A Balance between
Concentration and Diversification
While we adhere to the benefits of diversification, we believe
that an overly diversified portfolio by definition leads to
average returns as outstanding investments are diluted by
mediocre investments. The vast majority of academic research
demonstrates that the benefits of diversifying beyond 15 -
30 holdings are relatively negligible. Investing
in more serves to limit the value of insightful analysis. Just
as important, we believe that a portfolio manager can at best
follow thirty companies diligently; beyond that, warning
signs and opportunities may go unheeded. Consequently, we
construct our portfolio with 15 - 30 companies.
Superior performance lies in a portfolio
of diligently analyzed holdings.
A Long-Term Time Horizon
A long-term horizon, we suggest at
minimum five years, enhances a client’s overall probability of
achieving investment success. First, holding an investment
for a period of years allows for tax-deferred compounding and
lower capital gains tax treatment. While the benefits of
lower capital gains tax treatment are readily understood, few
impart the significance to tax deferred compounding that it
deserves. Second, time increases the probability of realizing
absolute positive returns. Historically, an investor with a
one year holding period has experienced returns ranging from
over +/- 50%; yet over twenty year holding periods, investors
have experienced only positive returns. While history cannot
guarantee future results, history does suggest that time is on
an investor`s side. Finally, a long-term horizon also allows
investors to focus on companies strategically positioned to
generate outsized returns .
Outstanding
Companies Purchased at a Reasonable Price
Our philosophy of investing for the
long-term in a sensibly diversified portfolio necessitates
that we identify outstanding companies. We look for companies
in industries that are experiencing tailwinds, not headwinds.
To paraphrase the legendary Warren Buffett, when a manager
with a sterling reputation attempts a turnaround in a
difficult industry, it is usually the industry`s reputation
that remains intact. Superior companies will often
generate strong fundamentals: a high return on invested
capital, positive economic value added and free cash flow,
growing earnings per share, and a solid balance sheet.
Critically, such companies will have strong management teams
with a focused strategy to increase shareholder wealth and
high standards of corporate governance. Finally, when such
companies are identified it is imperative to pay a reasonable
price.
Define Risk as
Enduring Loss To Generate Earnings
Too often fear and greed dominate
investors` emotions. The founding father of security
analysis, Ben Graham, created "Mr. Market" as an eloquent
analogy for our instruction. You and Mr. Market are co-owners
of a business. Unfortunately, Mr. Market suffers from
manic-depression. Invariably, Mr. Market`s mood swings
permeate his business judgment. On days of euphoria when he
believes that the company`s prospects are unlimited, he offers
to buy your interest at vastly inflated prices. On days
of depression when he believes that the company`s prospects
are negligible, he offers to sell his interest at
vastly discounted prices. Nevertheless, everyday he comes into
your office and offers you a price. Immeasurably important is
that you are not influenced by "Mr. Market`s"
manic-depression.
Our task is to identify the long-term
value of the business without volatile emotions. By so doing,
we are then able to determine when to take advantage of Mr.
Market`s mood swings. We sell not because Mr. Market
offers us a lower price for our business, but rather because
Mr. Market offers a price we cannot justify based on our
prospects. To do so however, we must understand the long-term
earning potential of our company.
Conclusion
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