A: We have about 56 companies in the portfolio now, and generally between 50 and 60 names. We feel we can find those companies here in the U.S. without having to expose ourselves to any risk of investing in international markets.

We don't buy highly leveraged companies. Financial flexibility is very important to us. We don't buy concept issues. Our companies have to have real earnings and proven business models. And we don't buy turnarounds. Our feeling is that if a company has turned around and is back on a growth path we are happy to invest in it but we will wait until they are back on that growth path. We will not abandon our discipline or process to capitulate to transient market themes.

Q: Once you are through that screening process, how do you do your fundamental research?

A: Our fundamental research includes reviewing the company information. We talk with management and we use sellside research for information, because they have teams of people that are doing detailed work such as, channel checks. We do keep our own counsel, though, when it comes to determining when to buy and sell. We don't use sellside recommendations for that. The emphasis for us is traditional hands-on research which allows us to thoroughly understand a company's competitive advantage and their long-term growth potential.

Once we are through the fundamental research, we have a proprietary valuation model that ranks stocks in our universe on performance potential.

We also do a technical review. We look at long-term and short-term charts. These technical and valuation overrides also aid in avoiding significant downside risk in that we are not buying something that's on a valuation basis too expensive, nor are we buying something that on a chart, on a technical basis, looks like it's overextended or conversely looks like it's breaking down.

When we use technical charts, we are looking at longer term three and fiveyear charts, and in some cases 10-year charts. We are looking for companies that have a nice steady uptrend. We do want all of our companies to fit in with our longer term economic and investment outlook.

Q: Could you describe your sell discipline?

A: There are lots of reasons to trim a stock √ when the stock becomes overvalued, extended on a technical basis or becomes a large part of overall percentage of the portfolio. The only reason to sell a stock completely out of the portfolio is because there's a change in the long-term outlook, fundamentals of the company or the industry.

Q: How do you identify a longterm change versus a short-term change?

A: A few things go into play there. One of them certainly is judgment, being around long enough to see some of the signals in the market. I do think you get some warning early on from the technical indicators. So when you see a sustained break in a long-term uptrend in a stock price chart that can be a signal that something is fundamentally changing. If we saw something like that, we would trim the position immediately to reduce risk. And then we would go back and try to identify whether or not it's a longer-term fundamental change or just short-term psychology.

Q: Could you illustrate your selection process with an example?

A: We added LKQ about a year ago. They are an after-market auto parts recycler. The management had experience in running Waste Management and were looking for businesses with similar characteristics. So they put some of their capital that they made with Waste Management to work in acquiring salvage yards across the country, which primarily were junk yard operations. Recently they acquired Keystone, which does generictype manufacturing because what they found was they were losing some of their business to generic manufacturer. Customers did not want to buy recycled parts; they'd spend a little more and get a new part, albeit generic. On that management move the stock has been up about 80% in the last one year.

The thinking behind picking this company was that it is in a heavily fragmented industry and in an area that the returns on capital are very attractive with huge barriers to entry in that fragmented industry. LKQ is already a leader in the field and it would be very difficult to try to replicate what they have done.

Q: How do you mitigate risk?

A: One of the ways that we try to mitigate risk is by continually trimming names. We usually take a 1% to 1.5% position in a stock. We let that position grow to 3% to 3.5% and when it gets that large we're taking profits and trimming our position.

We have no more than 60 stocks, and if our holding period on an average is between four to five years or longer, we are not really looking for more than 10 new ideas every year. We are only bringing our very best new names to the table every year.

Q: How important is diversification for you?

A: We are big believers in diversification. We never have more than 15% in any one industry. We don't hold more than 5% in any individual stock. Once a name gets to 3.5% in the portfolio, we are trimming it back.

In our sell discipline we trim names that get overextended on a technical basis, that become overvalued or that become a larger percent of the portfolio. We do not try to minimize tracking error.