Our value-oriented investment process emanates from the framework established by Benjamin Graham and David Dodd. We seek to invest in businesses (stocks) that trade at a discount to our estimate of intrinsic value. Three primary themes dominate our approach to investing:
- Search for value in businesses
- Focus on the long-term when evaluating businesses and people
- Think independently of the Wall Street crowd
Our investment process includes an assessment of quantitative and qualitative factors in estimating a company's intrinsic value. To estimate the intrinsic value of a company, it is important to have a reasonable understanding of its assets and liabilities, free cash flow, capital investment needs, return-on-capital capabilities and competitive position. We are attracted to companies priced below their historic price-to multiples and to the market. Ideally, candidates will have growing revenues and increasing profit margins, earn an adequate return on capital, and have management compensation that is aligned with shareholders' interest. Judgements regarding the quality of the business are made to complete the valuation process. Portfolios are constructed from the bottom-up based upon individual security analysis.
Quantitatively, we employ a wide range of resources and tools in our analysis. Ideas may be generated from database screens, research reports, periodicals, and a knowledge base of companies going back more than 30 years. In seeking new investment ideas, we search for companies trading at a low multiple of cash flow, earnings, book value and/or sales. Certain multiples are more or less relevant depending on the industry in which the company operates.
Qualitatively, we consider a company's industry and competitive position, risk of product or service obsolescence, insider ownership, quality of management, compensation structure and corporate culture. We prefer to invest in businesses with management compensation plans that are aligned with the creation of shareholder value and have meaningful insider ownership. Qualitative analysis may also include company visits and discussions with competitors.
Thinking independently of the Wall Street crowd reduces our risk of adopting a herd mentality. Being part of a crowd can ensure a level of comfort, but rarely leads to above-average returns. Our disciplined investment process dramatically reduces the emotional element of decision making.
Companies meeting our quantitative and qualitative criteria may be considered for investment. Equity portfolios are typically diversified across several economic sectors and hold 25 to 35 securities that we believe are attractively priced. We may be void or overweight certain sectors. Individual equity positions are generally limited to 5% of the portfolio at initial purchase, and held for three to five years on average. A sell decision can be driven by: a security becoming overpriced relative to our estimate of its intrinsic value, a deterioration of the fundamentals or outlook of the business, the position becoming too large in relation to the portfolio, the emergence of a more compelling opportunity or the recognition that our initial investment thesis was flawed.