Philosophy & Process
Market inefficiency is the central tenet of our philosophy, and fundamental analysis is the basis of our repeatable process.
Philosophy
Market inefficiency generates investment opportunity.
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Markets exhibit inefficiency when prices deviate from intrinsic value.
Markets misprice intrinsic value due to information disparity, errors in judgment, behavioral biases and emotions such as fear, greed and impatience.
We seek attractive absolute returns that compare favorably to each strategy’s benchmark over a long-term investment horizon.
Fundamental, bottom-up analysis identifies undervalued companies resilient to circumstances over-emphasized by a near-sighted market.
All investments bear the risk of loss. Our investment strategies may underperform other investment strategies.
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Intrinsic value is a function of capital resiliency, compounding potential, and vested leadership skilled in operations and capital allocation. These durable sources of return are persistent indicators of business quality and are identifiable and quantifiable through fundamental analysis.
We conduct fundamental analysis of a company’s durable sources of return to assess business quality. The degree to which these attributes are mispriced by the market is the difference between our estimate of intrinsic value and price, which we refer to as the “margin of safety”.
We require a meaningful “margin of safety” for each investment meeting our high quality threshold. We encounter investment opportunities along a continuum of quality. The highest quality businesses are associated with lower risk, and thus we demand a greater “margin of safety” to invest in businesses with more risk.
Applying this discipline is intended to reduce the risk of permanent capital impairment.
Our estimate of a company’s intrinsic value could prove incorrect or there could be an error in our judgment or fundamental analysis that results in the loss of capital.
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We generally limit investments to companies with sufficient durable sources of return available at attractive prices relative to our assessment of business quality.
This practice expands our scope beyond low-expectation and out-of-favor businesses or industries. We typically avoid companies offering high growth prospects but scant free cash flow or those we cannot reliably assess based on durable sources of return.
Position size is directly proportional to our assessment of business quality and the “margin of safety”. We seek to benefit from concentration by emphasizing our highest conviction holdings while maintaining a sufficient number of positions for adequate diversification.
We typically hold between 25 and 35 companies in each strategy. Concentrated portfolios are subject to the risk that a single holding will materially affect performance as compared to portfolios with a greater number of holdings.
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In our experience, the resolution of market inefficiencies often requires more time than the market’s average holding period for stocks. Thus, value derived from durable sources of return tends to manifest over the longer term, resulting in relatively low holdings turnover.
We maintain an ownership mindset that is reflected in our long-term perspective. We believe a longer time horizon increases the potential for price and value convergence. Lower-risk, higher-compounding businesses tend to remain in the portfolio longer. As with the discount to intrinsic value we require under our “margin of safety” discipline, holding periods for investments vary with our assessment of business quality.
We exercise our sell discipline, even for businesses of the highest quality, when a holding’s compounding potential and “margin of safety” no longer warrant continued investment.
We believe in the merits of our investment approach; however, markets may not recognize a company’s intrinsic value within expected investment holding periods.
Process
We identify investment opportunity through fundamental analysis.
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Our decision flow is a continuous process and each decision begins with identifying instances of mispricing relative to a company’s durable sources of return. Our research team of generalists is unconstrained by industry, sector or style, affording the opportunity to find mispriced durable sources of return wherever present.
We review a variety of internally developed financial screens, regulatory filings and other company information along with trade publications, and other economic and industry data. Ideas that exhibit the potential for portfolio inclusion proceed to the fundamental analysis stage of the process.
Our process is not designed to identify all actionable instances of market inefficiency consistent with our philosophy and meeting our investment criteria. Conversely, our ability to identify instances of market inefficiency may be limited due to prevailing market conditions.
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We conduct fundamental analysis from the bottom up utilizing company financial reports, presentations and regulatory filings. We review relevant external research and evaluate company leadership in terms of track record, shareholder orientation and ownership. We conduct interviews with company management, competitors and others as we deem appropriate. We seek to assess earnings power, cash flow generation potential, balance sheet attributes and business model resiliency using financial modeling, and supplement our efforts with precedent transaction, peer valuation comparisons and other methods.
We also seek to understand, among other factors we deem relevant, industry dynamics, competitive positioning and the effects of catalysts to valuation where present. When we identify sufficiently mispriced durable sources of return, especially when enhanced by potential catalysts for improved valuation, an idea moves forward to the investment thesis development stage.
The value-oriented strategies we implement may underperform various benchmarks or the market in general, for an indeterminate time.
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The development of a variant view with regard to a business’s intrinsic value per share is central to our investment thesis. This requires understanding where and to what degree our insights differ from the prevailing market view. The research team achieves this through discussion and debate of the merits and risks of an investment case. If a decision to invest is made, the research team proceeds to portfolio construction and management activities.
We invest in many types of businesses and we are not experts in the industries, sectors or companies we evaluate. We believe the level of understanding we require to invest is high. However, there can be significant divergence between our projections and corporate results due to unforeseen competitive pressures, regulatory challenges, and errors in our judgment, among other risks.
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Our strategies are differentiated only by company equity market capitalization. We determine which investments are made into each of the four strategies on this basis.
Investments are subject to general guidelines for position size and our risk factor assessment of company, industry, sector and macro level exposures.
Companies with smaller equity market capitalizations may exhibit greater price volatility and lower trading volume and liquidity than companies with larger equity market capitalizations.
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We continuously evaluate our opportunity set to improve prospects for intrinsic value compounding and to reduce investment risk.
We tend to remain invested in positions where intrinsic value growth is sufficient to exceed opportunity cost. However, when a holding’s compounding potential and “margin of safety” no longer warrant continued investment, we favor capital reallocation.
An inadequate “margin of safety” can occur in two instances: price appreciation without commensurate intrinsic value growth or a reduction in our estimate of intrinsic value due to significantly impaired company fundamentals.
Unforeseeable events can occur that impair the intrinsic value of a company. Errors in our judgment or analysis can and do occur, rendering our estimates of intrinsic value inaccurate. In either case, material reductions to our estimate of intrinsic value can result in an inadequate “margin of safety”, compelling the sale of the position. Our “margin of safety” discipline does not ensure protection from the loss of capital.
