With a macro investment thesis established, LCM defines its investment universe for the Peak Resources & Energy Portfolio from a number of sources. These include the constituents of the S&P Energy Index as well as the Philadelphia Gold & Silver Index, and are supplemented with foreign stocks, sector Exchange Traded Funds (ETFs), alternative energy companies, conservation-related companies, and pure-play commodity ETFs and Exchange Traded Notes (ETNs).
This universe of over 1,000 stocks is then screened for market capitalization greater than $250 million, and valuation – with a Forward PEG ratio less than that of the S&P 500. The resulting watch list totals 75 to 100 companies and is culled to a portfolio through a rigorous fundamental research process.
LCM’s fundamental research process incorporates the following inputs:
• “DCA” Analysis (Dominant & Competitive Analysis) – LCM’s research process places an emphasis on
identifying companies with strong franchises that are dominant in their sector or industry, since dominant
companies tend to be less affected by changes in an industry than other players in the market. The following
factors are evaluated to determine a company’s dominance and relative competitive position: market-share
analysis, differentiation of product/services, industry trends & competitor analysis, sustainability, and financial
• Growth Factors – On the security level, LCM defines growth companies as those within each identified
growth sector with EPS growth rates in excess of those for the peer group. For production companies (energy,
materials, precious metals, etc.), LCM further looks for a visible production growth profile. LCM will not purchase
just any company that meets the firm’s definition of growth, as the stock must also be trading at a reasonable
price. In order to determine the correct price for a stock relative to its growth rate, portfolio managers will
calculate a PEG ratio for each company, which is based on the firm’s internal growth projections for it.
Candidates for investment should have a PEG ratio below that of the S&P 500.
• Company & Quality Analysis – When analyzing a stock, LCM will assess the overall financial strength of the
company and will review factors such as a company’s assets/liabilities, capital structure, financial leverage
(debt/equity), operating leverage, free cash flow yield and growth, return on equity, and its debt rating if
applicable. LCM will also evaluate each company’s management and assess such factors as its strategic
vision, stability, reputation, experience, and operational track record.
Once investments are identified, the portfolio is constructed under general weighting guidelines. These include but are not limited to:
- A 50/50 split between energy & materials (including precious metals)
- Typical diversification among 30-40 positions
- An 8% maximum weighting for any single company (see below for details)
- Including investments in other sectors that could be beneficiaries of resource scarcity (defense, etc.)
LCM employs strict sell disciplines to protect its clients’ portfolios. Positions will be sold if a stock:
- Becomes overpriced –LCM does not use explicit price targets in the valuation of companies, but rather relies upon relative valuation metrics, such as PEG. LCM views a sector and company’s value on a relative basis (in accordance with macroeconomic assumptions), and will sell a position if the company’s PEG ratio is no longer less than the broad market.
- Can be replaced with better risk/reward opportunity – If an Investment Committee member believes that a current holding can be replaced by another security with either better upside potential, a more favorable PEG or a less risky profile, the company will be brought to the attention of the Investment Committee. A discussion will occur as to which position is better suited to the current strategy the firm is pursuing; subsequently a decision will be made.
- Changes occur that affect a stock’s fundamentals – The firm’s fundamental research does not stop once a security is included in the portfolio. This process is also used to ensure that no adverse factors are changing the original fundamental case made for the stock’s inclusion in the portfolio. If one or more factors do change and the stock is no longer fundamentally sound or is no longer likely to meet our expectations, the position will be sold.
- Position weight reaches 8% –Under normal circumstances,LCM’s investment process will not permit a position in single security to exceed 8% of the portfolio. Once a position approaches this level, it will likely be scaled back. In the past, exceptions have been made for certain investments, e.g. an ETF invested in gold bullion.
- Price depreciation – Portfolio managers regularly review stocks whose performance lags on both an absolute and relative basis. Any discrepancies in performance relative to a company’s sector and/or market—i.e., 20% underperformance on a 6-month trailing basis—are immediately reviewed by our Investment Committee. If this depreciation is fundamental in nature, the company’s PEG ratio will be adjusted accordingly. If the resulting PEG is no longer attractive relative to the sector, then such circumstances will warrant this position being sold. If the company’s fundamentals remain sound and its earnings and growth prospects remain intact, the investment committee can decide to retain the position.