Part 1: Philosophy
Our Process
The biggest portion of our time is spent doing research/due diligence on public companies. This includes companies we already own as well as potential investments. We do all research in-house. Our research includes:
- reading press releases (quarterly earnings, management changes, M&A announcements, etc.) and government filings (annual/quarterly reports, proxy statements, etc.) to understand the business and results
- meeting with management and investor relations teams to understand the context of their results and the direction of the company
- building spreadsheets to review historical trends and calculate reasonable valuations
The point of this research is to learn how the company actually operates, who their customers are, how they treat their employees, and what their intentions are for the business in the next several years. When we invest, we consider ourselves to be part owners, so it is important to us that we understand the business, their processes and goals, and what we should expect in at least five to ten years.
What We Look For
We like companies that serve an important role to their customers (consistent and high margins, growing sales, best-in-class products or services), to their employees (employee retention, promotion from within), and that are not easily replicated (monopolies, critical infrastructure or services). We look for profitability on a consistent long-term basis. We like seeing companies share that profitability with their investors, especially through dividends. We like companies that consistently meet and outperform their goals.
Portfolio Construction
We have a portfolio of roughly a hundred companies we invest in which we have built up over decades. We are slow to add companies, and when we do it means we have done a significant amount of work to get comfortable with their business. When we invest, our goal is to keep a position in the business in perpetuity. While invested, we continue to monitor a company on a regular basis, continuing our research process of reviewing financial results, press releases, and speaking to management/investor relations. We may remove a company from our portfolio for things such as: a new management team with an aggressively different strategy that adds significant risk; changes to the underlying business, often through large M&A deals; failure to achieve their stated goals due to factors within their control; degradation of the quality of the company, its products or services; or sometimes the company is bought out and we have no choice in the matter.
Part 2: In Practice
Due Diligence
We meet with several hundred companies each year, some for the first time, some on a regular basis, and some every few years. Following these meetings, we write up our notes which we keep in our archive. We have, over our entire history, met thousands of companies. Investing is a never-ending process and having this archive allows us to track a company, its intentions and our expectations over a long period.
We prepare ahead of meetings so that we can get a better idea of how the business really runs. Every management team wants to portray their company in the best light they can, so by having some background we can go off-script and get more informative answers. Most meetings last about an hour, during which time our goal is to get context for their reported results, and identify any red flags.
If after a meeting we all agree that a company is strong, consistent and worth considering, we will do a longer-term look at their results and a deeper dive on their filings. If everything looks good, that is the point at which we decide whether the security (stock, preferred stock or bond) is worth its market price.
Decision Making
The entire investment team (Al Mason, Gregg Picillo and Elliot Bruce) must agree on making an investment.
Decisions are company specific. We are bottom-up, meaning we review a company on its own merits rather than the merits of the industry or market as a whole. The market and industry may provide important context, but that is all incorporated in the review of the company itself.
We review a company and decide whether or not we want to own the equity or fixed income securities of that company. If so, we will decide how much exposure we want to have, largely depending how risky the business is rather than how significant the returns could be. We limit our position size based on the risk profile of the business. If it is something we want to own but the price is not as attractive as we would like, we may wait (and have waited) years before making an investment. These securities go on our watch list.
Portfolio Construction
Position size is critical. A normal position size is 1%. Very rarely would we have a 2% position, and usually if it gets to this level, we will cut it back in order to limit company-specific risk. We would rather take a bruise than be brought to our knees. If the worst-case scenario is that we do not have enough of a good thing, that is a good scenario.
Diversification is critical. Our portfolio has in a natural way become a diversified portfolio covering most major industries, headquartered in various jurisdictions, and ranging in company size from nine to thirteen figures. We also buy bonds and preferred stocks so that we have both equity and fixed income exposure.
Implementation
We invest one way, so when a new client joins us, we already know what we will be buying. We keep a portfolio template with the various companies we want to own as well as our target positions size. Our client accounts all have a similar portfolio of names with some room for drift due to timing of cash inflows and outflows, as well as some variance if the client has unique requirements.
When we make changes to our template it is for reasons specific to the companies. We may buy a little more or a little less of a company depending where the stock price is, but we do not try to time the market by buying pieces of the portfolio here and there and hoping we can get the best price for every security.
We want to own this set of companies. We do not want to be shaken out of a position just because the stock looks relatively expensive, or buy more than we are comfortable with just because the stock looks relatively cheap. We review the portfolio companies on an ongoing basis and through that process we decide whether those companies will remain in the portfolio, and if so, how much we would like to own. The template is under constant review, but not constant flux.
What you should expect is that shortly after funding your account, you will own a portfolio of companies that have been vetted and purchased on the merits of their business. We expect that these companies will be bigger, better and more prosperous over the long-term, and that they will share their prosperity through an increasing level of dividends.
