How We Invest

How Do We Choose Investments?

As a rule, we identify value investments among companies that are temporarily out of favor with the market. Typically, these belong to one of three categories:

1) Cyclical businesses

The investing crowd often forgets the recurring characteristics of cyclical businesses and starts believing that a decline is secular — or it is not patient enough to wait for the ultimate recovery. In fact, cyclically depressed sectors/industries and markets may offer attractive opportunities to pick up good companies due to the combination of depressed earnings and the compression of valuation ratios. We are also attracted to particular geographic regions with high secular growth potential, where equity markets have experienced short-term negative volatilities. If the cyclicality is regional or sectoral and we cannot find suitable individual names at an early stage, we might initially use low-cost Exchange Traded Funds (ETF’s) to gain exposure.

What do we look for? Our investment checklist

  1. Extremely negative and progressively worsening headlines and consensus views on particular industries or geographic regions.
  2. Solid companies that would survive the downturns and see their growth prospect restored in 3-5 years.

2) Good businesses with temporary challenges

When good, growing businesses have stumbled but seem likely to fully recover and continue to grow later, we reassess the obvious short-term challenge vs. the long-term opportunity. We prefer a company-specific stumble. These are often former divas that have suffered an accident and whose stock is down substantially from recent highs – in large part because momentum traders and index investors have been liquidating the stock. We do keep in mind the cockroach theory, where one trouble uncovered often leads to the exposure of more problems, so we carefully review growth / profitability assumptions. Even if the valuation is unlikely to return to previous highs, we want to reach a good estimate of the potential long-term valuation.

What do we look for? Our investment checklist

  1. Good quality — businesses with good margins and returns, requiring relatively little capital, and generating substantial cash flows
  2. Capable, trustworthy managements that are shareholder-friendly and think like owners — we are looking for partners in business, and we strive to pick the best teams
  3. Promising long-term prospects — we are long-term investors, and we like to see big opportunities for businesses to grow, expand, and flourish

3) Under-followed, unloved, misunderstood and neglected businesses

We search out businesses where expectations — without being negative — are low. Often, we consider stocks that have been neglected because very few analysts follow the company and its story is dull with no catalyst for change in sight. Among those candidates, we sometimes find misunderstood businesses, where the real money-making activity or skill is ignored or hidden by other, less profitable activities, negatively affecting the perception of the company

What do we look for? Our investment checklist

  1. Unique and complex business models that are misunderstood
  2. Hidden asset value or long-term growth potential camouflaged by outwardly boring existing businesses