Crabtree Asset Management was founded by Barry Randall, who serves as the firm’s Chief Investment Officer. He’s had nearly two decades of investing experience in the technology sector and has worked as a professional portfolio manager since 2000. He runs the Crabtree Technology investment model on Covestor.
Randall says he seeks to generate alpha by building a portfolio of tech companies that consistently generate cash, hold on to or increase their market share, and execute on their operational and financial plans.
I recently sat down with Randall to ask him about his approach and the current state of the technology stock sector:
You’ve been investing in technology for over 19 years – how have things changed over that period? And what hasn’t changed?
Here’s a good snapshot of the state of technology: I started as a junior sell-side analyst in 1993, right after getting my MBA. My firm hired five of us from my graduating class at the University of Texas at Austin. We got brand new Dell (DELL) desktop computers – the CPUs ran at 50 MHz. The machines ran Microsoft (MSFT) DOS and Windows 3.1. We built spreadsheets using Lotus 1-2-3. We had a Novell network that allowed us to use a shared Hewlett Packard (HPQ) laser printer. There was no Internet. No e-mail. Only wealthy people had cell phones, generally in their cars; hand-held cell phones were the size of a brick. Satellite TV still required one of those giant dishes in your yard. I read technology trade journals to learn about what was happening in the industry. Broadband was an arcane technology term used by microwave engineers.
So clearly, a whole lot has changed in 19 years. What about now?
I think there is surprisingly little innovation these days. Twenty years ago, when Oracle (ORCL) was just going mainstream with relational databases, or Lotus with spreadsheets or Motorola (MSI) with cell phones, these were game-changing developments that conferred huge advantages to companies willing to pay for them. Another change is the availability of amazing productivity tools for free. Like Google (GOOG). Or LinkedIn (LNKD). In the old days, you’d have to pay for everything. Now, with server-based apps, often backed by advertising, so much is free of charge.
Who and what do you read to get the information you need?
I developed a computer program that combs well-known financial web sites to create a large spreadsheet of information about 1100+ technology companies. I then distill this information down to a model of between 80-120 companies that meet all three of my investment criteria. Beyond that, I read widely, including The Wall Street Journal, The New York Times, Silicon Alley Insider, D-AllThingsDigital, the Infectious Greed blog, Clusterstock, TechCrunch, Quartz and Slashdot. I also subscribe to about a dozen general purpose magazines, including the New Yorker, Harper’s Atlantic Monthly, Pacific Standard and Wired. I also frequently read the online versions of those magazines.
You say you invest “with a time frame of quarters and years in mind.” Can that be particularly challenging for a tech investor?
Not really. I’ve simply learned over 20 years that reacting to news is a losing strategy. And this is backed up by a lot of research. Here’s a New York Times piece that discusses the issue.
I can sum up my theory on this topic by saying that the plural of stock-picking is not portfolio management. The popular perception of tech investing is that it requires a great deal of domain expertise, so that your radar can pick up subtle changes in the tone of business at a particular firm, or notice some technology breakthrough and know immediately how that will affect relevant companies. Then, because your portfolio manager believes in being a stock picker, he or she will immediately buy or sell to reposition the portfolio.
But it’s very hard to imagine that a single person or even a multi-person organization could simultaneously possess all that knowledge and immediately be able to convert it into investment decisions. There are over 1000 technology companies with market capitalizations greater than $100 million trading on U.S. exchanges alone, each of them with a unique business model.
So rather than invest in such a way, trying to react to everything, I simply look at larger issues that play out over quarters and years and invest accordingly. For example, I place huge value on a company management’s ability to execute on their business model. A headline in tomorrow’s paper isn’t going to affect that. And rather than research individual companies to a fare-thee-well, and thus only have time to do such research on maybe 30-40- companies per year, I use a proprietary model to search for the five key factors about every stock in my universe.
Some VCs (like Fred Wilson) say that they believe they’re good at investing in private companies, but not necessarily in public ones. Do you think those are very different disciplines? Do you follow what VCs say on their blogs?
The private versus public distinction is real. I’d be using a somewhat different set of criteria were I investing in private companies, even very large ones that might under other circumstances be public. But I don’t buy the idea as some do that I should look at a public company and come up with a private company value for it. Look at Apple (AAPL). It’s so large that only a sovereign nation could afford to buy it. So it’s basically going to be public for the foreseeable future. Might as well focus on what is, not what might be.
I do read some VC blogs, like Fred Wilson’s A VC and Ben Horowitz’s Ben’s Blog. But I do that mostly for the larger perspective on issues, like Silicon Valley’s ridiculous self-absorption, or its VCs’ fetish for always trusting founders to be effective CEOs, no matter how young or inexperienced. Venture capitalists only have to be right about 3-5% of the time. I have to be right 60% of the time. So if a VC thinks that something is the next big thing, the burden of proof is on the VC, not on me.
How do you incorporate scans into your research? And what are the five Crabtree criteria?
As I previously mentioned, my whole portfolio process is based on a scan or screen that I run every three months and act upon. I’m looking for companies that 1) generate cash, 2) hold on to or increase market share, and 3) execute upon their own operational and public company plans. Additionally, I favor companies (all other things being equal) that are less rather than more well known.
My screen looks for five criteria, that, when taken singly or in some cases together, reveal whether a company is doing those three things. Obviously, I’m not going to reveal all five. They seem to work and I’d like to keep them for myself. But one, for example, is operating cash flow: every single company in the Crabtree model has positive operating cash flow for its most recently reported four quarters. This fact addresses two of my three Crabtree attributes: it obviously demonstrates cash generation, but it’s also an indirect form of measuring management execution.
But I’m not just being modest when I say that there is no great woo-woo or magic in these five criteria. Success is mostly about the application and the discipline to not waver. I have had blow-ups, like Vocus (VOCS), which dropped more than 40% in a day this past February. In hindsight, I see that I’ve missed huge winners like Apple (AAPL). But it seems to work over time if I don’t sabotage myself.
As a tech manager, why do you not own a stake in Apple stock?
My quantitative model caught Apple very early in its turnaround, and I owned it for a double in the early part of the last decade. It always had the cash flow, and then suddenly they were taking share again with the colorful iMac. Then it grew too “famous,” and I sold it, and basically missed the increase thereafter. It was a huge winner that I missed. But it’s not the only one. I missed Priceline (PCLN) too. And some others. I congratulate those who made huge returns in Apple.
But three years ago, when I started the Crabtree Fund, my screen caught a company I’d never heard of, called SXC Health Solutions, now known as Catamaran Corp (CTRX). That company’s stock has been a surprising contributor since early 2009. While that’s exceptional, so was Apple. So I’m proud of the fact that my performance is not the result of a few big winners, but from the whole portfolio.
Where are we in the tech cycle? And is it worrisome that tech is lagging the rest of the market?
I’m not sure I view tech as being cyclical as a whole. Some segments, like PCs, servers and big-ticket software (such as Oracle) are essentially industrial supplies, and sales of these products rise and fall with the larger economic cycle. Other, subscription-based products, like Software-as-a-Service have such low initial costs of ownership that they move independent of any purchasing or development cycle; new features are simply uploaded to the server, and made available to existing customers.
The semiconductor business is still cyclical, but the cycles are shallower now, thanks to supply-chain software that alerts chip-makers earlier to changes in demand.
I’m pretty sure that tech has been among the best-performing sectors in the S&P 500 in 2012, though it has weakened throughout the summer into the fall. This is certainly consistent with historical trends. I think what is worrisome about technology is the lack of game-changing innovation. When Apple spends its time patenting the rounded shape of the corners of the iPhone, that can’t be a good sign for innovation in general.
Where is the next big thing? A cell phone. An Internet. A fax machine. A television. A big, this-changes-everything kind of breakthrough. It’s been a long time. Tech has been resting on its laurels for a few years now.
Thanks, Barry
My pleasure.
