren Buffett. Hogan and Putnam started out as classic value managers—much in the style of Ben Graham and David Dodd, authors of the value-investing treatise Security Analysis. That strategy was to buy cheap stocks, get a final shot of returns, then sell when they hit a valuation target. Putnam, whose father started a textile business in the 1930s, learned about Berkshire Hathaway (BRK/B) because it also originally was a textile company, so he began to follow Buffett. After his father left the textile business, Putnam launched Fenimore Asset Management in 1974 with the proceeds from its sale.
Back then, it was easier “to be a Graham and Dodd disciple,” Putnam says. “In the mid-1970s, you could buy companies for two, three, four times earnings on a [price/earnings] basis...Now it’s more important to find companies with high returns on invested capital.”
Hogan now embraces a high-quality investment style, seeking strong businesses that can fend off competitors—much like Buffett does. But the fund looks for midsize stocks that pay dividends and are less widely known, rather than an Amazon or Apple (AAPL). When the fund launched, it was called FAM Equity Income, as many value stocks had high dividend yields. Gradually, as valuations increased, the fund shifted to companies with growing dividends.
“Increasing the dividend payment is really a reflection of management’s belief that the company can continue to grow,” Hogan says. He won’t buy a company unless it’s growing its dividend by at least 10% a year, he says, and midcap companies can grow dividends faster than large ones. The fund changed its name in July to reflect the shift in approach.
The fund’s largest sector weighting is growth-oriented tech stocks, at 27% of its portfolio. Diversified information-technology services company CDW (CDW) is its top holding, at almost 7%. The company's dividend growth rate has averaged 44% over the last three years. “CDW’s providing solutions like cybersecurity, cloud computing, and virtualization to satisfy all the needs of small businesses,” Hogan says, adding its goal is to grow two to three percentage points faster than the U.S. IT market. “They’re taking market share, and the larger they get, the more advantage they have versus their competitors.”
Smaller companies tend to focus on selling and servicing one tech company’s products—such as Microsoft’s (MSFT) — because hiring technicians licensed to service different companies’ products is expensive. Yet CDW’s scale enables it to diversify. “They have a lot of people who are licensed and certified on a number of different technologies,” Hogan says. “So they can tailor a solution for a customer based on what type of hardware that customer already has.”
Hogan also has a 12.9% allocation to financial-services companies, although he says he’s “very choosy” about the banks he invests in. After a lengthy economic recovery, he feels the only way bank-loan credit quality can go is down. One bank favorite is First Hawaiian (FHB) because it dominates its region’s market, is selling off risky loans to buy back stock, and has dividend growth averaging 10%. “Other companies have tried to come into the Hawaiian market and compete, and they haven’t really been very successful,” he says.
Still, there is always room for improvement. FAM Dividend Focus’ expense ratio is 1.24%, which Morningstar rates “above average” for its fund category. “Our shareholders have gotten exceptional performance for what they paid for it,” Hogan says. Thanks to the strategy tweaks he’s made, they certainly have of late.
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