Q:  What is your investment philosophy?

A: We believe that by building a portfolio of stocks that are trading at a discount to the market we will generate better performance over the longer term with less risk.

We believe that a focus on controlling and minimizing risk is a big part of maximizing performance. While we want a company to be inexpensive we also want to buy the highest quality companies that we can find that fit within our valuation discipline. By high quality I mean companies with sustainable businesses that generate high returns on capital by way of superior management, products, brands, business models or operational excellence. Quality is not just a function of a clean balance sheet, although we like that too.

Q:  How is your research process organized?

A: We utilize a three stage process in the building of our portfolio. The first step is a screening process where we identify companies that fit our portfolios discipline on valuation and market cap. Next, through fundamental, qualitative research, we cull down the pre-screened candidates to a much shorter list of companies that we feel represent high quality businesses selling at discounted prices. We oftentimes analyze situations where a company that we feel is high quality has a temporary problem. At that point our investment process focuses on analyzing exactly what is the nature of the problem and how long it is likely to persist. The companies where we feel that the problems are temporary and fixable we then look at more closely.

We first talk to the management team. If they are not honest with themselves about what exactly the problem is, that’s a big red flag and we stay away from these companies. The management must have a good handle on the problem and a vision on how they are going to solve it. It is very important that they can assess the problems and their skills in solving them, and also to be brutally honest about the challenges they face in solving these problems. Then we try to determine the time the company will take to recover from the problem and how long it will take investors to realize this.

Our interest in companies with problems does not extend to companies that are on the edge of bankruptcy or in highly distressed types of situations. We feel that would expose our clients to a higher level of risk than is warranted. We are trying to build a portfolio of good businesses and also generate superior risk adjusted performance.

Q:  Do you measure yourself against a particular benchmark?

A: We produce a fair amount of research internally starting with a screening process that defines our universe of stocks we can invest in. We use the Russell 2000 Value Index as a universe of stocks to select from. Although we have a significant awareness of what is in the benchmark, we don’t restrict ourselves only to stocks in the benchmark.

Q:  Could you highlight your screening process?

A: We use the parameters of the index, not simply the holdings of the index but the parameters in terms of market cap, and the size of the companies to define the universe. We could buy companies that for one reason or another have not been included in the index but still show up on our screens as making sense from the valuation and quality perspective.

We use quantitative screens where we look at valuation from several points of view. Price to earnings and price to cash flow are two measures of valuations that we look in the preliminary evaluation. The valuation measures we apply to determine if something is inexpensive enough are going to vary depending upon the company and the industry. We are looking for at least a 20% discount to the market multiple to initiate a position.

Another consideration which could prevent a company from including in the portfolio is liquidity. We don’t get into stocks that are smaller than $300 million in market cap simply because liquidity starts to be an issue at that point.

Q:  What are the criteria you follow to identify a quality company?

A: Quality can mean a lot of different things. We allow ourselves to use a little more judgment and we are going to be dealing with companies that are not necessarily perfect all the time but that doesn’t mean that they are not high quality. It just means that they are going through some phase that has caused them to be inexpensive and those are the kind of opportunities that we try to get involved in.

We are looking for business sustainability and look for answers to questions such as does the business add value in a way that their competitors do not? Is there something special about it that will lead to a higher return on capital, higher margins or higher growth rate? What are their competitors doing? Do they have pricing power with their products?

Then, we are looking at the quality of the management team. What is their track record? What have they done in the past and what are they saying about the problem the company is facing?

Q:  What is the structure of your research team?

A: We have a team of analysts who deal with different sectors and industries. We have a smaller, three-person team that handles the portfolio decisions. I am the lead portfolio manager and we have two other portfolio managers whose names are Brad Ohlmuller and Robert Milmore. The three of us make decisions on a consensus basis about what goes in and out of this portfolio. If we have difference of opinion, I do have power of veto but we prefer to arrive to consensus.

All of us function as analysts including myself but we identify things that fit initially within our conceptual framework. Then we look into the qualitative factors. We analyze the business and the industry, we take a look at their competitors and suppliers, we try to get a full scope of the business environment and company capabilities. If the company doesn’t pass the test of business quality and sustainability, then we do not continue further.