Q: Much of Kopp's recent performance has been due to issues in the communications field. What prompted you to invest in communications and why did you concentrate so heavily in that area?
A: Early on, we recognized that the changes going on in the communications industry (particularly in new products and new technologies) would be numerous and would surely alter the way we conduct our daily lives - both in terms of business and leisure. We saw these changes as long-term opportunities, especially for the equipment suppliers who we expect will be major long-term beneficiaries of the increased spending worldwide for communications upgrades. The reason for our heavy focus in the communications area is fairly simple - we do not see as much excitement, predictability or potential in other industries. In order for our accounts to be somewhat diversified, however, we do include a smattering of stocks, or special situations, from a variety of other industries - health care, retailing, environmental and waste management, and financial services, to name a few.
Q: Is concentrating heavily in one industry your usual course of action, or is this just an unusual situation?
A: We should point out that we are definitely not a sector fund. It is not our "usual course of action" to concentrate heavily in any one industry, but we are also not afraid to significantly overweight an area if we feel that it has particularly strong growth potential (and we obviously feel this way about the communications sector currently). In 1991, approximately 80% of our assets were in health care and financial stocks. Currently, 80% of our assets are in the broad category of technology. The primary thrust within this category is telecommunications, with an emphasis on a number of niches including networking, telephone company suppliers, video conferencing, voice processing, and wireless. Thus, ours is a "basket approach" to investing in the broad "communications" industry.
In 1990-91, we had a heavy emphasis on health care, primarily medical device companies. Uncertainties surrounding the industry, due to the current Administration's health care plan, have kept us on the sidelines of late with regard to this group. However, we are continuing to selectively monitor health care stocks and believe that we will revisit the group over the next several quarters. In fact, we recently hired a third senior portfolio manager who has an extensive background in the health care area.
It is our belief that a manager can overdiversify (both in terms of number of industries and number of companies) into mediocrity. Good performance is a result of knowing the companies you own, knowing managements and understanding their long-term goals and strategies. But it is also the result of being in the right industry at the right time. You can invest in a great company with great management, but if the industry is out of favor for an extended period of time, the stock won't do a thing for you. We see continued strength and momentum in the communications area for the next tow to three years and perhaps well beyond. For that reason, we expect that our focus will remain in communications for an extended period of time.
Q: Many stocks you favor are small-cap issues. What is it about small-cap issues that make you favor them as investments?
A: We find that small-cap, underfollowed companies often provide superior growth potential. Small-cap issues are companies that, in our opinion, are in more control of their destiny. They are more agile, less run by committees and tend to be niche players. And, from a research perspective, it is easier to get through the door of a smaller company for face-to-face visits with top management (in other words, managements of smaller companies are often more accessible). In addition, because small-cap stocks are not as extensively researched by Wall Street analysts, there are opportunities to take advantage of inefficient pricing circumstances. For a long-term perspective: the Ibbottson charts going back some 60 years indicate that the annual appreciation of small-cap stocks is closer to 12% annually, as compared with large-cap performance numbers of 10% annually.
In a shorter time frame: small-cap stocks have outperformed their large-cap counterparts in each of the past three years, and we expect that this will continue to be the case throughout most of the decade of the 1990s. The statistical experts tell us that, historically, small-cap stocks have outperformed large-caps in six-year cycles (six years being an average, with cycles lasting anywhere from four to nine years). If history is any guide, we could be just halfway through the current period of outperformance for small-cap stocks as a group - yet another reason to continue our focus on this segment of the market. Finally, small-cap stocks have tended to do better during a Democratic administration.
Q: You seem to think Midwest companies have something special going for them. Why the Midwest?
A: The two senior portfolio managers at Kopp Investment Advisors had approximately 60 years of combined experience with Dain Bosworth Incorporated, a Minneapolis-based regional (Upper Midwest) brokerage firm, and thus a strong familiarity with the stocks in the area. Because the Upper Midwest is "our own backyard," we believe that we can have an edge in knowing and understanding fundamentals and managements of companies located there. We are able to schedule more frequent face-to-face meetings with managements, tour local facilities and, through local contacts, hear bits and pieces of information that may be relevant.
When we started the company, our exposure to Upper Midwest companies was very high, due in part to our focus on health care companies (our area has tended to be a hotbed for emerging health care companies). We would point out, however, that while we definitely started out with an Upper Midwest focus, our focus has broadened as we've grown, and we now look coast-to-coast for new investment ideas. When searching for new stock ideas, strong fundamentals and strong management are more important factors to consider than a company's regional location. We are not as heavily exposed to Upper Midwest stocks now as we were perhaps two years ago; probably 30-35% of our current holdings are companies located in the Upper Midwest. We expect that our exposure to Upper Midwest companies will likely expand and contract in the future, depending on our areas of focus at any given time.
Q: What specific factors are you looking for that tell you a particular company is a good candidate?
A: There are several criteria that we believe are important in researching a stock. The most important are as follows:
· The company has superior earnings growth or earnings growth potential. As a minimum, we look for a company that can produce sustainable growth of 15-20% annually.
· The stock's Price/Earnings ratio should be relatively attractive when compared with the market multiple or the industry group multiple.
· The stock's Price/Sales ratio should be relatively attractive when compared with the market multiple or the industry group multiple.
· Spending on Research and Development efforts should be above average when compared with similar companies (this is particularly important in the area of technology).
· Probably most importantly, we place a good deal of importance on management capabilities and integrity.
Q: How do you adjust for factors like price/earnings which often indicate the relative value of the stock versus the market?
A: A stock's P/E multiple rises as the market begins to recognize a company's growth potential. We try not to be too hasty in selling our winners as they become more recognized by the Street, but rather let them run.
Q: When you invest, do you first look at the sectors you feel will be strong and then look for companies within those sectors, or are the individual companies the most important factor?
A: Ours is a bottom-up approach to investing, so our focus is primarily on individual stocks. However, as we learn more about a few stocks in a certain industry, we hear from company managements and industry contacts about other stocks that they believe are worth a look. This pattern can build exposure to a particular industry. After satisfying our core industry holdings in a portfolio, we round out the balance of the portfolio with an eclectic mix of companies (special situations). This mix of companies truly points out our bottom-up approach to investing. An example is Damark International (NASDAQ: DMRK), a catalog retailer based in the Twin Cities. While the stock was not in one of our focus industries, we were attracted by the capable, enthusiastic management at the company. We started buying the stock in the low-to-mid single-digits, before it attracted much attention. It has traded recently in the high-$20s.
Q: How much of your investment interest has been in leading edge technology stocks? How do you go about analyzing technology as an investment?
A: With technology stocks, it is particularly important to look at growth rates, especially versus price/earnings multiples. Further, the level of spending on research and development is another significant factor. While leading edge technology is a factor in a company's success, it is not everything. The bottom line is that people run companies, whether those companies deal in technology, automobiles, housing, or whatever. Successful companies are run by competent management teams. A company may have a great product, but without the proper management team, that product may sit on the shelf unnoticed. In our universe of managers, I see that Kopp Investment Advisors is our top performing manager for the past one, three and five years based on annualized returns.
Q: What is the single most important reason for the consistency of your success?
A: We attribute our uniqueness to (1) the sixty-plus years of investment experience that our senior portfolio managers bring to the firm and (2) our sensitivity to overdiversification. The many years of experience in the investment business have taught us patience, as we've lived through many cycles of the market. We look at a company's fundamentals, paying particular attention to management capabilities. If we've done our homework and have a strong sense of conviction we can weather the normal fluctuations that may scare other investors away. Small, emerging companies are like little nuggets - it's hard to find the golden nuggets, but when you do find one, you'll be rewarded by it for an extended period of time. Don't sell out your winners too quickly. In my own portfolio, for example, I've owned ADC Telecommunications (NASDAQ: ADCT) since 1979, when I began buying it at a split-adjusted price of about $2.50 per share. The stock currently trades in the high-$30s, and we continue to buy it for our new accounts because we have a great sense of confidence in the company's management and products.
Q: From where do you get most of your investment ideas?
A: We get information and stock ideas from a variety of sources: investment banking firms, traders, brokers, personal contacts, and media sources. As you can imagine, with a combined sixty-plus years of experience in the investment business, our two senior portfolio managers have a number of contacts in the industry. Gathering data from 25 different research sources allows us to filter out and focus on the top ideas in these research universes. Bottom-line instinct or gut-feel sometimes comes into play when deciding on a particular stock. Even the body language of the key executives can be of help in the decision-making process.
Q: Lee, how did you get into investment management?
A: After thirty years as a retail broker and branch manager with Dain Bosworth Incorporated, a regional Minneapolis-based investment firm, I had a chance meeting with an industrial psychologist who sparked the idea of starting an investment advisory firm. In the back of my mind, the idea had always lingered with regard to starting my own firm. The decade of the 1980s pointed out a significant flow of investment dollars toward investment advisory firms utilizing the brokerage industry as a conduit. Those thirty years of experience created the foundation and background toward a great deal of confidence in our ability to deliver. I felt that while marketing would be important, certainly stressing both service and performance would be paramount. Four associates elected to join me in this endeavor, and preliminary work was done in March of 1990, with the door being opened in June of 1990. The retail brokerage industry and its clients often focus on the idea or stock "du jour." The idea of discretion over accounts was appealing to me - the ability to make sound business/investment decisions based on the best interests for the future rather than the day-to-day emotions (of both brokers and clients).
Q: What prompted you to start an investment management firm?
A: At the age of 55, the catalyst was: it was either now or probably never, because very likely five years later would have been somewhat too late. What or who were the greatest influences on your investment style? Thirty years of working with small- and mid-cap companies for a regional brokerage firm provided me with a great deal of experience in this area, and obviously influenced his investment style which has focused on small-to-mid-cap stocks in the Upper Midwest. A significant degree of personal success, coupled with above-average performance for hundreds of clients brought home time and time again that real wealth could be accumulated in the market and, more likely than not, in companies that were under one billion in size either in market cap or in revenues. Without really tailoring ourselves after people such as Peter Lynch and Warren Buffet, we believe our success has been due to some of the same basic principles of investing - a fundamental, bottom-up, common sense, buy-and-hold approach to investing.
Q: What other people are in the Kopp organization and what are their functions?
A: The organization consists of two senior portfolio managers, Sally Anderson and myself. Prior to founding Kopp Investment Advisors in 1990, I was the Resident Manager for the Edina, Minnesota, branch office of Dain Bosworth Incorporated for thirty years. I spent four years as a Lieutenant in the U.S. Navy and Naval Reserve prior to becoming a broker with Dain Bosworth. My bachelor's degree is in business administration from the University of Minnesota.
Before joining Kopp Investment Advisors in November 1991, Sally Anderson worked at Dain Bosworth for twenty-six years as a Securities Analyst (following a variety of industries including oil and gas and medical technology) and Assistant Director of Research. Sally is a Certified Financial Analyst with a bachelor's degree in business administration from Northwestern University.
As mentioned before, a third senior portfolio manager, Steve Crowley, will be joining us in March. He has been in the investment business for eight years, most recently as a Securities Analyst following the health care industry for Summit Investment Corporation.
In addition to the three senior portfolio managers, Kopp Investment Advisors have four other portfolio managers, three traders, six marketing and service professionals, two administrative professionals, and five support staff. In total, the team of professionals at Kopp Investment Advisors has cumulative investment experience of nearly 300 years.
Q: With such an outstanding performance record, expectations from new clients must be high. What do you tell them are your performance goals for their account?
A: We reiterate that our goal is a 15-20% annual return over a three-to-five year period. We also point out that, with a focus on small-to-mid-cap stocks and low turnover, our quarter-to-quarter performance can be quite volatile. Volatility can be your friend as much as being your enemy. We would think 10-15% downside risk would be considered normal for a Kopp portfolio. We believe that we will shine during a flat or rising market and more than capture the gains of a rising market.
Q: The amount of money flowing into Kopp Investment Advisors is extraordinary. Where does your firm go from here?
A: The issue of growth has been discussed extensively. Over the past year, we have significantly raised the minimum account size in an attempt to control the growth (our minimum account size is currently $1 million). Even with this change, the asset growth continues. In order to serve our current clients' best interests and ensure the integrity of our investment discipline (focusing on small- and medium-cap stocks), we may find it necessary to close the door to new accounts at some point in the future, possibly in 1994.