advertisement

How a Socially Conscious Fund Beats the Market

Date: November 1, 2016      Publication: Bottom Line Personal      Source:  Jerry Dodson, Parnassus Investments      Print:

And You Can, Too

Jerry Dodson doesn’t think you have to sacrifice strong investment returns to support good behavior by Corporate America. And his Parnassus Endeavor Fund has the record to prove it. It has placed in the top 1% of funds in its large-cap-growth-stock category over the past 10 years while adhering to “socially conscious” standards for the companies it chooses to invest in.

Of course, different investors will have different ideas about what constitutes “good behavior” by corporations. But any investor can adapt Dodson’s stock-picking technique to suit his/her own ethical standards. Here’s how Dodson picks his socially conscious stocks—and how his strategies can help you be a better investor…

The Key Traits

Long before so-called socially responsible investing came into vogue, I believed that given a choice, investors would prefer to make a positive impact on society if they didn’t have to sacrifice performance. But the jury still was out on whether this strategy could deliver better investment returns. So I went in two directions.

advertisement


I developed a stock-picking strategy that relies, in part, on the ideas of ­Benjamin Graham, who often is called the father of value investing. He was also Warren Buffett’s mentor.

At the same time, Fortune magazine’s annual list of the 100 Best Companies to Work For—which surveys employees on topics ranging from management credibility and job satisfaction to salary and benefit programs—was a catalyst for my approach. With the Parnassus Endeavor Fund, I specifically emphasize workplace issues as a critical factor. If you treat your employees well, they will go out of their way to help you have a successful company. If you don’t treat your employees well, there are hundreds of ways that they can sabotage your enterprise. The elements of a good workplace can include profit-sharing plans…matching 401(k) contributions…and programs that support work-life balance including flexible working hours, telecommuting and sabbaticals.

In addition, every investment that any of our six Parnassus funds makes must meet rigorous environmental, ­social and corporate governance criteria. In the spirit of those standards, the ­Endeavor Fund excludes companies that get significant revenue from making alcohol or tobacco products or weapons…that are significantly involved in gambling or nuclear power or in fossil-fuel production or refining…or that do business in Sudan, given that country’s record of ethnic cleansing.

To find stocks that have the greatest investment potential, I look for financial characteristics that include the following—a strong balance sheet or low debt-to-equity ratio…a competitive advantage with a unique product or service…and a quality management team. I buy shares when I believe a stock’s price makes it undervalued, which means that a company is trading below its five-year average on a number of key ratios including price-to-earnings, price-to-book and price-to-sales ratios and when I expect it to gain 50% or more over the next three years.

My Favorite Stocks Now

Autodesk (ADSK) is the leading software provider for architects, engineers and designers. The company is ­transitioning its business model to subscriptions and flexible ­licensing, ending the sale of new perpetual licenses for most of its products. In the short term, this could reduce revenue as sales are no longer recorded up-front but spread over the period of the licensing contract. I expect this stock to move much higher over the next few years, especially as the global economy improves and sales pick up. Autodesk has a unique product with a strong competitive advantage.

advertisement


The do-good element: Autodesk ranks number 54 on Fortune’s list of the 100 Best Companies to Work For, and 95% of its employees say they are proud to tell others that they work at Autodesk. The company offers a sabbatical program of six weeks’ paid time off ­every four years. It offers college-tuition ­reimbursement up to $10,000 and paid time off for volunteering. Beyond the workplace, Autodesk gives 800,000 schools in 188 countries free access to its design software.

Cummins Inc. (CMI), which designs, builds and sells diesel engines and components, has faced headwinds from soft economic conditions in overseas markets such as Brazil. But I believe Cummins is positioned to do very well once global economic growth resumes. By focusing on both engine design and design of components such as turbochargers, it has made its products very fuel-efficient and has grown to be more than twice as large as the next closest dedicated ­engine manufacturer. It has gained a 40% share of the North American market for heavy-duty over-the-road engines as competitors pulled back, partly because of stringent emissions-reduction requirements from the Environmental Protection Agency. Similar new environmental requirements in other countries, in conjunction with joint ventures in those countries, will help Cummins gain market share globally.

The do-good element: The company has done an admirable job of meeting—and helping its customers meet—stiff emissions-reduction standards. Also, for 10 consecutive years, it has been ­included in the list of Top 50 Companies for Diversity compiled by DiversityInc, ranking number 19 on the 2016 list.

Gilead ­Sciences (GILD) is a biopharmaceutical company focused on producing innovative treatments for ­infectious diseases such as HIV/AIDS and hepatitis C. Increased competition for its blockbuster hepatitis C treatments hurt earnings and caused the stock price to slide from just over $121 per share in June 2015 to below $80 in September 2016. But I expect more new profitable products from the company, which should move the stock much higher. Gilead currently has 34 products in development for treatment of diseases ranging from liver disease to cancer to Crohn’s disease.

The do-good element: Although the company has raised prices by up to 10% on six drugs this year and its hepatitis C treatments are hugely expensive, I believe the global importance of its lifesaving drugs and its good corporate citizenship justify including it in a socially conscious portfolio. Its tiered pricing, sharing of drug patents and licensing of more than two dozen generic-drug manufacturers to produce cheaper ­versions of its drugs have provided access to lifesaving medicines for nearly 9 million people in developing countries.

advertisement


Intel (INTC). Intel’s crown jewel is not its best-known business (computer chips that are used in consumer desktops, laptops and tablets) but rather its chips for massive data centers, which represent more than 50% of earnings. This business can grow significantly because these chips are critical to the processing of Internet traffic. The company’s $16.7 billion acquisition of ­Altera Corp. last year strengthened its competitive position, allowing Intel to offer data-center chips that are faster and more energy-efficient.

The do-good element: Since 2008, ­Intel has invested more than $145 million in energy conservation projects. It has focused on reducing greenhouse gas emissions, water use, energy use and waste generation from its operations. Intel ranked number 11 on the Reputation Institute’s 2016 Global CSR RepTrak 100 list of companies with the best reputations for behaving ethically, treating employees well, protecting the environment and supporting good causes, among other criteria.

Micron Technology Inc. (MU) is a global leader in the dynamic random-access memory (DRAM) semiconductor chips that provide high-speed data storage and retrieval in personal computers, smartphones and other electronic devices. Demand for memory chips is rising in part because of the increasing use of DRAM in smartphones to improve performance…and the proliferation of Internet-connected devices. Production costs should shrink as a result of a planned decrease in the amount of silicon used.

The do-good element: The company recycles 70% to 80% of the water it uses in its semiconductor manufacturing, which is an increase from a 30% recycle rate in 1995. The reclaimed water is sent back to production for reuse or used for other on-site needs, such as landscape irrigation.

screen-shot-2016-10-24-at-12-07-50-pm

advertisement


Source: Jerry ­Dodson, founder and president of Parnassus Investments in San Francisco. The firm oversees nearly $19 billion in assets. Dodson is portfolio manager of three funds, including the ­Parnassus Endeavor Fund ­(PARWX), which had annualized returns of 12% over the 10 years through September 30 vs. 7.2% for the Standard & Poor’s 500 stock index.