Our objective is to generate superior long-term results while protecting capital. We believe the best way to deliver a consistent result is through a valuation-based investment approach using a multi-step and repeatable process to find high-quality businesses that are trading for less than we think they are worth.
Initial sources of ideas include our own screens for out-of-favour industries, sectors, and stocks, plus external relationships including sell-side research and other investment manager relationships.
- Initial Valuation: This includes discounted cash flow, price/earnings, price/book, EV/EBITDA, EV/sales, and other.
- Quality: We rank companies over the long term based on the consistency of various metrics such as return on equity and return on invested capital.
- Balance Sheet: An assessment of the company’s financial flexibility and ability to service and repay its debt.
- Industry Dynamics: We strongly prefer industries that are growing and have a low probability of disruption.
- Management: The track record and tenure of the management team, evidence of capital discipline, alignment with shareholders. (i.e., inside ownership) and the benevolence towards shareholders are important factors.
- Management Interview: If we have not recently met management, we will attempt to do so, or schedule a conference call.
- Detailed Valuation: If an investment idea passes the above hurdles, our team then works on a more detailed valuation model using a discounted cash flow (DCF) model. Like most DCF models, the valuation will be positively impacted by the growth rate of cash flows, low or declining requirements for capital reinvestment, and a discount rate that adjusts for a lower cost of capital. Generally, the longer a company can earn a higher return on its capital versus its cost of capital the more attractive the security.
If an investment idea survives the evaluation process and it appears to be undervalued, it is then considered for inclusion in the portfolio. The buy discipline is the culmination of that process and ultimately rests on whether we believe the security will provide an attractive return in the next three to five years. The portfolio weighting is determined by the ranking the security received from the evaluation process and the security’s trading liquidity.
When we identify a high-quality business that we would like to own but it is trading at a premium to our assessment of value, we wait for our desired price before assessing whether to buy.
Once included in the portfolio, the security’s value assessment is continuously updated and compared to the security’s trading price. If we believe a security in the portfolio is trading far in excess of fair value, we will not hesitate to trim or sell outright. If the outlook for a business changes due to any number of reasons, we will not hesitate to liquidate the position.
We believe the approximately 75 management meetings that we conduct per year are additive to the investment process, and we endeavor to interview management teams prior to making a new investment. However, we are comfortable making occasional new investments without interviewing management, particularly for larger companies. While we own a stock, we conduct ongoing interviews.
Liquidity is considered when making an investment, and we take a portfolio view when assessing liquidity. We will occasionally have a small portion of the portfolio invested in securities with limited liquidity.
Portfolios are constructed with a view to owning 25 to 35 stocks, with concentration towards the top 10 holdings. We do not consider tracking or shadowing market indexes when constructing portfolios, although we monitor our exposures to industries and prefer to be as diversified as possible. We do not employ leverage and do not use derivatives, except occasionally we will buy an exchange traded fund (ETF) to invest in undervalued sectors or geographic regions when individual stock selection is less efficient than a macro-based approach to investing.
We focus primarily on North America but are comfortable investing globally where we will limit our equity weighting to a maximum of 35% of the portfolio.