We look for good businesses we can understand and buy at a price below intrinsic value. The approach is simple, but it requires a lot of time, effort and emotional intellect.
We seek a discount to intrinsic value
Intrinsic value is an estimate of the discounted value of the cash that can be taken out of a business during its remaining life. It is what a prudent businessman would be prepared to pay for an entire business with consideration for the company’s long-term prospects.
The lower the price of a share as compared to its assessed intrinsic value, the higher the margin of safety, and the more attractive we consider the share. The margin of safety is by definition, a favourable difference between price on the one hand and intrinsic value on the other.
We believe market prices are there to serve us, not to instruct us
We view each stock investment as if we were the owner of the entire underlying business because investing is most intelligent when it is most business like. In the short-term, share prices are affected by market psychology; but over the long-term, share prices are determined by the economic progress of the underlying business.
There are times when a company’s share price is above its intrinsic value, often when investors are overly optimistic and expect the price to continue to increase as greed dominates. There are also times when a company’s share price is below intrinsic value, often when investors are overly pessimistic and expect developments to continue to worsen as fear dominates.
We take a contrarian view
We are often attracted to shares that are disliked or unfollowed by others and are less likely to find great investments in areas that other investors or the financial community are excited about. Underappreciated securities are often underpriced by the market because sellers typically outnumber buyers.
We take a long-term view
We cannot predict the length of time it will take for a stock to be priced more rationally, therefore we take a long-term view and will hold an investment through short-term market pessimism and wait for the market to eventually recognise the company’s true value.
We are unable to time and predict a share price trough or peak and make no effort to do so. Instead, we focus on assessing a business’s intrinsic value and we wait to buy at prices below and sell at prices above such value.
We focus on risk
We believe that risk is the possibility of a permanent loss of capital and we focus on the margin of safety because we believe it is important for absorbing the effect of miscalculations or worse than average luck. If an investment is bought on a bargain basis, even a moderate decline in the earning power need not prevent it from showing satisfactory results. The margin of safety will then have served its proper purpose.
The portfolio is considered in two parts: the small-growth and cyclical stocks; and the conservative stocks and cash. When the market heads lower, we sell the conservative stocks, utilise more cash and add to the small-growth and cyclical stocks. When the market picks up, we sell some of the winners from the growth stocks and cyclical stocks and add to the conservative stocks and keep more cash on hand to be utilised later when more appropriately priced opportunities become available.
We prefer wonderful businesses
Businesses with wonderful economic characteristics and which can increase intrinsic value over time at an attractive rate are preferred. Other businesses with less promising long-term prospects are also considered, however a wider discount to intrinsic value shall be sought when purchasing shares in these companies.
We work hard to understand businesses
Our investment research is focused on understanding businesses, estimating intrinsic value, and seeking undervalued companies. Research includes but is not limited to: reviewing company and competitor financial statements and historical records; meeting company management; testing company products and services; questioning industry contacts; reading industry news; and screening various databases for undervalued businesses.
A key component of our research process is direct contact with company management through calls and face-to-face meetings. This is because we believe that company management should be industry experts best positioned to explain drivers of the industry’s supply-demand dynamic and profitability. We believe that successful investing is 90% hard work and our annual goal is to have over 100 company meetings and to read over 400 financial statements.
Investment evaluation includes an assessment of: the earning power and quality of company assets; the level of company debt and cash; the quality and integrity of company management; and the competitiveness of the company and the industry. Companies which are poorly managed or are vulnerable due to excessive debt or competition are avoided.
We consider specific investment categories and characteristics
To foster an organised rational decision-making process, we classify investments of interest into one of the following Investment Categories: Fast growers; Stalwarts; Cyclicals; Turnarounds; and Asset plays. We also consider whether potential investments possess certain specific favourable Investment Characteristics.
We monitor the portfolio by ranking investments
We constantly monitor portfolio positions and the correlation between them to control diversification. Investments with the highest expected return and the lowest risk are prioritised. Conviction is based on how well we know the company and to what extent the outcome is predictable.
We acknowledge the wisdom of intelligent investors
Although there is no monopoly on investment ideas, one must give credit where it is clearly due. Our investment philosophy is based on the shared wisdom and generous teaching of Benjamin Graham, Peter Lynch and Warren Buffett.