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Investment Commentary

Report to Investors 2nd Quarter 2022

Dividend Growth Summary

Note: LTM Dividend Growth is the median of the actual trailing 12-month dividend growth of the individual stocks held by Strategies or Index constituents as reported by Bloomberg on June 30, 2022. FTM Dividend Growth is the median of the Bristol Gate Model’s forward 12-month prediction for the individual stocks held by the Strategies and the median of consensus estimates for the constituents of the Indices as of July 15, 2022. Companies without a consensus dividend forecast were excluded.

Source: Bloomberg, FactSet, Bristol Gate Capital Partners.

Commentary – Patience Pays Dividends

“Good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild.”

– Morgan Housel – “The Psychology of Money: Timeless Lessons on Wealth, Greed and Happiness”.

Investing involves a lot of analysis, numbers and data. The most underrated part of investing, however, is psychological. The psychological challenges are particularly difficult during times like these where global markets posted one of their worst first half year results in decades. Not only are human beings prone to numerous behavioural biases, but our challenges are compounded with us being constantly bombarded with new information and instant analysis from 24-hour cable news and online pundits. Unfortunately for investors, this often involves those so-called experts usually manufacturing a reason that all this information matters. We imagine it might not make for much “must-see tv” if the hosts repeatedly keep telling the audience to ignore most of what is going on.

The average person has never had an easier time accessing the financial markets and products, whether it be through traditional stocks, bonds, mutual funds, and ETFs or new-fangled products based on cryptocurrencies, blockchain technology, NFTs, etc. At the same time, information has become almost infinitely abundant and instantly accessible. It has never been harder to sift through the daily noise and focus on long-term goals. To guide us, our evidence-based approach means the question we ask ourselves everyday is how much of the daily tsunami of information is useful for a long-term fundamental investor.

Bristol Gate has a single approach to investing: We build concentrated portfolios of high-quality companies that we expect will grow their dividends at much faster rates than the market because we believe that will lead to attractive long-term returns. In the short-term however, we also know that quite often, as a result of that concentration, our performance will be quite differentiated from that of the broad market. We have no control over how our holdings will be perceived by the market in the short-term but attempt to benefit from the market overlooking their strong fundamentals.

Part and parcel of being a successful long-term investor is understanding the difference between poor performance and returns that are not correlated with the index. Academic research has shown that portfolios that closely resemble the index are unlikely to outperform over the long-term[1], even though their relative performance may make them easier investments to stick with. Morningstar also published two pieces of research that highlight how important it is to stick with an investment if the fundamentals remain sound, regardless of relative returns. The first[2] showed that over a 15-year period, the average number of months that accounted for a strategy’s outperformance was six months. If an investor was unable to remain invested for the full period and missed that critical, but small, window, they did not benefit from the manager’s outperformance. The second piece of research[3] showed that funds that outperformed their benchmarks over 15 years, underperformed in 60% of calendar years. In other words, the investor would have had to tolerate underperformance for nine of those 15 years.

Achieving long-term success is neither simple nor easy. The evidence is clear however that patience pays dividends. Investors who can look past the short-term noise put the odds of success in their favour. An example of this is our investment in Broadcom, which we first made in mid-2017. As the stock chart below shows, when we bought the stock the company’s stock price grew in line with their free cash flow growth, but starting in 2018 the company’s market price did not keep up with the continued growth in free cash flow per share the company was generating:

Exhibit 1. Broadcom

Source: Bloomberg. As at June 30, 2022

At the time, Broadcom’s 2018 acquisition of CA Inc. was, in our view, broadly misunderstood by the market. As we outlined in our third quarter note of that year, we had a different view that CA’s mainframe software revenue stream was very attractive, providing high margins and stability to Broadcom’s existing business. Following our process and doing the fundamental work alongside the dividend growth prediction allowed us to look through both the market’s perception of the acquisition and the short-term stagnation of the company’s share price. Although it took almost four years, eventually the market price of the company came back in line with the fundamental operating performance of the business. In the meantime, the company was able to grow its quarterly dividend from $1.75/share when it announced the CA acquisition in July 2018 to $4.10/share last quarter, a 234% increase.

As long-term investors, we are willing to be patient with the companies we own. As they continue to grow their dividends, we have the added benefit of being paid to wait for the market to reward our company’s superior fundamentals. We believe this year is another example of this in action.

The macroeconomic backdrop has challenged many asset classes, not just stocks. We are still experiencing the effects the global pandemic supply chains and what was expected to be transient inflation has proven to be much more persistent. As a result, interest rates are rising much faster than previously expected. However, focusing on the short-term price return of the companies in our portfolio rather than underlying operating performance and long-term drivers of the businesses would be a disservice to our clients. At Bristol Gate, we invest differently. We focus on the evidence; on the companies we own (or would like to own) and on finding high quality companies with high dividend growth trading at attractive valuations. We trust our process and remain confident that over the long-term our clients and our partners will be rewarded for their patience.


[1] Cremers, K. J. Martijn and Petajisto, Antti, How Active is Your Fund Manager? A New Measure That Predicts Performance (March 31, 2009).

[2] Kaplan and Kowara, “Is there a ‘Good’ time to buy or sell actively managed funds? Staying Invested is the name of the game”, Morningstar, July 11, 2019.

[3] Kaplan and Kowara, “How Long Can a Good Fund Underperform its Benchmark?”, Morningstar, March 2018

US Equity Strategy (all returns USD, gross)

During the quarter, the portfolio outperformed the S&P 500 Total Return Index, and a significant amount of progress was made in closing Q1’s performance gap. Unfortunately, both the market and our portfolio continued their year-to-date declines in an environment where interest rates are rising much faster than previously expected, fueling investor concerns over a possible central bank induced recession.

Exhibit 2. US Equity Strategy Risk and Return Metrics

Source: Bristol Gate Capital Partners Inc. Please Refer to “Important disclosures” section below

Security selection was the driver of the positive relative results, as our more defensive holdings in Consumer Discretionary and Communications Services benefited the portfolio compared to the benchmark. Dollar General, Activision Blizzard and American Tower were the largest relative contributors to returns. Activision’s share price continues to hold up well on the back of Microsoft’s $95/share all cash offer but remains at a large discount to the deal price given regulatory approval concern. Our belief in the deal closing within the June 2023 goal Microsoft outlined remains unchanged. Dollar General reported better-than-expected first quarter results that saw them maintain healthy gross margins despite inflationary cost pressures on the supply side. Dollar General is an example of our patience ultimately being rewarded. After lagging the S&P 500 for most of the time since acquiring the company in June 2020, its defensive growth characteristics that initially attracted us to the investment are paying off. Dollar General is benefiting from an environment where consumers have become more price sensitive.

Two of our three semiconductor related stocks, Applied Materials and Broadcom as well as Zoetis were the largest detractors on a relative basis. Our semiconductor stocks have experienced significant multiple compression on fears of a possible recession. In addition, Applied Materials continues to face short-term revenue and margin pressures due to lockdown-related supply chain issues. We view these issues as short-term in nature. The growing semiconductor intensity within the global economy and a slowing of Moore’s Law help us remain confident in the visibility of longer-term demand. Zoetis’ share price performance over the quarter does not reflect the operating performance of the business, which continues to demonstrate strong revenue growth and healthy margins.

Sector allocation detracted from relative returns. Our overweight in Consumer Discretionary and underweights in Consumer Staples and Energy were the largest negative contributors.

On an absolute basis, Dollar General, American Tower and UnitedHealth were the largest contributors while Broadcom, Applied Materials and Microchip were the largest detractors.

In April, we rebalanced the portfolio, reducing our allocation to UnitedHealth Group as it exceeded our weighting threshold. Proceeds were allocated to Starbucks and Allegion, our two lowest weights at the time.

Staying invested through the volatility we have experienced this year is an example of the mental tax investors must pay to earn the attractive long term returns equity markets have provided. While we recognize that there are still several significant headwinds we face from a macro perspective, including the risk of a recession, there are some reasons for optimism.

As we enter the Q2 reporting season, the intra period commentary provided by several of our holdings has generally been positive. Despite the year-to-date price return challenges and macro concerns, 11 of our 22 holdings have announced dividend increases thus far in 2022. They have averaged 21%, indicating what we believe is the confidence our holdings’ management teams have in their longer-term business fundamentals.

We are also encouraged by the historical results after a significant market decline in the first half of the year. The S&P 500 Total Return Index has declined 20% to June 30, 2022. Since 1928, there have been six instances where the index has declined more than 15% in the first half of the year, including this year. Of the five previous instances (1932, 1939, 1940, 1962, 1970) all had positive returns in the second half, with an average return of 26%, median of 18% and minimum of approximately 10%. After the tough start to the year, we think investors will once again be well-served exercising a bit of patience.

Canadian Equity Strategy (all returns CAD, Gross)

During the quarter, the portfolio outperformed the S&P/TSX Composite Index, and a significant amount of progress was made in closing Q1’s performance gap. Unfortunately, both the market and our portfolio continued their year-to-date declines.  Interest rates are rising much faster than previously expected, fueling investor concerns over a possible central bank-induced recession.

Despite the year-to-date price return challenges and macro concerns, 13 of our 23 holdings have announced dividend increases thus far in 2022. They have averaged over 10%, indicating what we believe is the confidence our holdings’ management teams have in their longer-term business fundamentals.

Exhibit 3. Canadian Equity Strategy Risk and Return Metrics

Source: Bristol Gate Capital Partners Inc. Please refer to “Important disclosures” section below

Security selection was the primary driver of the positive relative results. Sector allocation detracted from relative returns, as our lack of Energy, and to a lesser extent, Utilities and Real Estate holdings were the largest negative contributors.

Zoetis Inc., CCL Industries Inc. and Element Fleet Management Corp were the largest contributors to relative returns. Zoetis, one of our two non-domestic holdings, saw its share price performance over the quarter decline less than the broad Canadian market. The business continues to demonstrate strong revenue growth and healthy margins. CCL reported strong first quarter earnings driven by margin expansion and resilient demand. Management also announced a bolt-on acquisition that was well-received by the market. Element also reported strong first quarter results. The company continues to win new business adding to an already strong the backlog which we expect to convert to revenue over the next 12-18 months. 

InterRent Real Estate Investment Trust (IIP), Premium Brands Holdings Corp. and Brookfield Asset Management Inc. (BAM) were the largest detractors on a relative basis over the quarter. InterRent struggled as concerns over possible changes to the Federal government’s taxation of multifamily REITs weighed on sentiment. We believe the concern is overblown and does not necessarily address the government’s goal of improving housing affordability. Premium Brands’ share price has suffered due to worries over higher input prices, which we believe will be at worst a short-term margin issue for the company due to the strength of the overall business. Despite reporting strong quarterly results, Brookfield’s shares lagged in the quarter. We view the company’s plans to spin-off their investment management business as a potential catalyst in coming quarters.

On an absolute basis, Element Fleet Management Corp., CCL and Dollarama Inc. were the largest contributors while InterRent, Enghouse Systems Limited and Brookfield were the largest detractors.

During the first half of April, we followed our quarterly rebalancing process, trimming Alimentation Couche-Tard, Telus and Dollarama, while bringing up CCL Industries, Open Text, Colliers and Premium Brands to equal weights. One name change took place during the rebalancing, as we exited Quebecor and introduced Element Fleet in the portfolio.

Quebecor was an underperformer in the past year due to the uncertainty surrounding national wireless expansion aspirations. We believe the company’s dividend growth prospects have deteriorated given a limited growth opportunity within Quebec and the possibility of a costly expansion nationwide.

Element Fleet Management is the largest company in the North American fleet leasing and management industry. It is an attractive industry dominated by a few large firms due to high barriers to entry and switching costs. It has both defensive and growth characteristics, is well positioned for an inflationary environment, and is insulated from increasing interest rates. The company itself has had an impressive turnaround led by the current management and has an attractive growth opportunity ahead based on multiple levers. The COVID induced global supply chain challenges resulted in reduced OEM vehicle production and therefore lower originations, offering an attractive entry point for us. The company is sitting on a record backlog which we believe will be realized in the coming years.

Staying invested through the volatility we have experienced this year is an example of the mental tax investors must pay to earn the attractive long term returns equity markets have provided. While we recognize that there are still several significant headwinds we face from a macro perspective, including the risk of a recession, there are some reasons for optimism.

We are encouraged by the historical results after a significant market decline in the first half of the year. The S&P/TSX Composite Total Return Index has declined by just under 10% to June 30, 2022. Since 1957, there have been six instances where the index has declined more than 10% in the first half of the year. In all but one of those instances (1962, 1970, 1982, 1984, 2001) the index had positive returns in the second half, with an average return of over 12% and a median return of over 11%.  After the tough start to the year, we think investors will once again be well-served exercising a bit of patience.

Firm Update

Like all our companies, we continue to invest through this challenging period with an eye on the future opportunities we see. We welcomed two new members to the Bristol Gate team during the quarter. Patrick Hamm joined the firm in April and will lead our sales efforts in the family office, endowments, and foundations channel. Shehryar Khan joined in June as an Investment Specialist and will support business development and investment functions, creating content and analysis relevant to our investment philosophy and process.

To all our clients, thank you for your continued trust and confidence. Since our inception, we have continually invested for the long-term by owning the best prospective dividend growers for the coming year. Our strategy has served us well over time and we look forward to being rewarded in the future once again.

Sincerely,

The Bristol Gate Team



Important disclosures

Gross returns in this report refer to the Bristol Gate US Equity Strategy Composite and Canadian Equity Strategy Composite. No allowance has been made for custodial costs, taxes, operating costs, management and performance fees, which will reduce performance. Past performance is not indicative of future results. Allowance for withholding tax in the US strategy composite is partially reflected in the composite returns for periods commencing January 2017 and after. The Net returns for the Bristol Gate US Equity Strategy Composite and Canadian Equity Strategy Composite are reflective of the maximum management fee charged by Bristol Gate of 1% and 0.70%, respectively.

The Bristol Gate US Equity Strategy Composite was formerly known as the Bristol Gate US Dividend Growth Composite until April 1, 2015. The Composite inception date was May 15, 2009. The Composite consists of equities of publicly traded, dividend paying US companies and is valued in US Dollars.

The Bristol Gate Canadian Equity Strategy Composite was formerly known as the Bristol Gate Canadian Dividend Growth Composite until April 1, 2015. The Composite inception date was July 1, 2013. The Composite consists of equities of publicly traded, dividend paying Canadian and US companies and is valued in Canadian Dollars.

The S&P 500® Total Return Index measures the performance of the broad US equity market, including dividend re-investment, in US dollars. This index is provided for information only and comparisons to the index has limitations. The benchmark is an appropriate standard against which the performance of the strategy can be measured over longer time periods as it represents the primary investment universe from which Bristol Gate selects securities. However, Bristol Gate’s portfolio construction process differs materially from that of the benchmark and the securities selected for inclusion in the strategy are not influenced by the composition of the benchmark. For example, the strategy is a concentrated portfolio of approximately equally weighted dividend-paying equity securities, rebalanced quarterly whereas the benchmark is a broad stock index (including both dividend and non-dividend paying equities) that is market capitalization weighted. As such, strategy performance deviations relative to the benchmark may be significant, particularly over shorter time periods. The strategy has concentrated investments in a limited number of companies; as a result, a change in one security’s value may have a more significant effect on the strategy’s value.

SPDR S&P 500 ETF Trust (SPY US) sourced from Bloomberg has been used as a proxy for the S&P 500® for the purpose of providing non-return based portfolio statistics and sector weightings.

The S&P/TSX Total Return Index measures the performance of the broad Canadian equity market, including dividend re-investment, in Canadian dollars. This index has been provided for information only and comparisons to the index has limitations. The benchmark is an appropriate standard against which the performance of the strategy can be measured over longer time periods as it represents the primary investment universe from which Bristol Gate selects securities. However, Bristol Gate’s portfolio construction process differs materially from that of the benchmark and the securities selected for inclusion in the strategy are not influenced by the composition of the benchmark. For example, the strategy is a concentrated portfolio of approximately equally weighted dividend-paying equity securities, rebalanced quarterly whereas the benchmark is a broad stock index (including both dividend and non-dividend paying equities) that is market capitalization weighted. As such, strategy performance deviations relative to the benchmark may be significant, particularly over shorter time periods. The strategy has concentrated investments in a limited number of companies; as a result, a change in one security’s value may have a more significant effect on the strategy’s value.

iShares Core S&P/TSX Capped Composite Index ETF (XIC CN) sourced from Bloomberg has been used as a proxy for the S&P/TSX Total Return Index for the purpose of providing non-return based portfolio statistics and sector weightings.

There is the opportunity to use leverage up to 30% of the net asset value. Leverage is not used as an investment tool to enhance returns, but for cash management needs of certain composite portfolios.

This Report is for information purposes and should not be construed under any circumstances as a public offering of securities in any jurisdiction in which an offer or solicitation is not authorized. Prospective investors in Bristol Gate’s pooled funds or ETF funds should rely solely on the fund’s offering documents, which outline the risk factors associated with a decision to invest. No representations or warranties of any kind are intended or should be inferred with respect to the economic return or the tax implications of any investment in a Bristol Gate fund.

Bristol Gate claims compliance with the Global Investment Performance Standards [GIPS®]. To receive a list of composite descriptions and/or a presentation that complies with the GIPS® standards, please contact us at info@bristolgate.com. Bristol Gate Capital Partners Inc. has been independently verified for the periods commencing May 2009 until December 2015 by Ashland Partners International PLLC and from January 1, 2016 – December 31, 2020 by ACA Group, Performance Services Division.

This piece is presented for illustrative and discussion purposes only. It should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities and it does not consider unique objectives, constraints, or financial needs of the individual. Under no circumstances does this piece suggest that you should time the market in any way or make investment decisions based on the content. Investors are advised that their investments are not guaranteed, their values change frequently, and past performance may not be repeated. References to specific securities are presented to illustrate the application of our investment philosophy only, do not represent all of the securities purchased, sold or recommended for the portfolio, and it should not be assumed that investments in the securities identified were or will be profitable and should not be considered recommendations by Bristol Gate Capital Partners Inc. A full list of security holdings is available upon request. For more information contact Bristol Gate Capital Partners Inc. directly. The information contained in this piece is the opinion of Bristol Gate Capital Partners Inc. and/or its employees as of the date of the piece and is subject to change without notice. Every effort has been made to ensure accuracy in this piece at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and Bristol Gate Capital Partners Inc. accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. We strongly recommend you consult with a financial advisor prior to making any investment decisions. Please refer to the Legal section of Bristol Gate’s website for additional information at bristolgate.com.

A Note About Forward-Looking Statements

This report may contain forward-looking statements including, but not limited to, statements about the Bristol Gate strategies, risks, expected performance and condition. Forward-looking statements include statements that are predictive in nature, that depend upon or refer to future events and conditions or include words such as “may”, “could”, “would”, “should”, “expect”, “anticipate”, “intend”, “plan”, “believe”, “estimate” and similar forward-looking expressions or negative versions thereof.

These forward-looking statements are subject to various risks, uncertainties and assumptions about the investment strategies, capital markets and economic factors, which could cause actual financial performance and expectations to differ materially from the anticipated performance or other expectations expressed. Economic factors include, but are not limited to, general economic, political and market factors in North America and internationally, interest and foreign exchange rates, global equity and capital markets, business competition, technological change, changes in government regulations, unexpected judicial or regulatory proceedings, and catastrophic events. Readers are cautioned not to place undue reliance on forward-looking statements and consider the above-mentioned factors and other factors carefully before making any investment decisions. All opinions contained in forward-looking statements are subject to change without notice and are provided in good faith. Forward-looking statements are not guarantees of future performance, and actual results could differ materially from those expressed or implied in any forward-looking statements. Bristol Gate Capital Partners Inc. has no specific intention of updating any forward-looking statements whether as a result of new information, future events or otherwise, except as required by securities legislation.

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