- We begin with the Value Line Index and apply screens that help us identify companies with established business models, strong balance sheets and long track records of producing high returns on invested capital.
- We attempt to determine if these companies are experiencing short-term headwinds that are cyclical and not secular, potentially offering an attractive entry price. Is the company’s business model and financials easily understandable?
- Companies on our watch list are a collection of high-quality companies suitable for long-term investment.
Determining Appropriate Entry Price
- Determining the fair value of a company on our watch list is a qualitative process, which includes assessing the risk of an investment and the corresponding potential realization of projected cash flows.
- We will buy or add to a portfolio position when the price is at an appropriate discount to our estimate of fair value.
- We will trim or sell a portfolio position as its price approaches/exceeds our estimate of fair value.
- Assess and Monitor Fair Value: We seek to initiate positions at a significant discount to our determination of fair value, focusing on absolute returns vs. relative valuation.
- Risk control: We define “risk” as the probability of the permanent loss of capital—not price volatility. As a result, we believe in concentrating our portfolio in the most attractive investment ideas. Targeting 15 to 30 holdings permits for what we believe is ample diversification.
- Cash: Our patient approach to portfolio construction often necessitates we hold cash. In our mind, this is not ideal, as our goal is a fully-invested portfolio comprised of well-managed operating companies that trade at significant discounts to their fair value. However, as entry price is a key determinant of return, we wait for special opportunities.
- Price Appreciation: Ideally, we will trim or sell a security when price reaches our conservative appraisal of fair value.
- Superior Risk/Reward Elsewhere: We may sell a position and replace it with another if we believe we can improve the Fund’s risk/return profile substantially.
- Eroding Fundamentals: We may exit a position if we believe the future earnings power of the company is impaired by competitive threats, balance sheet deterioration, or poor capital allocation.
- Loss of Confidence in Management: We sell when we no longer believe management can build shareholder value and we believe that efforts to find new corporate leadership would be unsuccessful or too costly.
Equities purchased at prices substantially less than their intrinsic worth may limit the effects of drawdowns and may also appreciate substantially once the market recognizes the company’s economic value.
We typically will initiate or add to a position when the company’s market price trades at a discount to our estimate of intrinsic value. We estimate intrinsic value by studying and analyzing information from a variety of sources including financial statements, speaking with corporate management, analyzing regulatory information, or reading trade publications, as well as other industry and corporate journals.
We may assess the company’s liquidation value based on the current economic worth of assets and liabilities or we may determine the company’s ongoing value based on its ability to generate free cash flow after required capital expenditures and working capital needs. We calculate the present value of the projected free cash flows plus a terminal value, using a conservative discount rate. Our analysis should represent the price that rational, independent buyers and sellers would negotiate in a private transaction.