We are mostly long-term value investors: we look for great companies selling at good prices that we can own for a long time. As such, we search the world constantly for such companies, frequently going for extended periods without finding any value (See Our Approach to Investing).
We hold cash if we cannot find good values; we do not feel any need to be fully invested at all times. (See Investment Tactics.) We are absolute investors. We are not aiming simply to outperform a benchmark, or do as well as other managers; we want to give clients absolute returns, which means finding absolute values. Being based in Annapolis, we are able to retain our independence and avoid Wall Street fashions.
What we look for
We spend time on candidates, frequently waiting to meet management before buying. We use fundamental tools: the financial measures (particularly the balance sheet, debt, margins, and free cash flow); and management and its reputation. This means asking others involved in the same sector or same geographic region. And, of course, we want to have a positive outlook on the industry.
Most of our purchases are made as long-term holdings, though we also trade part of accounts, more for aggressive clients, of course. (See Our Approach to Investing) This may involve "story" stocks (such as mining exploration companies) or short-term situations (quality companies whose stock is depressed suddenly), or trades around our core positions. If the stock of a top holding drops, then we may buy more for clients, as a temporary trade around our core position. (See Investment Tactics.)
Is the price right?
And after all this, after we have decided we like a sector and a particular company, we look at the price: is it a good value today?
We look at a lot, and we dismiss most candidates immediately, whether because of the quality of the company or the price. Most that meet the quality test are not trading at good prices, and, of course, we watch these continually for a time when the price is right.
But it can happen that one can find a top-quality company at an attractive price:
- the stock may be down temporarily for a specific reason (such as the sharp decline in the price of HSBC Holdings when it acquired Household Finance, a move on which most analysts at the time were negative);
- the market or the sector may be out of favor (such as a decline in the price of gold dragging down the gold stocks)
- a company may be illiquid, small or mundane, and the stock undervalued for an extended period (such as with some family-controlled European holding companies); we don't mind waiting if we are buying the proverbial dollar's worth of good assets for 50 cents.
The buying begins
We then decide on price, both the maximum price we are willing to pay in the current circumstances, as well as the best price at which we might be able to buy. We then decide for which clients we wish to buy; we do not necessarily buy for all clients at one time, but rather buy incrementally, considering not only client objectives, but also other criteria: new clients without any exposure to a sector might come first, as would larger accounts with lots of cash, or clients for whom a company is particularly suited.
The number of different stocks held in an account depends mostly on the size of the account. A $100,000 gold account, for example (our minimum account size) might hold 12 different stocks. A diversified account of $1 million, for example, might hold as many as 50 different securities at various times.
If appropriate, we will also seek to "go long" the stock through the sale of puts. This will be determined not only by a client's account parameters, but also the premiums available on the puts and our willingness to miss owning the stock should it move up. (See Investment Tactics.)
We operate a parallel system to our custodians, with multiple checks that trades have been executed and booked correctly.
Why we are buying
Before buying, we consider the place of a particular company in portfolios, what is expected and factors that would cause concern, as well as an anticipated holding period. Generally, we look for a potential holding period of three to five years, though of course this can change with changes in circumstances and performance. If we are buying as a long-term core holding we are not concerned by short-term price volatility and less keen to sell on any rally or worried at a decline. Typically, these are better quality companies with less sensitivity to the economy and frequently a good yield.
We monitor continuously company fundamentals and stock price, particularly the key criteria established early on. For our long-term holdings, we are very patient if the company remains on track even if the stock remains undervalued.
We can be quick to sell
If we are buying as a trade, for a specific development, perhaps, or a stock that is particularly oversold for a temporary reason, then we will be quicker to sell on a good rally, and be more concerned at price declines.
(See Our Approach to Investing)
For a trade, particularly a stock in a volatile sector or market, price may be a key consideration, sometimes selling just part of a position to lock in a profit and reduce the purchase price.
If a company fails to fulfill its objectives, we are usually quick to sell. Certainly, if a company changes its focus, we do not change our objectives to match.
We may also sell a company if we have a need for cash for a better buy, either because it is a laggard in a strong sector or it has reached its full value. This might happen more frequently within a particular sector; we might, for example, sell a gold exploration stock to buy another one with better prospects if our allocation to that sector is full.
Different ways to sell
When we decide to sell, we may simply sell the stock outright, or we could sell only a partial position (particularly of very volatile stocks, in order to lock in some profits while retaining some exposure), or sell calls against the stock (if the stock is fully valued but we still like the company and the premiums on calls are good), or use trailing stops (to protect profits in a strong market).
As discretionary managers, we are not constantly calling clients, though we are always ready and happy to hear from clients with any concerns or questions. The independent custodian mails monthly statements and we send quarterly investment reports.
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