Q:  What is the investment philosophy of your fund?

A: As a manager we look for stocks trading at bargain to the value of its business. I believe that investing in companies that sell at a discount to intrinsic value will produce exceptional long-term returns over a market cycle. We believe that value can be found in all sectors of the market, so we are looking where our competitors in the value space may not traditionally look in trying to find positive potential that is undiscovered. As a fund manager we pay attention to the price we pay for the company’s earnings and cash flow growth.

Q:  How do you define intrinsic value?

A: We look at value from several dimensions, including discounted cash flow, stock price to earnings ratios and traditional valuation metrics, breakup valuation or liquidation valuation, to find undervalued stocks with good potential. Some industries and sectors are influenced more by certain valuation parameters than others. For example, when valuing financials, the weight we give to certain parameters would be different from the weight that we’d use for the telecom and media space.

Q:  What are the key elements of your investment process?

A: The first step is to figure out what a company is worth, or what its intrinsic value is, and then compare that to the current stock price. We want to know what the market is discounting while keeping its expectations in mind. We look for stocks that are undervalued and have low market expectations. When expectations are low, people aren’t looking for the next positive catalyst.

We also spend a lot of time considering the downside scenario. We have a healthy respect for the fact that we might not always pick the exact bottom. There is always a chance that there is still downside left when buying a turnaround candidate or a contrarian idea.

When we have figured out intrinsic value, current expectations and possible downside, we then have a good idea about the potential risk and reward. We want to have an upside of at least 25% from today’s price and we want a downside of 10% or less. Through our calculations we aim at purchasing a stock during the time a downside scenario occurs.

Q:  How is your research process organized?

A: We are fortunate enough to have a very experienced team. I’m head of the Value Group, Jim Carroll has about 30 years of experience, and Art Barry has been in the business for about 12 years. We complement each other and value each other’s opinions.

We have an entirely bottom-up approach and look for individual stocks that are underappreciated by the market. Our portfolio is constructed one stock at a time and the weightings are dictated by where we’re finding good value opportunities. Areas where we might find a lot of interesting ideas are likely to be an industry or a sector that we’ll overweight versus the benchmark. Areas where we do not find a lot of ideas, we’re likely to underweight.

We understand the impact the economic environment can have on industries and companies but we try not to predict what the top-down factors may bring. Fundamental analysis is of primary importance for us and we work with a number of senior equity analysts. It’s a process in which we attempt to identify a company’s worth and try to project its earnings and cash flows into the future.

We like to see strong cash flow from companies. If a company is in the bottom of its cycle but has good cash flow, even if it’s not reflected in earnings, we believe that a good management team will eventually put that cash flow to work profitably and in time improve the rate of return.

Q:  Do you find the meetings with managements valuable?

A: Yes, we find them very valuable. I’ve never found meetings to be a disadvantage because they usually lead to a more qualitative understanding of a management team that is not readily available otherwise.

We try to determine if a management team has a good grasp of its business and a good vision for the future. Our findings eventually help us make a decision about the long-term potential of the company. However, it is the case now that many management teams can no longer disclose as much as they did previously.

I’ve been in this business for 24 years and I feel that over the years the investing time horizon has compressed. I call it the ‘hedge fund impact’, which means that there is an increasing short-term mentality on the part of investors who are playing the next quarter’s earnings numbers. This mentality drives stock prices to extremes in the short term and is a great benefit to us as value managers with a reasonably longer time horizon. Although we value companies on a two to three-year horizon, it is very rare that we have to wait two to three years for the value to be recognized. When we’re buying stocks with lower expectations, people aren’t expecting a positive event, and we use a lot of the volatility in individual names that the shorter-term mentality creates.

Q:  Can you give us some examples of ideas that turned into holdings through your research process?

A: One name that has been played out in the press quite dramatically is Microsoft. If you look at Microsoft on any valuation metric, it looks cheap relative to its history. But does it have an absolute low P/ E relative to the marketplace? No. When we bought the stock, it sold at a slight discount to the market multiple, but relative to its history, it was quite depressed, and relative to its earnings potential it looked very attractive. So we bought Microsoft on the bad news and the positive developments surprised everybody.

That is a good example of looking for value in every sector, including sectors that traditional value managers may overlook. We valued the company at a fairly decent upside to where we bought it. We felt that expectations were very low and the downside at that price was very manageable and very little, as the earnings and the cash flow generated over time were substantial.