Our Investment Style
Value Investing
We use a disciplined approach to investments which is called “value investing”. Value investing is not new. This method was first developed in the 1930s by Benjamin Graham, articulated in his legendary book, Security Analysis(1934). Warren Buffett made his fortune by being a value investor, and says Graham's framework provided the guiding light throughout his career.
Graham wrote that it was better and safer to buy stocks that are undervalued, or trading at a discount to their intrinsic or net asset value (break-up value of a company if it were sold in a private transaction to another buyer). He argued that the process of purchasing stocks at bargain prices would give the buyer a “margin of safety”, allowing the investor to better withstand the normal up-and-down moves that take place within an economic cycle.
Here is a common sense explanation of value investing, in the words of legendary investor Walter Schloss: “…if a business is worth a dollar, and we can purchase it at 80 cents, something good may happen.”
We will buy a portfolio of large cap individual stocks that fits our value investing criteria. The list usually consists of approximately 15-20 names. We purchase securities over time as they become available price-wise; we never purchase a whole portfolio all at once. However, after we buy, we sit. Often for years. While we pay careful attention to our individual investments, as long as there aren’t any fundamental changes in the underlying business, we are content to wait. It is my opinion that it is folly to think anyone can predict the future in security prices…so I don’t try. I do believe it is possible, however, to identify undervalued securities or industries from time to time. By purchasing this way, we potentially enhance our odds of making money long term.*
People ask me how I select individual stocks. There is no firm, cut in stone formula. But here are some things I look for, so that when many of them line up, AND, the price where the security can be purchased is reasonable, I will put it on the radar screen:
• It has to be a large company and have a large market capitalization. Large caps are liquid, and there is plenty of information available on them.
• The business must be easy to understand. This makes it a lot easier to value what the company is worth. There are dozens of easy to understand large businesses; and hundreds that are difficult (for me) to understand. I’ll stick with the former.
• Company has intrinsic characteristics that give it a durable competitive advantage. That advantage is so strong that it will last decades, not years. The company must have an “economic moat”, so that it is very difficult for a competitor to enter this type of business.
• The company’s stock has a long term record (10+years) that has outperformed the S&P 500**. Best in class companies are generally aligned with the long term interests of the shareholder. This idea should be common sense, yet many investors refuse to embrace it. Better companies have a culture, a process, and a product or market that sets them apart from their competition. Their superior performance doesn't happen by luck or accident. It is this kind of stock for which I am constantly searching.
• Management doesn’t pay itself excessively, and owns lots of the company’s stock. You’d be amazed at the positive correlation between the amount of stock management owns and long term share performance.
• The company has a low level of debt, and is committed to maintaining a conservative (strong) balance sheet. Businesses that are underleveraged and have solid financial footings typically can generate what is known as “free cash flow”. Free cash flow is money the company has available after laying out money to run the business. The cash can be used to pay out dividends, or buy back and reduce the number of outstanding shares.
• Most important, it must be available at a reasonable price (off its high) so that it provides a “margin of safety”. No matter how wonderful the company, it doesn’t have an infinite price attached. I want to have purchased it at a price low enough that I can sit still and maintain composure should the market head south.
*Investing in stocks involves market risk, including loss of principal.
**The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
S&P 500 is an unmanaged index which cannot be invested into directly. Past performance is no guarantee of future results