Core competency:

We are experts at evaluating change

•  Change = Opportunity

•  Discipline = Success

1. A process that identifies “winners”

2. A process that can be repeated. One that:

- Generates consistent, above average investment results

- Is not dependent upon a single individual

We have a well-defined security selection process (our “discipline”) that’s designed to uncover the type of investment opportunities that we’re looking for: industries and companies undergoing a change that will drive their valuation higher. And preferably a change that others haven’t already identified. (We’d rather be trend spotters than trend followers.).

We distinguish ourselves from other value investors by (1) buying statistically “cheap” stocks and (2) significantly overweighting companies and industries that are attractive.

(1) We buy statistically cheap common stocks, not ones that are relatively attractive. We screen the Standard & Poor’s Compustat database for domestic companies selling (a) below the median level of several valuation measures, e.g., the price / earnings ratio, and (b) those “outliers” with extraordinarily high valuation ratios. Unlike peers that focus on the relative valuation of companies, we focus upon companies whose common stock is statistically cheap. We also look at companies with extraordinarily high valuation ratios because that’s where companies in out-of-favor cyclical industries first appear as they return to profitability. A company whose common stock sells for $20.00 and earns $0.01 has a price / earnings ratio of 2,000. (The p/e of a cyclical falls as the company’s profitability increases.)

We then look for the unique characteristics that will, in our judgment, cause an industry and / or company to outperform the market. For example, traditional “value stocks” such as companies in out-of-favor cyclical industries or financial difficulty (“turnarounds”). Also, companies with new management and / or new products, particularly market leaders that are suffering temporary growth pains (“fallen angels”). We are, in other words, looking for diamonds in the rough.

(2) We significantly overweight companies and industries that are attractive. We don't hug a benchmark, i.e., maintain the sector, industry, and component weights of an index (as do many large firms that can only manage money at the margins). We are traditional “bottom-up” investors. When single company gets into trouble, it stands out from its peers (and we'll watch and await the right time to buy the turnaround if it occurs). When an industry slumps, numerous companies generally pass our screens. That's particularly true of cyclical industries, e.g., housing. Our job is then to select the best companies, i.e., from an investment standpoint, the ones that will profit most when the rebound occurs. That drives the overweighting of an industry in our portfolios.

Portfolios typically hold twenty (20) issues with an initial commitment of 5% of the portfolio's market value. We'll allow a single issue to appreciate to 15% of a portfolio. We have no limit to how much of a portfolio can be committed to a single industry (or how much we can leave in “cash” when we think it warranted).

While the question of what to buy is answered by accounting and financial analysis, the question of when to buy is a matter of judgment. Because we establish (relatively) strict “buy limits” for all securities, client portfolios often do not look alike.

When buying, we maintain a “margin of safety” by establishing a buy limit and price target for each security. So if, for example, we expect a common stock currently selling for $20.00 to reach $40.00-to-$60.00 (a double or triple isn't uncommon for a cyclical), we might stop buying at $30.00 per share. Because value stocks have often been declining in price for some time, the downside is generally limited. As they rise in price, though, the risk-reward ratio shifts: the reward diminishes and the risk rises. That is, as the profit potential falls, the risk of a mistake rises.

We sell when (a) the security reaches its “fair value” [its “target price”], (b) the stock's fundamentals deteriorate, (c) we get frustrated as time lapses [the Achilles Heel of value investors] and / or we decide that we made a mistake, or (c) we identify a better opportunity for investment of the funds. We also sell when we think that reducing the portfolio's risk is warranted. That may involve (a) reducing the exposure to a particular industry, (b) reducing overweight positions, and / or (c) selling entire positions to raise cash.