I've always been a data kind of guy. Over the years I've kept spiral notebooks, folders, and legal pads filled with all kinds of information strategy notes, books to buy, trips to take, and the ever expanding file of golf swing tips. And I never, ever throw any of this valuable data away, although with my swing, perhaps I should...

We live in a world that is awash in data.  For example, Wal-Mart utilizes databases in support of all its customer transactions that are equivalent to 167 times all the books in the Library of Congress.  Or how about this?  The telescope used by the Sloan Digital Sky Survey in New Mexico collected more data in its first year of use than had been amassed in the entire history of astronomy.  (Source: The Economist 2/27/2010).   According to The Economist, the amount of digital information increases tenfold every five years.  This explosive growth is being driven by advances in digital technology as well as overall economic growth around the world.  As this article points out, data is becoming as important as capital and labor as a key input into driving the global economy.

What do we do with it?... All of this data needs to be generated, analyzed, stored, shared, transported, and secured; and in real time no less!  All of which takes state of the art software and hardware.  This explosive use of data is a critical driver of ongoing technological innovation.  Moreover, as technology improves the demand for it increases, which therein drives further technology innovation.

In our core large-cap quality growth equity portfolio we own several leading technology companies that are well-positioned to benefit from this tremendous expansion in the generation and use of data, including: IBM, Cisco Systems, EMC, Hewlett Packard, Intel, and Apple.

The data explosion will continue to impact all facets of our society from how we spend our leisure time to who has access to our digitized health care records.  Information, properly used, can drive productivity and economic growth.  Improperly used, it can do the exact opposite, or worse.  In this regard, all the data in the world does not insure sound decision-making.  That, perhaps, was one of the important lessons learned from the financial crisis, as the computer models used to forecast risk failed miserably during the meltdown.

Management’s ability to transform the endless stream of data into decisions that enhances shareholder value, on a long-term basis, is one of the key differentiating factors we look for in our stock selection process.

Over the next few weeks as first quarter earnings are released, we will be analyzing the relative effectiveness of corporate strategies for reinvesting cash flow.  Share repurchases, dividend increases, mergers & acquisitions, and more aggressive spending on R&D and advertising are all targets for the continued growth in corporate cash flow.  Yet, the ideal balance between these potential uses of cash varies between firms, and is driven largely by industry-specific competitive dynamics.  Generally speaking, the challenge for management is to determine the right mix between using cash to boost earnings and shareholder value in the near term, like buying back stock or increasing the dividend, and using cash to enhance long-term growth potential through M&A, R&D, and increased spending on marketing.

On a more macro level, there has been an impressive rally so far this year in Financials and Cyclicals (Consumer Discretionary and Industrials) relative to more stable growth areas like Consumer Staples and Health Care.  My sense is this gap may narrow going forward given the prospects for higher interest rates amidst worrisome federal deficits.  A key aspect of our investment process is to identify industry-leading companies in attractive industries.  In this regard, the relative performance potential between the major sectors of the market is something on which we continually deliberate.

At the same time, we also try to identify secular themes to exploit.  The explosive growth of data, discussed above, is one such secular theme.  Another is natural resource utilization, particularly the ever-worsening shortage of potable water on  global basis.  And yes, there is a lot of interesting data on this topic as well.  Globally, about one billion people do not have access to clean dependable water, and nearly five million die every year from unsafe drinking water and poor sanitation.  According to a United Nations report close to 50% of the world’s population will face a water shortage within the next fifty years.

From an investment perspective there are several ways to take advantage of this secular trend.  We currently own a company that makes high-tech water meters (Badger Meter), a water consulting company (Tetra Tech), a leading supplier of irrigation systems (Lindsay Manufacturing), and a producer of pumps, valves, and flow control devices (Flowserve).

Next month I hope to share highlights from first quarter earnings reports.  That is if I can sort through all the data and find a few gems…

Michael Kayes, CFA