Q:  What’s your investment philosophy?

A: We follow a three-pronged investment philosophy. The first is a strong balance sheet. The second, high returns and the third is valuation. The firm has been around for more than 30 years practicing the same investment philosophy, so it’s a time-tested method of investing.

Q:  Why do you think these prongs are important?

A: Balance sheets are a cornerstone of what we do. As value investors, we tend to be contrarians in the way we think. We are generally willing to invest in companies where there is operating risk, where there is a problem that we believe to be more temporary than the market believes it is. We are willing to take on that risk if we are not taking on financial risk. So, if there is an operating problem that doesn’t turn around the way you have liked or as quickly as you would like, when there’s a bad balance sheet and financial risk, it could mean game over before there’s time to fix the problem. A rock solid balance sheet takes part of that risk away and the element of time is back in your favor because the companies won’t go out of business any time soon. If we have confidence in what we are doing, and stock prices go down more than they otherwise might, it allows us to buy them at continually more attractive prices without worrying that we have Chapter 11 candidates.

Then, we look at return on assets as a measure of high return. A company has to be in a good competitive position and have a good sustainable competitive advantage to have high returns. The high returns will prove to you that it is in fact a good business.

We are also looking to see that their returns on the capital invested are strong, have a track record of being strong and look like they are sustainable. If they were once strong, and now have temporarily come down for reasons that are definable with a good visible path to returning to good levels, that’s something we are interested in as well.

Q:  What is your definition of a strong balance sheet?

A: When we look at balance sheets we pull a measurement out of the fundamental DuPont formula and we look at assets divided by equity. In effect, it treats all liabilities the same, and it shows how much equity supports each dollar of assets, so it treats, for example, pension liabilities and long term health care liabilities the same as debt. We require that companies generally have an asset to equity ratio of two times or less. That is a very strict criterion, which makes our view of balance sheets generally more conservative than most our competitors.

Part of the risk in small-cap investing is the ability to survive, where a lot of companies flame out. We tend to avoid the flameouts over time because of our requirement of a strong balance sheet. Small-cap growth investing sounds exciting at cocktail parties, and there are always big winners to talk about, but the long-term statistics show that small-cap value investing has better returns over time.

Q:  How do you define the high returns?

A: We generally look for a return on assets of 8% or better. One of the ways you can raise your return on equity is to raise your leverage, but since we are focused on leverage, we are trying to find good performing assets that have high returns without a lot of financial leverage.

Q:  How do you look at the third tenant of your core philosophy - valuation?

A: We are trying to look at intrinsic values and to determine what a businessperson might pay for a company. We look at capitalization rates defined as operating earnings divided by enterprise value. In general, we try to buy companies at 15% capitalization rates. It varies a little from industry to industry, but we set buy and sell targets based on operating income. We are more focused on operating income than we are on earnings per share.

Q:  How would you describe your investment process?

A: Our day-to-day process is very much bottoms-up, stock by stock. We may find a stock in a company we like and it leads us to other investments in the same industry.

Q:  Do you spend a lot of time meeting with the managements of companies?

A: Yes, we are very focused on companies. As a group, we spend a lot of time meeting with the managements. In small-cap land you get really good access to the people that run companies. We sit down with the executives all the time, whereas in the large-cap world you might go to an Analyst Day once a year where the CEO talks about the long-term strategy, but day-to-day, you call the Investment Relations officer to talk about the company.

As a firm, we tend to be significant owners of the stocks we invest in, so we are important to the companies and they like us to be an owner of theirs, because we tend to be relatively long-term owners. We feel we are business partners with the managements, although representing the interest of our shareholders.

Q:  What’s the turnover of the fund?

A: Over time, we’d expect our turnover to be 35%-45% a year. That’s very low. As contrarians we approach everything that we do with a 3 to 5- year time horizon.