Our approach to investment is benchmark agnostic, targeting annual absolute returns of inflation +10% over a 5 year+ time frame. To support this style, the managers undertake deep bottom-up fundamental research – executing a Private Equity style of due diligence, which evaluates each holding as if they were acquiring the whole business. The emphasis of this due diligence is on business and management quality and risk assessment.
A rigorous process for identifying undervalued companies
We start with a proprietary quantitative screening system to build up a short-list of potential investments. We then undertake detailed forensic analysis on short-listed investment candidates, reading multiple years of accounts, broker reports and web-based research. We use our network within different industries to get further background on the competitive dynamics of each sector.
When we are comfortable with the investment opportunity, we interact with the management team either directly with small cap companies or through analyst briefings and conference calls. We look to satisfy ourselves that they are smart, understand their business and are making decisions which are in the best long-term interests of the shareholders; we are particularly interested in their approach to investing surplus shareholder funds. We treat these interactions as an opportunity to undertake commercial due diligence, testing hard any scenarios under which the business could suffer a significant or sudden reduction in profitability or cash generation.
A disciplined approach to price – in buying and selling
When we value businesses, we make conservative (pessimistic) assumptions about profit growth or decline over the next few years and very rarely assume a long-term growth that is greater than the long term growth in GDP; in the majority of investment valuations, we assume no long-term growth at all. We set a price which is at a significant discount to our intrinsic value (which gives us our Margin of Safety) and are disciplined to wait for market fluctuations to deliver us the investment opportunity at the discounted price we have set.
We follow our investments closely, interacting with Management regularly and in particular around the time of major announcements. If we believe that the fundamentals of our investment thesis have changed, we are not afraid to close out a position at a loss.
We will hold the stocks until the market addresses the price anomaly and the share price increases close to our intrinsic value. We believe that the market is often wrong in the short-term but ultimately is right in the long-term, as it tracks companies’ cash generation. We look to take advantage of this short-term frailty and are patient for the long-term recognition of value.