Research Process
We are focused on absolute returns as much as we are on relative returns. Avoiding large losses is critical for wealth creation. Therefore, our investment process is not just about picking good stocks, but also managing risk - business, valuation and performance. We believe buying the shares of a good business with credible and sincere management at a discount to Fair or Intrinsic Value gives investors several potential paths to wealth creation. First, the market may bid the shares to a premium over Fair Value. Second, management may grow the Fair Value over time at a faster rate than market appreciation. Third, the company may be bought by a larger company or private market investor.
A security must successfully go through our three-step research process where we evaluate different criteria before it is considered for the portfolio:
Step 1 - Qualitative Sector Factors. To pass this criteria and move on to the next step of the screening process, companies must be in an industry which meets our sector factor guidelines. For instance, in consumer stocks we look for companies with low fashion risk and brand loyalty.
Step 2 - Analysis of Company Attributes. A company must have the following criteria to move on: positive cash flow, low debt, sincere and capable management – which is reflected in how they pay themselves, and who they put on their board, a stable business model and superior relative growth (compared to other companies in the sector).
Step 3 - Valuation Analysis. We determine a company’s fair value using four different methods of analysis. We analyze the M&A activity in the space, we analyze the cash flow utilizing several models, we examine the company to see if it has franchise value – i.e. a secret sauce, which will shade the fair value a bit higher, and lastly, we verify that the company’s fundamentals are solid.
Some of the things we want to see here are positive market conditions and/or economic trends, new product cycles, and R&D spending. Weighing all these different factors if our analysis finds the company’s valuation looks attractive and the business outlook is good we then set strict price target levels for purchase, and will be very patient in establishing a good entry point for the investment.