The individual analysts put together a standardized report that identifies the investment thesis, the time frame that they think the investment idea will take to generate return, a price target with the annualized return and the risks we are incurring.

At that point the individual analysis presents the idea to our research group. The discussion after the presentation within the research group will decide the investment merits of the idea. The approved investment idea is added to the buy list and a portfolio manager will use this list to build a portfolio meeting our portfolio guidelines. We are trying to build a portfolio that meets our risk and diversification criteria.

Q:  Could you give an example to illustrate how an idea has turned into a holding?

A: We own Chiquita Brands (CQB), the banana company. When we initially looked at it, the street was pessimistic about Chiquita’s prospects. The company’s problems were well publicized concerning tariffs in the EU, but the banana sales and margins were healthy in the U.S. We analyzed the nature of the tariffs and what we though the impact on earnings would be using what we felt would be conservative assumptions. The end result was still a healthy, profitable business that we felt the stock price wasn’t properly reflecting.

We decided that the company has brand recognition in the market and has the potential to generate and grow earnings. Chiquita is an extraordinarily well recognized brand. They have been able to maintain premium pricing in Europe during a period of oversupply over the last year. The market became saturated with new entrants who weren’t subject to the tarrifs and who tried to take advantage of what they felt would be an opportunity to gain share. This caused, predictably, a poor pricing environment. Many of the new entrants have now been flushed out, and the market is returning to health.

The other temporary problem in the industry was related to E-Coli bacteria in spinach. While none of Chiquita’s products were directly affected or contaminated, the overall effect on the bagged salad segment was negative as consumers simply stopped buying what they felt was a high risk product. The stock reacted poorly to this. We talked to management several times about whether they thought this was temporary or permanent problem and what they could do about it. And we concluded that this was a temporary problem. We decided that the trends on convenience and health are both things that people want in their food choices and pre-packaged salads are a big part of that. Chiquita is also doing innovative things with packaging for bananas to extend shelf life and packaging of fewer quantities and selling individual bananas for people who just want to buy one banana at lunch.

The company has a high debt load and we were aware of that. We liked the company’s plan to sell and lease back its fleet of refrigerated trucks and use proceeds to reduce leverage on the balance sheet.

While I don’t think S&P would consider Chiquita to be high quality, we do because of the combination of a strong brand and an innovative management team that is aware of the company’s problems and dealing with them in a realistic and responsible fashion.

Q:  How do you go about portfolio construction?

A: We hold between forty and sixty stocks in the portfolio at any given time. Right now we are holding 56 stocks and we will always try to stay close to 60 stocks for purposes of diversification and portfolio structure. We want a well balanced portfolio in which the biggest positions will be generally between 1.5% and 2.5%. We will occasionally let something get bigger than that if we have a very high conviction in an idea and we see a limited downside. We don’t go straight to 1.5% but we build a position over time knowing that our timing isn’t going to be perfect.

We try not to have too much concentration in the top ten names and we invest with an awareness of the index but we certainly are not trying to mirror the index in any way. Our awareness of the index is simply designed to make intelligent decisions about the sector weighting relative to the benchmark.

Q:  What kinds of risk do you monitor?

A: A big part of value investing is trying to minimize the downside. Why value investing works over time is not because you have high flyers that work better than growth investors during the good times but because your strategy is designed to give more downside protection and do better during times when the market has gone sideways.

We have invested in a company with a problem and we hope they can fix it but what if we are wrong? So we have taken into account the trade-off between what the possible reward is and what is the risk. We have analyzed ideas with tremendous upside that we haven’t bought because they also had tremendous downside risk, and that’s not an acceptable trade-off to us. The performance of any portfolio is determined as much, if not more, by the losers as by the winners.

Q:  How do you control risk?

A: We control risk in three ways. First, through our philosophy and research process, we are buying stocks that we deem to be inexpensive. We are concentrating on what we feel is high quality and sustainable businesses with higher return than industry peers and we are trying to focus on what’s the downside risk.

Second, we are trying to maintain a diversified portfolio, equally weighted among several stocks so that no one stock holding can affect the performance to an extreme degree.

Third, when a stock is down a certain percentage from our average price, we will sell it. It is a mechanical rule but it is one that has worked for us. This is a risk control measure that is really designed for extreme situations, and it does not come into practice very often.

The opinions expressed herein are provided for informational purposes only and should not be used or considered as an offer to sell, buy or subscribe to other financial instruments. Opinions contained herein reflect a judgment as of the day of publication and are subject to change.