Our approach to stock selection is a “bottom up” style. We are concerned with identifying individual businesses that we expect to grow and thrive over many years. We have a rigorous selection procedure that is applied consistently to candidates for purchase. While we look at a myriad of ratios and other financial data, we examine five primary criteria to determine the suitability of a particular company:
Return on Assets and Equity
. We consider only companies that we believe have a unique business position that will produce decisively higher than average returns. Such companies
must have a long history of generating consistently superior returns on assets and equity as a concrete demonstration of the durability of their market advantage. Such high returns must have prevailed for at least five years and, in the vast majority of cases, our candidates have produced such returns for more than ten years. Companies with high returns on assets and equity typically are very strong competitors within their respective industries: so strong, in fact, that they have a sort of protective moat built around their business that shelters them from new competitors. These moats are more commonly known as “sustainable competitive advantages.”
- Financial Strength. Before we consider a stock, we examine its balance sheet, income statement and cash flow statement carefully. We will only buy into a business that is soundly financed. We will not consider companies whose accounting is complicated and difficult to understand. Companies with total debt in excess of total shareholder equity introduce into a portfolio more risk than we are normally willing to assume.
- Dividends. While not a requirement for investment, we generally insist on dividends from our investments. Furthermore, we look for companies who have historically increased their dividends by at least 10% per year.
- Relative Prices. Our final investment objective, that of buying companies at reasonable prices, requires enormous discipline and patience. The best company in the world is a bad investment if you pay too much for it. We thus look for companies that are available at a price that we believe will produce the returns we seek on our common stock investments – those that are selling for both at a discount to our perceived value of the business and at a price multiple below the stock’s historic median. This discipline provides our clients with the margin of error that is so critical to successful long term investing.
In summary, our overriding equity investment objectives are: (1) Identify superior companies, and (2) Buy them at historically low prices. Neither is easy to do. The successful investor manages to do both well. We do not pretend to know what the overall stock market will do over the next several years. However, we are fairly confident that the earnings of the companies we own will be considerably higher five years from now. Stock prices ultimately track underlying earnings. We will be rewarded for our patience.