Investment Committee Interview
The Search for VALUE in Global Stock Markets
WHAT IS VALUE INVESTING?
Value investors seek to buy stocks trading at prices well below the estimated value of the underlying businesses. We believe that, in the long term, the prices of these stocks will rise as the market recognizes their true worth. By holding these stocks for three to five years, we believe they will help us deliver favorable long-term results with a margin of safety.
We look for a business with a potential margin of safety – one selling at a price below our estimate of its intrinsic value.
HOW DO YOU DETERMINE WHETHER A STOCK IS A GOOD VALUE?
We carefully evaluate the price we pay for the business. We analyze long-term rates of return, cash flows, balance sheet strength, management, asset values, and liquidation values. We also often look at private market transactions to determine intrinsic, or fair, value. We look for a business with a potential margin of safety – one selling at a price below our estimate of its intrinsic value. A margin of safety provides some protection from error and uncertainties. This is a conservative approach that aids in preserving capital and gives us the opportunity for profit.
HOW IMPORTANT ARE BOOK VALUES IN YOUR METHODOLOGY?
Book values can be very misleading as a measure of value. They are the result of generally accepted accounting principles that can be inconsistent with the true value of a business, depending upon the industry and nature of the business. As a result, our team of research professionals may make adjustments to book values to more accurately assess different companies. For example, an obsolete steel plant may be worth far less than the stated value on the balance sheet. Conversely, a well known, dominant brand name may have accumulated tremendous value that is not reflected on the balance sheet. We tend to purchase a stock if it is trading at a significant discount from its intrinsic value, as calculated by our fundamental research and analysis. Ultimately, we are business buyers. We approach investing as would any rational, private businessperson who was about to purchase a company.
DO YOU OWN STOCKS WITH LOW P/Es?
Most of our stocks carry low price-to-earnings ratios (P/Es). This is fundamental to our approach. But, as in the case of asset values, earnings may need adjustment – and we focus on “normalized” earnings, not the most recently reported results. In general, we tend to pay as little as possible for the earnings stream of a business. Stocks that are capitalized at very high rates (high P/Es) generally have high expectations attached to them. If these expectations aren’t met, the stocks may be vulnerable to steep declines. Stocks with low P/Es generally have lower risk and a greater margin of safety.
HOW IMPORTANT ARE DIVIDENDS?
Typically, dividends are not considered in our process of screening for value stocks. However, businesses priced at bargain levels in many cases pay higher-than-average dividends. Therefore, our portfolios usually have higher dividend yields than their respective benchmarks. If a company has a high return on investment, generally we prefer that it reinvest earnings rather than pay out cash dividends, creating a potentially undesirable taxable event. If the returns on investment are low, however, we prefer high dividend payouts.
We think independently and make investment decisions based on quantifiable evidence. We seek to shield ourselves from the influence of short-term public sentiment, and our actions tend to counter current opinion. We are patient, conservative investors who are willing to wait for values to surface.
IS IT REALLY POSSIBLE TO ACQUIRE COMPANIES AT BARGAIN PRICES?
Yes. Many companies are overlooked, misunderstood victims of investors’ overreactions, misplaced fear, and exaggerated focus on short-term performance. We are often able to acquire companies inexpensively when they experience temporary difficulties or when market conditions are generally weak. We think independently and make investment decisions based on quantifiable evidence. We seek to shield ourselves from the influence of short-term public sentiment, and our actions tend to counter current opinion. We are patient, conservative investors who are willing to wait for values to surface. We also seek to capitalize on changes in corporate direction and strategy that increase a company’s intrinsic value. Often, the market is slow to respond to positive changes, creating an opportunity for the patient value investor.
HOW DO YOU FIND INVESTMENT IDEAS?
We find ideas in many ways, including database screening and researching annual reports, as well as industry, general, and business publications. We also visit companies and closely review analyst reports. Each of our investment professionals has sector and industry specializations. Our integrated, team-oriented approach, with professionals focused on global industries, provides the leverage necessary to effectively cover the world’s markets and evaluate thousands of opportunities. We sift through investment candidates, searching for opportunities meeting our basic criteria and meriting further investigation.
DO YOU USE COMPUTER SCREENING TO FIND IDEAS?
Using computers, we do screen fundamental characteristics for thousands of companies. Screening, however, is just one tool we use, and we recognize its limitations. We do not make buy or sell decisions based exclusively on computer screening. Fundamental, company-by-company analysis is the major driver of our stock selection.
We do not base investment decisions on our opinion of future changes in interest rates or economic growth. Instead, we focus on gauging the prospects of individual businesses.
WHAT IS THE ROLE OF ECONOMIC AND INDUSTRY ANALYSIS IN YOUR INVESTMENT PROCESS?
Analyzing or attempting to predict future macroeconomic trends plays virtually no part in our investment process. For example, we do not base investment decisions on our opinion of future changes in interest rates or economic growth. Instead, we focus on gauging the prospects of individual businesses, sometimes referred to as a “bottom- up” approach.
By contrast, a typical “top-down” investor starts with an economic overview that seeks to highlight attractive countries and industries. For example, “top-down” investors, believing oil prices will rise sharply over the next year, may invest in a number of companies in the oil industry.
“Bottom-up” investors begin with the company itself. We approach investing as if we were purchasing the entire business – not simply its stock. Ultimately, we believe the current value of a business reflects the discounted values of future cash flows it will generate. And in attempting to gauge future cash flows, we must analyze a company’s strengths, weaknesses, and industry dynamics. Thus, industry analysis plays a role in our investment process. However, we recognize it is extremely difficult to project future cash flows with a high degree of confidence, especially in more remote years. Therefore, we maintain conservative estimates and seek to capture as much value as possible over three to five years – or what we consider a typical business cycle.
We do not exclude opportunities based on preconceived industry perceptions, and typically, our portfolios are well diversified across many industries.
DO YOU USE INDICES AS A GUIDE IN SECURITY SELECTION?
No. We select holdings without reference to an index. Each security is selected based purely on its own merits. Country and industry weightings are residuals of our bottom- up stock selection process. We do not exclude opportunities based on preconceived country, sector, or industry perceptions. Typically, our portfolios are well diversified and may differ in composition from relevant indices.
WHAT SIZE COMPANY DO YOU INVEST IN?
Our International Equity, Global Equity, Global Balanced, and U.S. Value Equity portfolios are diversified among various sized companies with a bias, however, toward larger companies. Overall, we invest in companies across the capitalization spectrum. For example, we manage portfolios of U.S., global, and international mid and small-cap stocks.
HOW IMPORTANT IS COMPANY MANAGEMENT IN ARRIVING AT AN INVESTMENT DECISION?
We prefer companies with management teams dedicated to the interest of shareholders, not to building empires and their own net worth, independent of the shareholders. We look at a variety of factors such as compensation arrangements, stock holdings, management goals and statements, and actions that indicate attitude toward owners.
HOW DOES A STOCK GET ON YOUR BUY LIST?
Members of our team of professionals constantly review investment candidates in their respective industries of expertise. Promising candidates are researched and analyzed based on a variety of factors including fundamental traits, financial history, and management record. Team members also evaluate broader, longer-term issues related to the industries in which the company operates. Often, face-to-face meetings or calls with company management are arranged. After this process, if the company proves its merit and its stock price is still within an acceptable range, the idea is brought to the relevant investment committee for consideration. The investment committee makes all final purchase and sale decisions. Securities approved for purchase are placed on a buy list with a specific price range for purchase and a target price for eventual sale.
WHO MONITORS A STOCK ONCE IT’S APPROVED?
Overlapping responsibilities for various members of our investment team ensure each holding remains closely monitored. Analysts monitor ongoing developments and notify the investment committees of any material changes that may affect valuations. Investment committees review the portfolios at least once per week.
HOW DIVERSIFIED ARE YOUR PORTFOLIOS?
We concentrate our portfolios in 35 to 85 stocks. However, country and industry weightings (at time of purchase) are not to exceed the greater of (a) 20% of the portfolio value (at time of purchase) or (b) 150% of the applicable benchmark weightings. We believe our value discipline enables us to confidently take positions that can be significantly different from the composition of popular indices.
When a company’s stock price reaches our estimation of its intrinsic value, or if we are able to identify a superior alternative, it is sold. Our holding periods typically average three to five years.
HOW LONG DO YOU HOLD POSITIONS AND WHAT IS YOUR SELL DISCIPLINE?
We have no fixed holding period. We may hold an investment as long as the intrinsic value exceeds the stock’s market price. When a company’s stock price reaches our estimation of its intrinsic value, or if we are able to identify a superior alternative, it is sold. Our holding periods typically average three to five years.
DO YOU THINK VALUE INVESTING WILL WORK AS WELL IN THE FUTURE AS IT HAS IN THE PAST?
While we refrain from predicting the future, we remain confident our approach can continue to reward investors with favorable results and a margin of safety. Based on the fundamental strengths of portfolio holdings, we believe our approach, as it has since 1974, will continue to help investors toward long-term goals.
OUR GOALS:
PRESERVE CAPITAL
PROVIDE DIVERSIFICATION TO REDUCE RISK
GENERATE SOLID RETURNS FOR OUR CLIENTS