Equity Selection

We base our selections on a rational evaluation of long-term prospects.

Buying stock in a public company is like entering into a partnership with the people who manage the business: we put up our money and they do the work of running the company. The companies we buy all possess the requirements we are looking for, or we don't buy their stock. Fundamental changes in management or in the nature of the business could cause us to sell, but if the company is performing as expected, we hold its stock.

All of our investment decisions are based upon a rational evaluation of long-term prospects rather than near-term events. Our portfolios are diversified primarily in five industry sectors: consumer non-durables, consumer services, financial services, healthcare and technology. Most of our holdings are in large multi-national corporations, but we also purchase a select number of mid-cap stocks.

Our research and portfolio management teams evaluate company characteristics using both qualitative and quantitative analysis. Embracing both of these aspects in our fundamental research, we look at three critical variables: sustainable competitive advantage, quality of management and valuation.

Competetive Selection

First on our list, a company must have a sustainable competitive advantage. This competitive advantage could be because the business enjoys a “virtuous cycle” where lower costs for the product or service mean the company can offer lower prices, resulting in higher volume and, therefore, continuing low costs.

A business could also sustain its competitive advantage through barriers that prevent competitors from entering the market (government regulations, start-up expenses, etc.) or through complexities that prevent others from duplicating what the company has to offer.

Finally, the competitive advantage could come simply from the superiority of a company’s product.

Management

A company’s management team must be both “good” and “great”. Management must be “good” in terms of its ethical standards, and “great” based on its abilities to capitalize on the company’s competitive advantage and its commitment to the shareholders. Management should strive to maximize share value by making acquisitions, buying back stock, and increasing the company’s dividend. Both the management team and the board of directors should have significant stock ownership so they will have even more reason to ensure that both the company and the shareholders make money.

Valuation

Finally, the company should provide attractive valuation based on its long-term earnings potential. We look for companies where necessary expenditures are low, but the potential for profit and growth is high. In this context, discretionary cash flow is an important criterion. Money left over after depreciation, amortization, and necessary capital expenditures can be put back into improving the company. It can also be used to make acquisitions, buy back shares or be returned to stockholders in the form of a dividend.

Predictability of earnings is a critical factor our researchers examine. Here is where the terms “growth investing” and “value investing” merge. Companies like Coca Cola with a sustained competitive advantage enjoy predictable long-term growth of earnings, a factor which enables us to put a price on expected returns over many decades. A sustainable competitive advantage creates predictable growth, which is the critical factor for determining the inherent value of the stock at its current selling price.