Investing

OUR PROCESS

Summary

We examine businesses across multiple industries to identify prospering companies whose securities trade at significant discounts to our estimate of their fair value range. Within the examined industry, we study every company on the market for which at least a decade of financial reporting history is available. We strive to fully know the industry of an enterprise in which we are investing. We skip the vast majority of mediocre investment opportunities and don’t pursue portfolio diversification, as there are few businesses that meet our criteria and trade at attractively low prices.

We aim to hold from five to fifteen investments with a target investment horizon of two to ten years. We always seek to eliminate speculation and leverage from our investment operations, as we are opposed to unnecessary risks, gambling, overreliance on forecasting as well as application of borrowed funds.

Company Analysis

Our company valuation process is almost entirely based on detailed examination of a given company’s financial reports (e.g., 10-K) wherein we study: (1) main statements of: • comprehensive income • financial position (balance sheet) • cash flow • changes in equity; (2) notes that provide specific disclosures and detailed breakdowns to certain items not limited to: • segmental assets, earnings, operating income, and profit margins • amortisation and depletion • depreciation • leases • rent • tax • interest • impairment charges and write-downs of capital assets • goodwill account • long-term debt and its constituents • share-based compensation charges and outstanding share-based reward balances • details on any legal proceedings • breakdown on properties operated • property, plant, and equipment account; (3) enterprise’s profile presenting business information not limited to: • product • brand/s • company’s strategy • business seasonality • sourcing and logistics • distribution channels • human capital resources • suppliers • customers • competition and market share • divestitures, acquisitions, and other business transactions.

Based on this examination, we produce several models of normalised earnings historical record (10-20 years) adjusted to non-recurring charges, gains, or losses (e.g., goodwill write-offs, unusual gains on divestitures or revaluations of capital assets) as well as specific charges (e.g., depreciation, capital expenditures, share-based compensation). We also estimate the effective debt by accounting for outstanding obligations other than loans, notes, and credit lines already included in the debt balance (e.g., lease liabilities, rent charges capitalised at a rate of an average weighted cost of debt). We further use the estimation of the effective debt to determine the enterprise’s effective capitalisation structure, which we also adjust to upcoming dilution arising from convertible issues, warrants and share-based rewards.

Based on the resultant data, we compute and analyse specific financial ratios and figures, particularly their current and 10- or 20-year average values. Finally, we assess the earning power and sustainability of a given business with the qualitative appraisal, which centres on its nature, inherent risks, strategy, and management. At this stage, we examine information disclosed in financial reports (e.g., 10-K) comprising details regarding the enterprise’s business, operations, and processes (e.g., product, strategy, competition, distribution, logistics). In this assessment, we also consider trends in revenues, operating income, and earnings.

Securities Valuation

We estimate the fair value of a common or preferred stock mainly in reference to (a) the relation of market price to 10-year average adjusted earnings,(i.e., adj. P/E, as per our calculations and models); (b) tangible, cash, or current assets, less total liabilities per share of common stock. We consider all other derived ratios, calculations, data, and business information to determine how liberal we are willing to be in our valuation. We, however, don’t invest in common stocks with the adj. P/E (as per our calculations and models) beyond 20, i.e., we are not willing to accept a 10-year average adj. earnings of less than 5% upon the market price.

When considering senior (e.g., bond) or preferred stock issues, we primarily focus on the safety of the specific issue. The assessment of the safety of the issue likewise centres on financial ratios and factors considered in our general company analysis. However, we place more weight upon • the size of the enterprise and the issue • the terms of the issue • the record of solvency and dividend payments • coverage of annual fixed charges, i.e., the relation of earnings and operating cashflow available for fixed charges to interest requirements • the relation of the value of the company’s property to the funded debt • the relation of the stock capitalisation to the funded debt.