Our Philosophy
Our investment philosophy is derived from a combination of views from some of the most successful and well recognized names in the investment community: Benjamin Graham, Phil Fisher and Warren Buffett. While the philosophies are different from each investor, the same sound principal is consistent: to find and invest in businesses that are selling for less than what the company is truly worth. Our philosophy is based on a few principals on how the marketplace truly operates as compared to theories that are widely taught and practiced in the investment community.
Market Efficiency
The widely taught and believed notion by many in the investment community today is that the market is efficient. The Efficient Market Theory states that at any moment in time, the security is trading at the true value of the company in regards to all known public information about the business. This can not be more wrong!! In January of 2009, the average number of shares that traded per day on the NASDAQ alone was 3.5 million. In one day, on one exchange, 3.5 million shares traded hands! Do you think that it is realistic to believe that for every company, the transaction price was in line with the true value of the business? I think not! One real life example can truly nail this notion home. Imagine that you are at a sporting event. Like most of us, you feel the urge to visit the concession stands to purchase a snack. As we all know, there are concession stands everywhere throughout the facility with lines of customers. You stumble upon an area where there are five concession windows next to each other. If the Efficient Market Theory were true, the eager customers wanting to buy their snack and get back to the sporting event would be dispersed evenly throughout the five lines to ensure efficiency. You notice that there is a large disparity in the length of the lines. One line has ten people, another has seven, two have five and the last line at the very end only has two. Which line are you going to choose to stand in? Although this life based example is far from Wall Street, it still has relevance. The human factor is the single most important factor as to why markets are not efficient. A single person has an adequate sense of knowledge and patience and can make intelligent decisions most of the time. People in masses, however, are far from having the ability to make intelligent decisions any of the time. Because of this, mouth watering opportunities can be made available in the stock market, you just need to know where to look.
Price vs. Value
To truly understand our investment philosophy, you have to have a solid foundation in understanding the difference between the price and value of a company. The price is simply the last executed trading price per share for the company on the open market and can easily be identified and is an undisputed amount. Value, however, is what the underlying company is worth and is derived from the assets the company owns and the ability to generate consistent and recurring income streams. Value is more difficult to calculate and is essentially an approximate figure for what the business is truly worth (an appraisal of the company). Wall Street typically gets the difference between the two definitions mixed up and usually uses them interchangeably as if they are the same thing.
Margin of Safety
The stock market can be a risky and dangerous place. Some days it will make you feel as if you just got your stomach kicked in and your jaw broken. Other days it makes you feel as if you are the heavyweight champion of the world. The Margin of Safety principal is used to limit the days of feeling and looking like you have been run over by a train. If used correctly, it will save your butt when the market is jittery and doesn’t know which way it wants to go (such as the current conditions). Margin of Safety, to put it simply, is to only invest in businesses that are at such a huge discount to the true value of the company that even if some negatively unforeseen changes were to occur to the business, your decision to invest would still be an intelligent one. By using this principal, it helps to filter out the investment possibilities that you are considering to take. If you are on the fence about investing in a business, no need to waste any more in depth thought, the answer is simply NO. If you did not get an initial gut feeling about the value of the company that you are analyzing, do not invest.
Putting It All Together
When you buy and sell shares in the stock market, you are buying and selling small fractions of a very real and operating business. This is common knowledge but sadly enough, a lot of people forget that. In our investment decisions, we are looking to receive the highest rate of return while experiencing the least amount of risk. This is easier said than done. We do this by purchasing great companies at large discounts in relation to their true underlying value and implement our Margin of Safety principal. In our technologically advanced world, where information changes hands in seconds and financial decisions are made at the drop of a hat, the stock market is a very volatile and scary environment to participate in. Because of this, we feel that owning GREAT businesses with the intention to hold for the long term will give us the most benefit in our investment decisions while limiting the inherit risk that all investments must experience. What makes a great business? A great business has several things to be considered great in our eyes.
- Plenty of cash compared to the total outstanding debt
- Generates consistent earnings
- Has a high growth rate
- Has great managers
- Has a high profit margin
Even though the stock market can be volatile and often misprices the true value of companies in the short run, in the long run it almost always gets it right. In addition, we believe a good investment portfolio should only be composed of ten companies at the maximum. The common outlook on this subject is to buy many companies to diversify the risk. We feel that by owning a few great businesses in which we know much about actually limits our investment exposure rather than owning a large amount of companies (most mutual funds own over 100) in which we know little about. While owning a large amount of businesses does limit the risk exposure, it makes the investment portfolio closely correlate to stock market averages such as the Dow Jones Industrial Average and truly can put a ceiling on the kinds of investment returns that are able to be experienced. While every person’s risk tolerance and investment purpose are different, we feel that purchasing great businesses at great prices should always be a part of the investment portfolio.