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   Interview

    Guest Interview:

   Coventry Capital Inc.

    200 S BRENTWOOD 21F
    Saint Louis,MO 63105

    Telephone: 314 863 9279
    Fax: 314 863 9279
    E-mail: bfssr@aol.com

 

    Interview Quarter: 1Q2015

 Brian F. Spengemann Sr.,

 CFA & CEO

  Brian, Coventry Capital might be described as a boutique investment manager. What do you offer investors that they canít find elsewhere?  
  Coventry Capital is dedicated to providing personalized investment services to investors who seek growth of investment principal. Coventry Capital manages common stock portfolios for people.

The initial goal is to crystalize the clientís investment objectives and design a program to meet those objectives.

The investment objective is to outperform the S&P 500 over a three to five-year period. For the most part, growth-oriented issues are emphasized.
 
  Please tell us about your investment background and the circumstances under which you became an investment manager.  
  When I was in college, I was taking an investment course. At that time I was an accounting major with 27 hours of accounting behind me and only tax and auditing to go. I decided to change majors to finance and added another major in economics thinking that it would fit with finance. I learned quickly that the markets run ahead of the actual economic event. The economics major helped me to understand the system of business.

The best part of my education came through job experience and the CFA program.

At Mercantile Trust in St Louis, I worked as an investment analyst reviewing utilities and a broad range of small trust department holdings called miscellaneous. At Harris Trust and Savings Bank in Chicago, I worked as an investment officer managing life insurance, casualty insurance, endowment, non-profit association, person holding company and a few personal accounts. Back in St Louis, I worked as investment officer at Brown Brothers Harriman & Company and founded Coventry Capital in 1981.

Coventry Capital is registered as an investment advisor and securities dealer.
 
  What do you and how do you do it?  
  The starting point is to find issues with projected earnings growth rates in excess of the S&P 500. If a client has a priority for current income, high-quality fixed-income issues are used to provide current income.

The common stock portion is kept intact for growth in a balanced account format. I look for large and mid-capitalization companies that dominate their markets.
 
  Please describe what you are looking for in one of those companies.  
  Large capitalization companies and mid- capitalization companies seem to shift back and forth in terms of investor favor with each market cycle. Regardless of company size, I look at revenue and earnings growth, return on equity, new products that the company introduces and the companyís price-earnings ratio relative to the estimated growth rate. The objective is growth at a reasonable price to the market.  
  How do you achieve high returns when your holdings are closely followed by everyone else?  
  I prefer to use issues that are closely followed by several analysts. I use a range of earnings estimates to construct an earnings range and look at the price range. Analysts set the target price.Thereareseveralother factors which contribute to the price range, but earnings trend is the starting point.

The target price can move upward or downward with the direction of earnings expectations. The return is a function of the projected earnings expectations. The direction and magnitude of interest rates and the growth of common stock earnings in the aggregate are the key areas of my focus. Stock prices move with the change in earnings growth, and that growth is affected also by a change in the interest rates, which serve as the discounting factor in equity prices.

In years when inflation is low, we experience a stable discount factor during a period of strong corporate earnings growth. Recent volatility has come from external factors such as the concern for the stability of foreign economies and their impact on the US economy. Of course, there is always the likelihood of intervention by the Fed to slow economic growth. We have to remember that target prices are set in a six to twelve-month time frame.
 
  What other factors do you look in assessing the potential of a company as an investment?  
  Management is the most important and the hardest factor to quantify. Meetings with officers at analyst meetings are of great value. You have a chance to see and talk with the people running the company and understand the company. In addition, the investment community gets an update of the regulatory, political and the industry challenges that are faced by company managers in that particular industry.  
  What do you consider when building a working list of Portfolio Issues?  
  When building a working list of common stocks for client accounts, I look at issues from a comparative stance. I look at the historical earnings growth for the past five years and then the projected earnings for the next three to five years. The objective is to determine what the future growth rate will be and how much of that growth will flow to the expected stock price. The projected earnings growth of the stocks on the Working List is about 13%.  
  How much of your investing is determined by numerical analysis and how by instinct?  
  Numerical analysis compromises about 75% of the input. The balance is judgement which comes from integrating all the factors. I have been managing money for about fifty years for equity and balanced accounts. In an equity account, the objective is 100% market performance. In a balanced account, the market performance objective is tempered by the clientís priority for current income need from fixed income investments. In the balanced account, the common stock segment is only a portion of the account, but the fixed income segment is expected to provide principal and income growth to offset the effects of inflation.

The starting point of the balanced account is the expected current return of the client. I have found over the years that a client with high current income needs should seek the current return from fixed-income investments and not stocks. The reason for this is that the income requirement pushes the equity segment toward high-yielding issues and the result is there is no capital appreciation in the equity sector.

The judgment factor is important when determining asset allocation or changes in asset allocations. From a broad conceptual point of view, expected returns of common stocks are compared with returns of competing instruments such as bonds.

Although several factors have been discussed here, it is important to note that in reality,the weighting of factors will vary with the clientís objectives. Each client has a different set of circumstances and objectives. It is important to remember that objectives change as retirement approaches or children go off to college or get married and have children.

When a client wants a 100% equity growth account, the judgments need to be made clear and be well-defined. When a client has a growth objective with no asset allocation parameters, the manager has to be right in terms of the allocation and the issues. An asset allocation needs to discussed and set up before proceeding.

Something we have not discussed is the quality of investment vehicles. I think investment quality should be high. I donít think anyone wants to compromise quality for unrewarded risk.
 
  Does macroeconomics ever enter into your analysis?  
  From the trend standpoint it does. The direction and magnitude of interest rates are important because the consumer is impacted. The consumer is important because consumer spending represents 2/3 of GDP. From a sector standpoint, I look at overall consumer trends. Important trends evolve gradually and effect consumption. In the US economy, as consumers make new consumption choices, markets and investment options change. Opportunities in investment come from changes in consumer purchases. The consumer has the financial power to support new products.

For example, during the period of gasoline shortages, consumers paid the pump price and shifted to smaller cars. Consumers want and pay for mobility. As consumers got weary of the small cars and believed the large car was desirable they shifted back to larger cars.

I am a big believer that history moves in cycles. The popular sport utility vehicle is a case in point. These cars have replaced the station wagon because they are more versatile, stylish, and carry more kids than the old station wagons.

Housing is another example. At one point people lived in the suburbs and worked in the city. With the next trend change people lived in one suburb and went to work in another suburb. Maybe people will shift back to the cities as suburban living takes them further and further out. Consumers want mobility and housing.

If you add demographics and technology to these consumer trends, the strength of the consumer is more evident. Technology provides computers, telephones and many other products of convenience. Communication products are another consumer demand. The population is aging and needs health products. New drugs are available for a host of illnesses. Retailing has changed dramatically in the US. Retailers use income and age data to target their customer base. The internet is changing how people make purchases.
 
  What is the average cap size of the companies you typically buy?  
  The range of capitalizations is $400 million to $300 billion. 80% of the issues are in the big cap range and the remainder in the medium-cap range. In addition to size, I need to mention domestic versus foreign issues. Many large US companies derive sales and earnings from overseas economies. My preference is to invest in domestic companies for participation in overseas growth. The advantage is that the exposure to overseas economies varies from company to company.  
  Do you ever buy emerging companies?  
  Not in the beginning because comfort level is an important factor with clients. Clients like to be able to recognize most of the names in their accounts. Investing in emerging companies is a skill which takes great analytical ability. There are always opportunities in the small cap area and the best way to play small caps is to invest in a fund that concentrates in this area. The same could be said for investors looking for straight foreign-equity or emerging investment opportunities. A fund is the best investment vehicle.  
  How many stocks do you typically hold and in how many different industries?  
  In larger accounts, 25 issues is about the maximum number held.These issues would be in nine major sectors and roughly 12industries. I have about 25 issues on the Working List, which has been expanded in the past two years. If you put 25 stocks in an equity account, each stock equally weighted is about 4% of the account. The account is well diversified with issues that have good growth prospects.  
  What resources do use for research?  
  I buy research from Wall Street firms and read financial newspapers. The reports include industry, company and economic information.  
  Do you ever time the market or build up cash when you think the market is overbought?  
  Yes. I consider the competiveness of an expected bond investment rate of return compared to the expected equity rates of return. One links the dividend yield with the expected earnings growth rate. If the dividend yield is 2% and the earnings growth rate is 6%, the forecasted total rate of return is 8% for equities. Ifthe 10 Year Treasury is yielding 2%, then equities have the edge by 6%.

If we, were to move to an inflationary environment with yields rising, it is likely that equities will begin to lose their most favored status in the markets. This environment would suggest a trimming of equity positions to be appropriate.
 
  How important are target prices?  
  Very important. The 6-12 month target prices are monitored daily. The target prices are sorted to monitor which issues continue to be the most attractive. Holdings are monitored to be sure accounts do not get over invested in any particular sector.  
  For clients who also emphasize income, how do you allocate between stocks and bonds?  
  The beginning point is to ask the client all sources of income and expenses. It is a good time to review current and future income and expenses. If a client is considering a second home, there will be additional expenses. Maintenance, travel and entertainment. It is a good time to think about costs to be incurred if the client plans to do any traveling that has been planned for a long time.

Additional insurance needs to be considered. The second home definitely needs to go into the budget with a cash safety reserve.
 
  For clients who also emphasize income, how do you allocate between stocks and bonds?  
  Within the common stock portfolio, one needs to look for stocks for that provide both principal and income growth. Also, look for short-term high-quality bonds that can be rolled over if rates rise. For most clients this financial goal-setting is challenging. The challenge is to make it work and to make it enjoyable so they can see that their goals are being achieved.  
  How do you go about estimating earnings when picking stocks?  
  I rely on the research firms for earnings estimates. I mainly look to see if there are any big differences in the earnings estimates or their opinions.  
  Are not earnings already calculated in the price of most stock prices?  
  Yes they are. You can see the impact on a stock when an unexpected earnings event happens.  
  There is a relationship between earnings and interest rates. How do these two fit together?  
  We all understand that there is a relationship between earnings and interest rates. The trick is where we are in the cycle of each. When market prices are rising and interest rates are low, the market outlook remains favorable. It also depends upon whether that particular company is in an interest-rate sensitive business.

There are a lot of ways to look at this. If interest rates rise quickly the whole market is negatively impacted. Again it depends where we are on the interest rate cycle. One needs to listen carefully to the analysts that follow these markets.
 
  How do you go about diversifying your portfolios?  
  I look at the industry market weighting of each industry in the S&P 500. I then compare the issues on the working list with the industry and sector list. I donít have to have every industry represented. All I want to do is have the most attractive issues in accounts.  
  Has there been any major changes to your investment approach in the past several years?  
  A change has been to look for income growth along with earnings growth. During a period of low interest rates, clients that are nearing retirement need to have growth of capital and growth of income.  
  Business trends come and go but the underlying investment principles you apply generally stay the same?  
  The US economy has shifted more to a service economy and the principles for the most part have remained the same. More data is available and presented at a more rapid rate.  
  Tell us when you might adjust your portfolios between large and mid-cap companies?  
  It is not so much a move from one size capitalization to another, it depends more on the constant search for issues that are expected to outperform the market and meet client objectives.  
  How important is a stockís trading range and how do you use it to time your investment?  
  I think the trading range is important because you can see the price history and get an idea of where the price might be heading. A chart that shows price movement relative to the market is useful.  
  With Globalization, do you ever find non US- markets attractive?  
  Non-US markets are complex. If I get involved in a non-US company, it would be a company like Schlumberger.  
  The mirror opposite of investment opportunity is risk. How do manage portfolio risk?  
  Basically, I look at the beta of the issues on the working list and the diversity of the account holdings by industry. If I limit the number of issues to 25, then each issue represents 4% of the account. If an issue would increase to 8% of the account, then I would cut it back and take some of the profit.  
  Do you have a sell discipline and what is the average turnover of your portfolio?  
  I look at the gains held by each issue and the market value size of each issue. If the target changes downward for a fundamental reason or the issue is getting close to the target, the issue is sold. Turnover I would estimate to be 35%.  
  How much emphasis do you put on the relative value of a given stock versus the relative value of the overall market?  
  It is important because the goal is to outperform the market. All the issues in the account should outperform the market. That always does not happen, but I hope that it will.  
  If interest rates were to begin to gradually rise over the next few years, what would your model forecast for the market?  
  I donít think you can go out a few years. I think 6-12 months is a reasonable time frame. I pick the 12 month frame and a range of 2.0 %-3.0% for the 10 Year Treasury. I use S&P 500 earnings estimated at $140 and a PE of 18, the value works outs to 2520 or about 20% 12 months from now.  
  Obviously, after so many years, you would not be here today if your clients were not satisfied with your performance. As an investment manager, what would you say is your greatest strength?  
  I guess listening to clients and reaching their goals. Then going back and doing it again to make sure we are on the right track.  
  It sounds like personal relationships add an important part of the way you do business. Are most of your clients located in the Midwest and have you met most of them?  
  I have clients located around the US and have contact with them. Our toll-free number is 1-800-648-8584.  
  Where can readers find more information about Coventry Capital?  
  Readers can find more information by contacting our brand new website : www.coventrycapital.com  
 
 
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