Why Amazon Has Been Hitting On All Cylinders And Should Be In Your Portfolio Too

An interview with

Carlos A. Dominguez

Co-Founder, President and Chief Investment Officer, Element Pointe Advisors

This article is more than 2 years old.

Carlos Dominguez: Element Pointe Advisors is a registered investment advisor located in Miami. We work with clients whose liquid portfolios range anywhere from $1 million to several hundred million dollars. In the case of our very large clients we often serve as their outsourced CIO, if you will, where we manage assets for them not only at our primary custodian, which is Fidelity, but we also oversee the activities of their other advisors and custodians.

We’ve built a great and experienced team here with complementary skills. My partner David Savir, a JD-MBA, is our CEO. Our COO, Mary Paz de Luis, comes to us from Goldman Sachs where she served both on the investment advisory and credit side. Our head of research, Tarek El Gammal-Ortiz, came to us from JP Morgan where he worked with sophisticated clients both in the U.S. and Latin America.

Wally Forbes: Sounds like great backgrounds there.

Dominguez: As for myself, I was a portfolio manager at a hedge fund called Alpine Capital and prior to that I was a derivatives market maker. We very much consider ourselves an investment advisory firm. We build customized multi-asset class portfolios for our clients using SMAs (Separately Managed Accounts -- portfolios of assets under the management of a professional investment firm), ETFs (Exchange Traded Funds), mutual funds, and individual securities. For fixed-income and our non-U.S. exposure, that's where we generally use SMAs, ETFs, and mutual funds. On the U.S. equity side, we build customized portfolios of individual securities and occasionally we'll use an ETF to quickly overweight a sector or to add market beta when we feel it’s an opportune time.

Forbes: That's interesting and makes sense.

Dominguez: Absolutely. The U.S. equity portfolios of securities that we build for clients usually consist of about 40 to 60 individual names and we think of it as sort of a hub-and-spoke model. The hub consists of our core holdings. Core holdings usually comprise about 50% of the equity portfolio. But that can vary a little bit depending on our market outlook. Also, each client’s portfolio is customized, so holdings will vary depending on a client’s profile or specific preferences.

Core holdings are names which usually share most, if not all, the following characteristics: sustainable competitive advantage, high margins, high returns on invested capital, strong free cash flow generation, conservative balance sheets. They normally pay attractive dividend yields. They often have superior management and attractive growth prospects. These are the companies that, over time, show steady and consistent earnings growth. And, over time, stock prices follow net asset value and earnings growth.

Forbes: And that's about 50% of your portfolio?

Dominguez: Yes, approximately 50% of the equity allocation in our portfolios depending on the opportunity set. Actually, in today's market where we want to be a little more defensive, it's skewing to the high side. So I would say today we're more like 60% allocated to core names in some of our equity portfolios. And these core holdings are generally household names that we all recognize. I can give you a few, like Johnson & Johnson (NYSE: JNJ), UnitedHealth Group (NYSE: UNH), Pepsi (NYSE: PEP), General Mills (NYSE: GIS), etc. I think it's more interesting to talk about the spokes, what we use to complement the core holdings.

Often these are names where we have a differentiated view. We break that world down into different categories. Two categories that I would say are more defensive in nature include value and contrarian. Then two categories that are more opportunistic include growth and momentum. Within the portfolio, we want to have exposure to all of these categories at any given time and we adjust the weights accordingly depending on the opportunity set and our market outlook.

Forbes: About how much is the U.S. equity part of your portfolio overall?

Dominguez: Obviously, every client is different. But if we consider a hypothetical client with a balanced or moderate allocation, their equity allocation would be something close to 50% - 60% -- and roughly 70% of that equity allocation would be in U.S. equities.

I think it's interesting to talk about some differentiated names, recognizing, of course, that not every specific name is appropriate for every client. One name that we put in the value bucket -- and it may be that traditional value investors wouldn't consider it a value name, but we do -- is eBay (NASDAQ: EBAY).

As you know, eBay is one of the world's largest ecommerce market places. What's interesting about eBay is that last year they spun out PayPal. PayPal was their fast growing darling of a business. Internally, when you have a fast growing asset like that within a larger company it tends to soak up all of management's resources and attention. So the core business was sort of undermanaged and underinvested for quite a long time.

Now post the spin-off, which happened in mid-2015, we've got a management team that is keen to turn around its core marketplace business. They're pushing through several initiatives around increasing their mobile penetration, revamping seller policies, improving the user experience for both buyers and sellers, and optimizing their search results to drive more traffic to their platform.

Forbes: So it's a changing circumstance situation?

Dominguez: Yes. What's also interesting is that within their core business they have two attractive growth assets. StubHub, which is their tickets business, is growing at about 30% and that's about 10% of their revenue, and their classifieds business -- which is their locals business -- is growing at about mid- to high- teens. There are also a lot of markets that they're entering into, so we think that growth will continue.

The stock has run up a little bit here over the last month, so it probably trades at about 15-or-so P/E relative to analysts' estimates. But this is a high-margin business that throws off a lot of free cash flow. On a price-to-cash-flow basis, it trades under ten times. And they're very committed to returning capital to shareholders, so they've got a huge buy-back program in place.

We think the business really lends itself well to a take out, whether it be a strategic buyer or a private equity buyer. This is a name where we see a lot of downside support, and we think that if some of their new initiatives reignite the growth in their core marketplace business, there's substantial upside to the name.

Forbes: Sounds very, very interesting.

Dominguez: Thank you. I’d also like to discuss a few of the names that we would classify as contrarian. These are names that are unloved at the moment for a variety of reasons. For example, some of the alternative asset managers -- such as Blackstone Group (NYSE: BX), KKR & Co. (NYSE: KKR), Apollo Global Management (NYSE: APO), and Carlyle Group (NASDAQ: CG).

This is a group that has really struggled -- for various reasons. Some are technical in nature. They're not part of many broad market indexes. So the big shift towards passive management and away from active management has actually hurt the flows into these names. They're also structured as limited partnerships, so investors own LP units and receive K-1s. Some investors are reluctant to purchase these partnership units because they don't want to wait for a K-1 at tax time, or because they perceive K-1s to be an inconvenience.

So that's sort of the technical part of it. On the fundamental side, these companies earn management and incentive fees. Incentive fees are earned through portfolio realizations, which occur through either mergers and acquisitions or by bringing their portfolio companies public and doing follow-on offerings. Capital markets have been very challenged over the last year.

IPOs and follow-on offerings are down about 90% and 64% year-over-year, respectively. So admittedly their numbers this year are not likely to be very good. But we prefer to look at these companies over a cycle. What we really find attractive about these companies is that they’ve done a great job diversifying away from traditional private equity into fully diversified investment platforms that also include real estate funds, infrastructure funds, energy funds, hedge funds, venture capital, distressed credit, structured credit, and business development companies.

Forbes: Can you buy direct shares in these companies?

Dominguez: Yes, the aforementioned names are publicly traded limited partnerships. Part of the opportunity is that they haven't been public companies for a long time. Most of them became public within the last five years. So the investor base and analyst community does not have a lot of historical data on which to base their projections.

But we see increasingly diversified businesses that have been incredible at growing assets under management (AUM). These names have grown AUM at over 15% a year over the last few years. We believe that the capital markets will open up again, whether it's this year or next year. Over time, their earnings trajectory will follow their AUM growth.

In the meantime, most of their earnings are paid as distributions. So right now they're all trading at low-teens multiples -- depending on which numbers you want to use. Their distributions range anywhere from 4% to 8% or 9%, so you get paid to wait when you hold these names.

Forbes: Carlos, I'm sure these ideas will be of great interest to our readers.

Dominguez: Thank you. I just want to give you one more example of a growth momentum name. It’s a name that we all know well. It is Amazon (NASDAQ: AMZN). Amazon has been hitting on all cylinders. We love exposure to e-commerce, which is growing anywhere from 10% - 15% a year. We think that growth continues and they're actually outgrowing the market at about two to three times. I think Prime is just an incredible value to the consumer and more and more people are going to sign up -- which sort of creates this virtuous cycle.

But we really get comfortable with the valuation when we consider the AWS business, which is their cloud business. In our view, it doesn't take herculean assumptions to arrive at a value for that business of $150 billion or so.

So when you do a sum of the parts analysis, we think you get the e-commerce business at something close to one times revs -- which for a company that's growing revenue that fast, we're comfortable with that valuation. It's one of our higher beta holdings in the portfolio.

Forbes: Terrific, Carlos.

Dominguez: Thank you, Wally.

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Wallace (Wally) Forbes, CFA, was President of the Forbes Investors Advisory Institute (FIAI) from 1993 through 2014, the division of Forbes Media that publishes the Forb...