[00:03:10] Rayna Lesser Hannaway: Some of the things that we care about here are a company’s competitive advantage, its market position, the robustness of its business model. For the management team, we’re looking for leaders who have great strategic vision that’s also matched with strong execution skills. And a capital allocation discipline that together those things can make that great vision a reality.

[00:03:37] Rayna Lesser Hannaway: And regarding reinvestment, we’re focused on a company’s ability to reinvest its profits for future growth. This is closely related to the business quality because it’s about the potential for sustained value creation. To us, these things are all connected. 

[00:03:56] Kyle Grieve: And so with your extensive 27 years of experience in small cap investments, I’m interested in knowing what motivated you to concentrate on high quality small cap stocks as opposed to other approaches within the small cap world.

[00:04:08] Rayna Lesser Hannaway: I have researched thousands of companies in my 28 year career and have seen many successes and also many failures. My interest in investing in high quality growth companies really grew from my early exposure to covering firms like Amazon and Netflix when they were small cap. Seeing these businesses rise to become industry giants, while also witnessing many smaller companies with short lived success, has really influenced my investment approach.

[00:04:42] Rayna Lesser Hannaway: As time has passed, I’ve learned to value high quality growth businesses because they really prioritize sustained long term expansion over quick profits. They continually reinvest in their business, they enter new markets, they’re always innovating, they’re always laying the groundwork for compound a success and watching these kinds of companies have, it’s really convinced me of the power of long term investments in these companies.

[00:05:15] Rayna Lesser Hannaway: You know, I’ve got a lot of appreciation for their journeys, as well as the pitfalls when companies lack the necessary attributes for lasting growth and consistent returns. 

[00:05:27] Kyle Grieve: So next up, I’d like to discuss your business flywheel, which is a set of five self reinforcing conditions that increase the odds of long term compounding.

[00:05:35] Kyle Grieve: So they are one, uniquely positioned. Two, repeatable sales process, three, a robust business model, four, effective management, and five, value creating reinvestment. So I’d like to know more about how this flywheel developed and how it has improved your filter for identifying wonderful businesses. 

[00:05:54] Rayna Lesser Hannaway: I created our flywheel for investing based on the fundamental values and lessons that I’ve learned across my career, which have shaped my investment philosophy.

[00:06:03] Rayna Lesser Hannaway: In essence, our flywheel creates a strategic road map for our team by focusing on these key conditions. Our flywheel creates a clear and shared understanding of what it takes for a company to thrive in the long run. And having that shared vision helps everyone on our team focus on the right types of companies and the right types of features.

[00:06:27] Rayna Lesser Hannaway: as a starting point, we’re always looking for companies that are uniquely positioned with durable competitive advantages. For long term compounding, a company must have something special that sets it apart from its competitors. This could be, proprietary technology. It could be strong brand recognition.

[00:06:48] Rayna Lesser Hannaway: Exclusive access to resources, whatever it is, they need to have advantages that make it really hard for others to replicate what they’re doing and that create a protective moat around the business. The next thing we look for as a part of our flywheel is that repeatable sales and growth process. To us, consistent growth is a key sign of success, and a well defined repeatable sales and growth process really allows a company to scale efficiently and sustainably, ensuring long term growth.

[00:07:22] Rayna Lesser Hannaway: What we want to make sure that we can see, that a company has a real recipe for how they’re going to repeat their success in the future. I’ve seen many companies that are one hit wonders in the small cap space. that really lacks this recipe. And I’ve seen companies that were lucky rather than skilled in where their growth came from.

[00:07:46] Rayna Lesser Hannaway: That’s exactly what we’re trying to avoid. Once we’ve determined that a company does have a repeatable sales and a repeatable growth process, We’re looking for a robust business model. To us, a strong business model is the foundation of long term compounding. It outlines how a company can create and deliver value while ensuring profitability and strong returns.

[00:08:12] Rayna Lesser Hannaway: A resilient business model is one that can adapt to changing market conditions and evolve with customer needs. Some of the hallmarks of a robust business model to us are strong gross margins. We want to make sure that a company has a margin model that’s conducive to generating a lot of cash. And typically when you have very strong gross margins, It says a lot about the value that you’re providing to your customer, and the kind of pricing power you have, and the stickiness of those relationships.

[00:08:46] Rayna Lesser Hannaway: The other thing that we’re always looking for is really strong cashflow returns on investment. We want to make sure that these businesses are earning returns well ahead of their cost of capital and that they’re earning enough to support their future growth. And that’s from a position of maintaining their business today, but also reinvesting in ways that are going to enhance their growth in the future.

[00:09:14] Rayna Lesser Hannaway: And that may be by growing in different directions, it may come in the form of extending their growth runway. We want to make sure that they can self fund that and that they don’t have to rely on external capital to fund their long term growth plans. And the last piece that I would say on robust business models is because we’re focused on self funding businesses, and we want to make sure that there’s a business where it’s success is really under management’s control.

[00:09:49] Rayna Lesser Hannaway: We want to make sure our companies have very robust balance sheets, and we do not like companies that have a meaningful amount of financial leverage or that need leverage to deliver on their growth plans. We think that is a risky proposition, especially in today’s environment. The next piece that we look for is effective management teams, and leadership is critical for guiding a company towards long term success, and it’s particularly true of small caps.

[00:10:18] Rayna Lesser Hannaway: Effective management teams, they really set the direction and foster the culture of innovation, accountability, and adaptability. They make tough decisions when called for, and they steer the company through challenges. We all can appreciate how important that is, having just lived through a pandemic, and now in this period where there’s dramatic change in financial conditions.

[00:10:44] Rayna Lesser Hannaway: This is a really hard environment to be operating any business, especially a small cap business. And we want to make sure that our management teams have the chops to do it well. The last piece that I would point to in our flywheel is that we want companies that are always reinvesting for the future.

[00:11:04] Rayna Lesser Hannaway: When you think about successful small cap businesses that have these strong growth rates, strong margins, strong returns on capital. Inevitably, that attracts a lot of competition, and so they need to be making plans and taking steps to stay ahead of everyone else. Companies that can compound over time, they’re always investing in their growth and in their evolution, and this could involve research and development, expanding into new markets.

[00:11:35] Rayna Lesser Hannaway: It could be mergers and acquisitions. It could be process improvements. But that reinvestment ensures that a company remains competitive and innovative, and that their growth runway is long. And as you think about all of these pieces, they’re all interconnected and they’re mutually reinforcing. A company with durable competitive advantages can attract top talent for its management teams.

[00:12:03] Rayna Lesser Hannaway: Effective management can make informed decisions about where to reinvest for the future. These pieces all work together to drive the compounding engine of a business. And we require all of these pieces for every company that we invest in. 

[00:12:20] Kyle Grieve: So I think the audience would take a lot from you using your business flywheel on a real world example.

[00:12:25] Kyle Grieve: So a business I know you’re an owner of is Globant. Can you let the audience know a little bit about the business and use your flywheel on that business as a case study? 

[00:12:34] Rayna Lesser Hannaway: Certainly. Let’s break down the Globant flywheel. So to start Globont is a cloud native IT consulting company that specializes in helping its customers with digital technology.

[00:12:47] Rayna Lesser Hannaway: And this is an area where companies across the globe all need help with today. Let’s start with what makes them unique. First is that they’re digital pioneers. They’re leading the charge in digital transformation, and that really helps them hire the top talent who want to work on the most groundbreaking projects and gives them a distinct edge in this rapidly changing landscape.

[00:13:14] Rayna Lesser Hannaway: It’s all about having the right people on the bus. On repeatability, they’ve demonstrated time and time again that they can drive recurring revenue and strong growth within their blue chip customer base. They have an excellent partnership with their customer, and they’ve proven that they can consistently grow within those customers.

[00:13:40] Rayna Lesser Hannaway: Working with giants like Google and Electronic Arts, LinkedIn, Coca-cola. They don’t just acquire these clients and work with them once or twice. They’re growing alongside them, and we find that very exciting. They’ve got mid teens, adjusted operating margins that really outperform the industry standards.

[00:14:02] Rayna Lesser Hannaway: They really have a rock solid business model. With mid teens adjusted operating margins, they outperform industry standards. And they’ve got robust cash flow, which puts them in a position to finance their growth without external help. On their management team, they have an experienced founder led management team that boasts a deep understanding of the industry, has great strategic vision, strong execution skills, and we’ve seen that they’re very wise decision makers.

[00:14:35] Rayna Lesser Hannaway: And then on reinvestment, they’re always investing in the future. They’ve acquired an integrated complimentary acquisitions. They’re always expanding their offerings and their reach. They do a great job embracing emerging technologies and building new capabilities that help to keep them relevant and keep them at the forefront of their industry.

[00:14:58] Rayna Lesser Hannaway: And then of course, they continue to invest in great talent, which is the most important part. All of these things, they work together to drive excellent long term compounding for the business, to bring it to life. I first met the folks at Glavant back in 2014, and at the time, the company was delivering about 200 million in revenue annually.

[00:15:24] Rayna Lesser Hannaway: This year, they should do over 2 billion. 

[00:15:28] Kyle Grieve: So let’s discuss small caps in some detail now. Depending on who you ask, small caps have all sorts of definitions. I’d love to know what your definition of a small cap business is. 

[00:15:38] Rayna Lesser Hannaway: The short answer is that we currently consider companies below 6 billion in market cap as small cap.

[00:15:45] Rayna Lesser Hannaway: But it’s changed a lot over time. When I started in the mid 1990s, we defined it as being below 750 million. The reason why the definition has shifted over time has to do with the fact that small cap is a relative classification. It depends on how a company’s market capitalization compares to that of the broader market, which changes over time.

[00:16:11] Kyle Grieve: So let’s talk a little bit more about your diversification strategy for small cap stocks. How do you approach portfolio diversification in the small cap space? 

[00:16:21] Rayna Lesser Hannaway: We believe that there are misconceptions about diversification in the small cap space. Many investors assume that diversifying a portfolio is the key to reducing risk and volatility.

[00:16:35] Rayna Lesser Hannaway: And while this is generally true for larger, more established companies. The dynamics are different in the small cap space. In the small cap universe, the profitability and broader quality dynamics are different. Not all companies are equal and many are lower quality, really low quality. As one proof point around this, only 50 percent of the companies in the Russell 2000 growth are profitable over the past year.

[00:17:04] Rayna Lesser Hannaway: as you add more holdings to a portfolio, There’s a higher and higher likelihood you’re making trade offs on the quality of those businesses, which actually works to increase risk rather than reduce it. This is why at Polen Capital, we manage concentrated portfolios. We believe this is the only way to truly have a high quality portfolio in small cap.

[00:17:30] Rayna Lesser Hannaway: Our small cap strategy typically owns 25 to 45 companies making us one of the most concentrated managers in the asset class. What this does is it allows us to stay focused only on high quality companies. We do not need to own low quality or even mediocre quality businesses. We can keep the bar really high on what we do own.

[00:17:59] Rayna Lesser Hannaway: And at 25 to 45 companies. This still affords us the opportunity to achieve broad diversification without diluting the quality of the portfolio. And you can see this in our portfolio. We own businesses across the growth spectrum with different characteristics. And that has the overall effect of reducing risk in the broader portfolio.

[00:18:25] Rayna Lesser Hannaway: For example, our largest position is currently Houlihan Lokey, a global investment bank that operates in a number of different segments. And they tend to deliver lower growth over the cycle, but with a narrower range of outcomes. But our second largest position, Goosat Insurance, An independent property casualty insurance broker, they have a very differentiated, fast growing business model.

[00:18:53] Rayna Lesser Hannaway: That’s attacking a very large market with a long runway. And so they are higher growth and earlier in their life cycle. And we have a nice balance of both these slower, more stable businesses that have already demonstrated Strong margins and strong returns, foundational businesses that are growing a little bit faster.

[00:19:17] Rayna Lesser Hannaway: But growing at a pace that we believe is very manageable and where they too have demonstrated high quality characteristics over a long period of time without a tremendous amount of cyclicality. And then we’ve got emerging growth businesses that are growing faster and where their businesses are a little bit earlier in their life cycle or perhaps less developed.

[00:19:42] Rayna Lesser Hannaway: Because they’re investing a lot in the future, or the returns are lower today than we expect them to be over time. We think it’s a really powerful combination to have these 3 very different types of growth businesses all together in a single portfolio. And it helps us to both protect capital in tougher times.

[00:20:06] Rayna Lesser Hannaway: And then also to participate in capital appreciation when the market is stronger. 

[00:20:13] Kyle Grieve: What would you say in the fund would be the average market cap size from when you make your initial entry price? 

[00:20:20] Rayna Lesser Hannaway: Typically, we’re buying companies that are between 1 and 6 billion. We will sometimes look at companies below 1 billion.

[00:20:30] Rayna Lesser Hannaway: But we’re very firm around that profitability, cash flow, positive commitment. And it’s a lot harder within the smaller market caps to find that. They’re not really ready for prime time. And so where we find ourselves. is in the kind of larger market caps within small cap rather than going more towards the very smaller micro cap end of the market.

[00:20:56] Kyle Grieve: You’ve been analyzing and investing in small caps now for a few decades. So I think you would have some unique insights into the advantages of investing in small cap businesses over medium and large cap counterparts. So what are some of the advantages that are only found in small cap businesses? 

[00:21:11] Rayna Lesser Hannaway: I believe there are many advantages.

[00:21:13] Rayna Lesser Hannaway: First, you can get enhanced diversification, you can get better returns over the very long term, and you can get access to the most innovative companies earlier in their lifecycle. To me, it’s really the second and third points I want to double click on. First, over the very long term, small caps have delivered better returns than large caps.

[00:21:38] Rayna Lesser Hannaway: And this is because they tend to grow faster. They’re also, they’re not often well covered or well understood. They get a lot less attention from sell side analysts or the media. And that is really good for a team like ours that’s skilled at doing primary research. You can find many companies that are undiscovered or misunderstood.

[00:22:00] Rayna Lesser Hannaway: And then, in terms of early access to innovation, who wouldn’t want the opportunity to be an early investor in Amazon or Netflix? One of the reasons that I was particularly attracted to Poling Capital back in 2017, after 20 years of investing in small caps, is that when I looked at our Poling Capital focus growth portfolio, which is our US large company portfolio, What I saw back in 2017 is that one fourth of the companies in that portfolio at the time were companies that I covered as an analyst when they were small cap.

[00:22:42] Rayna Lesser Hannaway: Think about how powerful that is. And so what we’re trying to do as a firm is give our clients exposure to these great companies earlier in their life cycle. Our goal is to buy tomorrow’s leaders today and to enjoy many years of long-term compounding that happen before they’re on the radar screen of large cap investors.

[00:23:09] Kyle Grieve: Now let’s examine some of the disadvantages of investing in small caps. What do you think some of the common mistakes are that investors make when investing in small caps after maybe being used to investing in larger cap businesses? 

[00:23:21] Rayna Lesser Hannaway: Sure. There are some potential disadvantages to small caps. First, they can be more volatile and liquidity is often lower, and many are lower quality as I referenced before.

[00:23:34] Rayna Lesser Hannaway: Roughly half of the companies in the Russell 2000 growth are unprofitable. These companies, they may face difficulties in raising capital. There’s more risk of dilution as they do large equity raises. And then there’s other mistakes that I see people making. You know, over indexing on a big idea or vision, given its growth potential, but without a lot of proof behind it.

[00:23:58] Rayna Lesser Hannaway: Or, not understanding whether the management teams really have the ability to execute on their great ideas. I’ve seen so many companies fail that had great vision, but they just couldn’t make that vision a reality. And it’s for all of these things that I think you need to be really discerning like we are investing in the small cap market.

[00:24:23] Kyle Grieve: So I’d like to get your insights into how small cap cycles work in terms of business cycles. What observations do you see in the ebbs and flow of small cap businesses as it relates to the general market and compared to mid and large caps? 

[00:24:36] Rayna Lesser Hannaway: So first, I think it’s important to convey that we believe that the crux of long term success lies in maintaining a steady long term allocation to the small cap asset class, echoing the principles applied to large caps.

[00:24:52] Rayna Lesser Hannaway: The long term performance of small caps supports this approach by owning small caps, as I described before. You can get enhanced diversification, enhanced returns, and access to the most innovative companies earlier in their life cycle. But we also acknowledge that there are points in time that present excellent opportunities to amplify small cap exposure.

[00:25:17] Rayna Lesser Hannaway: And we believe that this is one of those times. Your question was about cycles. Typically small cap and large cap, they trade off in leadership cycles that typically last about 10 to 12 years, and we’re currently in what I believe is the end of a 10 year period where large caps have enjoyed that leadership.

[00:25:38] Rayna Lesser Hannaway: We often see changes in leadership coming out of periods where there’s a change in financial conditions, just like we’re seeing now. And then another thing I’d like to emphasize about the why now for small caps is to remind listeners of what happened in the early 2000s. Following a period much like today, when the large cap market became very concentrated and there were just a narrow group of companies driving the market, like the magnificent seven is today.

[00:26:11] Rayna Lesser Hannaway: Coming out of that period, small caps outperformed large caps by over 600 basis points per year for six years. 

[00:26:20] Kyle Grieve: So leverage is a subject that is rapidly changing sentiment in today’s economic environment. Highly leveraged businesses are in a little bit more trouble given economic slowdown and the inability to refinance at lower rates.

[00:26:32] Kyle Grieve: So how are you navigating this with respect to your businesses? 

[00:26:36] Rayna Lesser Hannaway: Many small companies fail because they take on too much leverage. And this is something that we control for and where we aim to mitigate risk, not just in this high rate environment, but at all points in the cycle. We only invest in cashflow positive companies that can self fund their growth that aren’t reliant on external capital to grow.

[00:27:01] Rayna Lesser Hannaway: In my experience, the biggest challenges that companies that can’t self fund their growth face is when the availability of external capital dries up or gets very expensive, like we’re seeing now. It hampers their ability to grow, or in some cases, to survive. And at a minimum, it really gets in the way of making great long term decisions.

[00:27:28] Rayna Lesser Hannaway: This is why from our very beginning, we were focused on companies that have really strong balance sheets and that have business models that are conducive to generating a lot of cash without having these dependencies on external capital. We want to be confident that every company in our portfolio has intrinsic financial flexibility.

[00:27:52] Rayna Lesser Hannaway: To survive and thrive, not just today, but in any environment, and that their management teams can continue to invest for the long term, no matter what the economic or capital market backdrop is. One thing that I would really caution people on right now is I see many investors focused really on the risks around companies that need to refinance today, but I would encourage everyone to actually start thinking about the companies that are at risk for needing to refinance next year or the year after, because it’s going to be painful for that subsegment of the universe as well.

[00:28:36] Kyle Grieve: With the businesses that you’re investing in, obviously a lot of them have very high returns on invested capital. So what are your views on utilizing small amounts of leverage to help improve returns over the longterm? Are you okay with that? Depending on how good the business is at utilizing that? 

[00:28:52] Rayna Lesser Hannaway: We are okay with that.

[00:28:54] Rayna Lesser Hannaway: For us, sometimes it’s very strategic to use leverage and it can work to enhance returns when it’s done in the right way. What we don’t want is companies that need to take on a lot of leverage in order to fulfill their long term growth plans. We think that is a completely different scenario that carries a lot more risk.

[00:29:19] Kyle Grieve: So since you have such a big emphasis on quality businesses with long runways. You must often run into a common problem, and that is the problem of price. These types of businesses are often well known by the markets and therefore have a premium price attached to them. How do you evaluate these businesses to ensure that you are lowering risk while getting an acceptable rate of return?

[00:29:39] Rayna Lesser Hannaway: We try to be very disciplined on price and we understand that when you are investing in great companies, many often grow longer and stronger than you can imagine or that is priced in today. And I think it’s that last point that goes underappreciated in quality investing. When people say you pay up for quality, that’s not untrue, but the end of that sentence should be in the short term.

[00:30:08] Rayna Lesser Hannaway: In the long term, if the quality is high enough and the secular tailwinds are strong enough, there’s a good chance that business is undervalued. We have a minimum annual return hurdle of 15 percent that we use to underwrite all of the investments we make. We want to own companies that can at least double over our five year time horizon.

[00:30:34] Rayna Lesser Hannaway: Right now, with the amazing opportunity set that’s out there, we’re finding opportunities well ahead of that minimum. 

[00:30:43] Kyle Grieve: Let’s focus on when you think is the right time to exit a position. Can you explain your approach to exiting or selling in a position in your portfolio? 

[00:30:52] Rayna Lesser Hannaway: As you know, we’re long term investors.

[00:30:54] Rayna Lesser Hannaway: We have about 30 percent turnover in our strategy since inception. And in many cases, we’ll own businesses for several years. My hope is that our small cap companies will make way into our smid cap portfolio over time. And those companies will make way into our large company strategies. And I always get really excited when there’s a great opportunity to introduce one of our companies to my And I always think there’s a great opportunity when I have a business with a long enough runway that I can tell my large cap counterparts at Pulling Capital about it and we can do some research together.

[00:31:40] Rayna Lesser Hannaway: However, there does come a time, especially in small cap, when you may have to sell a position. for us, the best case scenario is that a stock has performed very well, and it no longer meets our valuation criteria, or it may no longer fit our definition of a small cap. Or in some instances, we may sell a position simply to upgrade the quality of the portfolio because we have another position that has a more attractive return profile with less risk.

[00:32:12] Rayna Lesser Hannaway: But sometimes a sale comes when something fundamental has happened to the business that disproves our thesis. And we call these flywheel violations. You know, I talked about the flywheel earlier and having those flywheel conditions firmly in place is essential for long term compounding. And so when we see that a piece of the flywheel is broken and we think that’s more permanent in nature, that’s a good reason to sell.

[00:32:42] Rayna Lesser Hannaway: And it could be that the competitive advantage is not as strong as we imagined or that it’s eroding. It could be that the business model has deteriorated in ways that we’re uncomfortable with, maybe the management team appears less skilled than we had originally thought, or they’ve made poor reinvestment choices.

[00:33:03] Rayna Lesser Hannaway: What I believe is really important is that we stay close to these companies and that we’re always updating our views and that we’re recognizing when these things may not be true anymore and move on dispassionately. 

[00:33:18] Kyle Grieve: When you see one of these things that maybe is a little bit broken in your flywheel, how do you differentiate between it being a short term headwind versus, you know, a secular headwind that’s unlikely to ever go away?

[00:33:33] Rayna Lesser Hannaway: The first thing that we do when we see a potential flywheel violation is that we put it back into the underwriting process. Oftentimes, we’ll actually ask a different team of analysts that the team that did the original work. To go deep on that name and it’s often valuable to have a fresh set of eyes and it really holds us accountable to seeing things very objectively and to looking at that company from every angle.

[00:34:03] Rayna Lesser Hannaway: What I’ve seen over time is that Every company, even the best performing one, has problems from time to time, and often it can take two or three quarters before you see a resolution to those problems, or where you see enough improvement that you have conviction that the flywheel’s not broken. There are other times where it’s more obvious that there’s a headwind or a challenge in their business that’s going to be really hard to overcome.

[00:34:36] Rayna Lesser Hannaway: And it’s in those cases after we have re underwritten the business that we simply make the decision to move on. I think it’s really important as an investor, especially in a concentrated portfolio like ours, to always be asking ourselves the question of, is this the best thing that we can own? We need to bring an opportunity cost mindset to how we manage the portfolio.

[00:35:05] Rayna Lesser Hannaway: And so if we believe something to be broken and we have so many other opportunities, especially today, where there’s more opportunity than I’ve seen in a long time to upgrade the portfolio, there’s no reason to stick around for two years and wait. 

[00:35:23] Kyle Grieve: So in one of your latest perspectives, you mentioned that you search for businesses that can sustain growth for five years or more while thriving in a variety of different economic climates.

[00:35:32] Kyle Grieve: I’m interested in understanding why you chose five years instead of a longer number and what lessons in your past helped you arrive at this number. 

[00:35:40] Rayna Lesser Hannaway: The short answer is that I don’t believe it’s possible to see beyond five years. We’re investing in small companies that show a lot of promise. But their moats are not solidified in the same way as large established companies.

[00:35:57] Rayna Lesser Hannaway: Over longer time horizons, the variables that can affect their growth and stability, they become increasingly difficult to predict accurately. limiting the evaluation period to five years, Helps us manage some of that uncertainty and make more reliable assessments. Also, small companies, they typically look at their own strategies using a similar five-year horizon.

[00:36:24] Rayna Lesser Hannaway: that’s strategically linked with their planning and milestones for the future. The last piece that I would add here, too, is it’s always important to remember that many of the small companies we’re looking at, they do have the potential to thrive beyond the five year mark. The choice of a five year time horizon, it’s a practical one for managing risk, but it’s crucial for us to stay close to these companies and to adapt to the specific circumstances of each company.

[00:36:59] Rayna Lesser Hannaway: Like I described before, in an ideal scenario, the small companies we’re investing in make their way into our large cap team’s research process one day. And all of the companies that we’re looking at today have the potential to be at least two to five times larger than they are today, if not more than that.

[00:37:21] Kyle Grieve: So let’s discuss some interesting new businesses that your fund has been purchasing. Let’s start with Clearwater Analytics. Please let the audience know more about this business and its global expansion plans, as well as the stickiness of its revenue. And feel free to use the Flywheel framework as well on it, as I really enjoyed that.

[00:37:38] Rayna Lesser Hannaway: Clearwater Analytics is a leading provider of investment portfolio reporting and analytics solutions. They do that through cloud based software, and their customers are large corporations, insurance companies, and pension funds. The company manages and analyzes over 6. 4 trillion in daily assets across numerous accounts today.

[00:38:04] Rayna Lesser Hannaway: And ultimately what their software does is it simplifies operations, it ensures accuracy, speed, and scalability, which is a real value add for its customers. Clearwater’s customers, before they come to Clearwater, they don’t have a single view of all of these assets. Clearwater is the only company we are aware of that enables this single view, and that’s what makes them so unique.

[00:38:35] Rayna Lesser Hannaway: That’s why they’re uniquely positioned, and it’s why they’re winning 80 percent of every deal that they go after. That’s an amazing win rate. And when you think about what’s driving demand for their services, it really stems from factors like increasing complexity in portfolios. growing regulatory demands, a need for transparent reporting, and a desire to be better risk managers.

[00:39:05] Rayna Lesser Hannaway: Think of it in practical terms, like for an insurance company. Insurance companies are operating across a diverse set of asset classes and geographies. Many of them have hundreds, if not thousands, of investments where they need to have a single view to understand their risk for regulatory reasons. And in a world where complexity is only ratcheting up with new asset classes, more complex regulatory requirements, and enhanced focus on risk management, having a single view of their investments has moved from a nice to have function to truly essential.

[00:39:45] Rayna Lesser Hannaway: And Clearwater uniquely delivers this solution for their clients. Their competitors have solutions that really fall short. And Clearwater’s unified platform that gives this single view, it supersedes legacy systems that really equips clients to be better positioned to deal with today’s intricate financial landscape.

[00:40:10] Rayna Lesser Hannaway: This is a 10 billion market opportunity. And they’re the clear leader with a very robust recurring revenue model and plenty of opportunities to grow and further enhance profitability. And they have a management team that we’ve seen continue to make really smart decisions, not only in how they manage their business today, and in this nice balance of revenue growth and profitability and returns that they’ve delivered to date.

[00:40:42] Rayna Lesser Hannaway: But also in increasing their reach to different geographies and into different asset classes and to different customer types that really speak to both their growth opportunity and their reinvestment opportunity. This is a business that when you put all of those pieces together, we believe that they can grow about 20 percent per year.

[00:41:05] Rayna Lesser Hannaway: That’s the revenue. While also increasing their margins about 1, 200 basis points, which would put them near 40 percent adjusted operating margins. That’s pretty good for this type of company. And it’s really exciting to think about this great growth runway that this company has well into the future and this moat that they have in the solution that they’re delivering.

[00:41:33] Rayna Lesser Hannaway: We’re really excited about Clearwater and this is a newer company to our portfolio. We actually only bought it in the past few months. But that was after doing 15 months of work on this company and waiting for the right entry point. 

[00:41:50] Kyle Grieve: Excellent. So you mentioned a little bit earlier that your biggest position is actually Goosehead Insurance, which I’d like to ask you about now.

[00:41:57] Kyle Grieve: It’s currently trading at 142 times earnings, which optically seems like a very high number for an insurance company, but it probably has more things going on under the hood than that meets the naked eye. So I’d be interested in knowing more about that company and what do you think is driving the evaluation of it right now?

[00:42:12] Rayna Lesser Hannaway: Sure. A couple of things I’d love to clarify. I think first is that Goosehead is our second largest physician today, but then also that the company is trading on our estimation at about 50 times this year’s earnings and about 40 times next year’s earnings. And sometimes I think when you’re looking at earnings in different financial databases.

[00:42:35] Rayna Lesser Hannaway: We can be talking about two different things, or the numbers might not capture that earnings and earnings power properly. And so I wanted to clarify that. But Goose Head is a business we’ve owned for several years. They’re a disruptor in the personal lines insurance market. They sell homeowner and auto insurance with what we believe to be is a real game changing model.

[00:42:58] Rayna Lesser Hannaway: They’re rewriting the industry’s playbook. Traditional insurance brokers face two major hurdles. They’re drowning in back office tasks, and the salespeople often are tasked with the ability of both selling and servicing their clients, which actually leads to being able to sell less efficiently, and oftentimes it means weaker customer experience, too, on the servicing side.

[00:43:25] Rayna Lesser Hannaway: And Goosehead’s model really flips the script on this. They centralize customer service, which frees up their top brokers from the tedious administrative tasks. And the result of that is a soaring net promoter score, more than twice the industry average, and premium growth well ahead of the industry growth rate, even in this tough environment, where there’s not as much insurance being sold, since there’s very little housing turnover, they still continue to deliver very robust growth.

[00:44:00] Rayna Lesser Hannaway: And it’s not just separating the sales and servicing that makes them special. Goosehead boasts an industry leading platform where they’re partnered with over 80 carriers. That means that they can offer their clients an optimal solution almost every time. this is a small player in a staggering market.

[00:44:22] Rayna Lesser Hannaway: This market is about 300 billion dollars in size. And Goosehead is doing it better. And we believe that their position for explosive growth and with a return model that’s off the charts. There’s minimal investment needed for expanding their business. It’s largely a franchise model where franchisees fund future growth.

[00:44:46] Rayna Lesser Hannaway: And we think this model is really a game changer. Your question earlier, it was about the multiple. And it’s about 40 times next year’s earnings. What I would say is, while that sounds high on the surface, this is one of those companies with both the opportunity to grow fast and with a business model that has incredible operating leverage.

[00:45:10] Rayna Lesser Hannaway: We believe that if you take a longer term view, it’s trading well below what we believe intrinsic value is. And just to put some numbers to this, is a company that grew its revenue 23 percent in the most recent quarter, but grew its earnings over 90%. That is incredibly powerful. I said earlier that when you’re focused on high quality companies, one of the things that needs to be appreciated is that many of these companies can grow longer and stronger than any of us can see today, or than is priced in today.

[00:45:48] Rayna Lesser Hannaway: And we believe that Goosehead is one of those companies. We also believe that they’ve made some very smart decisions in this past year. That are really about their mix of business between corporate and franchise that have greatly enhanced their business model and make the business even more profitable and with better returns than when we first underwrote the business.

[00:46:13] Rayna Lesser Hannaway: So this is one we remain very excited about. 

[00:46:17] Kyle Grieve: Raina, thank you so much for joining me today. Before we say goodbye, where can the audience connect with you and learn more about Polen Capital? 

[00:46:24] Rayna Lesser Hannaway: Thank you, Kyle, for having me here. I’m so glad that I had this opportunity to come back on the podcast and I really enjoyed our conversation.

[00:46:33] Rayna Lesser Hannaway: Thank you so much for your great questions. For those who want to learn more about Polen Capital and our small cap team. You can find us on our Polen Capital website. That’s www. polencapital.com. Thank you. 

[00:46:50] Kyle Grieve: Okay folks, that’s it for today’s episode. I hope you enjoyed the show and I’ll see you back here very soon. 

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