Q:  Could you describe your investment philosophy?

A: The key concept in our philosophy is the power of compounding. We have huge respect for compounding because it leads to strong aversion to permanent loss of capital. We’re always looking down first to see how much we can lose before we look up. It is extremely important how well a fund does during downturns, because it may be up 50% in the first year and up 50% in the second year, but if it's down 50% in the third, it will do worse than a constant 8% all the way through that period.

What we try to do is beat the market on a rolling 12 month period and achieve consistency and performance because investors need a systematic low risk approach that protects them in the downturns.

One of our goals is teaching the clients that by protecting them in flat to down markets and matching the ups, they’ll outperform over the long run. Everyone likes to concentrate on their five best ideas and hit home runs, but I believe that you have to protect first and then keep compounding. People don’t understand well enough the importance of compounding and that investing is about discipline, hard work, and thrift. There's nothing glamorous about it.

Q:  What's your strategy for achieving these goals?

A: I believe that we're not paid to take risks, but to minimize them. We are paid to be thrifty, to find superior business models, to monitor and understand them. Our first job is to assess the investment in its entirety. If it’s a company, we do a complete analysis of the balance sheet, the revenues, and the margins. Then we determine what is the risk of being wrong, because we try to avoid 'torpedoes', or high- expectation, high-operation companies that can get hurt on the downside.

We constantly compare businesses against stocks to evaluate how strong the franchise is. We're watching the stock and we’re trying to determine why it is down or up. Is it because of floods of easy money, IPOs in the industry, or are people making irrational global investments? For example, it could be just the excitement over new technology leading to irrational behavior. We determine whether it is a permanent or a temporary situation. If it's temporary, we’re interested.

Ideally, we'd grow the portfolio by buying cheap valuations, large expectations, solid earnings, and growing intrinsic value. The combination of growing intrinsic value together with upward re evaluation gives us a margin of safety and also pays for the risk. Usually, we try to buy the highest quality, highestreturn businesses with strong managements at bargain prices, but bargain prices often come with some negative headlines.

We’re identifying these businesses ahead of time, so when there’s a misperception of the true facts, we’re letting the price determine our movement. If we like the business and the management and can get a cheap enough price, then we’re interested. Typically, when we’re buying issues that are out of favor, the price is stagnant, flat. So we’re more active when the perception is negative and the bullish consensus is low.

Q:  In a sense, you’re always looking for value. Is that correct?

A: Yes. Value is getting more for your money than what you’re paying, so the margin of safety represents buying at a price point that is good value, because then you have less risk on the downside and more upside as well. You’re taking less risk for more reward, which has to be an oxymoron in conventional investing terms.

On March 10th 2000 people felt that tech stocks were low risk because they had done so well, but that was the highest risk time. In August 1982, when the market was trading down under 780, people thought that stocks were highly risky. A lot of this depends on a rational, businesslike, fundamental approach as opposed to keeping your ego up. It’s very important to control the emotions and the ego and to make sure that you’re doing the proper preparation.

Q:  What is your approach to stock selection? You probably aren’t the type of investor who looks at a long monitor list on a day-to-day basis.

A: Investing is a matter of voracious research and there is no easy formula. We look at the micro and the companyspecific factors, but you also have to identify bubbles on a macro basis. I think that you have to be a historian first and study the market's behavior over 200 or 300 years. Behaviors are consistent, whether it is a new technology that’s creating excitement, or a dull, mundane business, like Phillip Morris, which doesn’t go obsolete and is one of the best-performing stocks over a long time period.

You also have to study the behavior of proven wealth builders and investors. Study value investors and get on the right track by finding out who’s done it with his/her own money. We also look at the big picture. Since the mid 80s, half of the globe, India and China, was all of a sudden added to the big picture. You have to factor in that there used to be three TV channels, while now you’ve got over 100.

So we look for businesses that won't go obsolete. Historically, everyday products like beverages, foods, tobaccos, and drugs have been long-term winners and that's what we want to see. Has technology been a long term winner? No, because of the obsolescence factor. Then you have to understand the perils of borrowed money and easy money. We look at which management is really executing at everything.

There’s a lot to be said about the tenacity of doing the day-to day research. We had an exposure to Enron and got out at over $80 mostly because of real research on the entire business. You could recognize that this was a bubble because of the easy money and the deregulation. Historically, deregulation is a bad thing as it attracts a lot of competition.

Q:  Do you think that the housing market is a bubble?

A: Any time there is easy money, you have to be very careful. Whenever there's a lot of capital coming into one area, standards get more relaxed. Banks have been very aggressive, particularly in Southern Californian markets. There is a lot of deregulated creative financing that enables people to buy what they cannot afford. One has to be aware that if lending is really easy, the impact can look like Calpine or Enron.

In other words, if you’re buying based on price movements, not on the income you can extract from the investment, that's a speculation. A bubble or not, people are not buying real estate because of the rental income. They’re just buying the easy zero. If you don’t have to put any money down and have interest-only loans, you can inflate a market.