Q:  What is your investment philosophy?

A: Research shows that it is very difficult to beat the market, but there is one area that over time has done that. That is investing in temporarily broken growth companies. The market tends to discount those at an extreme level and we tr y to capitalize on that emotion and opportunity.

We therefore look into any company, from any industry that has had fundamental difficulties in its business resulting in declining year-over-year earnings. If we believe the company has since fixed these problems and is likely to resume long-term earnings growth, and valuation is reasonable, we invest.

Q:  How does this investment philosophy translate into an investment strategy?

A: Our investment approach is very bottoms up. We follow two cardinal rules: understand the long-term growth potential of the companies and pay attention to valuation. Our primary valuation measure is analysis of normalized earnings. We tr y to look past currently depressed earnings and determine what we think the company could earn in a few years when its problems are fixed. We believe that in the long term, earnings growth is the most important driver of stock performance.

Our ideal investment candidate would be a good company having problems that we believe are temporary. It is otherwise a leader, with a solid market share in a growing industry and where we see a clear path to returning earnings growth. The other criteria are a good balance sheet, stable or growing free cash flow, sustained returns on capital and a good management team.

We run screens to identify companies that are having declining earnings. We analyze these to find the best candidates and then we monitor these companies to determine whether or not we believe the problems are fixed and earnings growth will resume.

Overall, we believe the investment business is both an art and science but in the end it comes down to our estimate of intrinsic value. The science is in the financial statistics and the art is that people reach different conclusions when looking at the same valuation parameters and business characteristics. Consequently, we would pay more for some companies than for others. For example certain companies may be growing rapidly but we might not pay a lot for them because we don’t believe their growth rate is sustainable. It’s not a hard science.

Q:  How is your research process organized?

A: We have a research team of three analysts - James England, Jim O’Connor and Larr y Cordisco. I meet with them daily and we pool our inputs. The day-to-day research on all the companies is carried out by the research team.

We always talk to management before we invest in a company. We also peruse their financial statements, attend investment conferences and listen to conference calls. We occasionally look at broker research but we heavily research the companies ourselves.

Q:  How do you gain the expertise to evaluate different companies from different sectors?

A: The members of our research team are all generalists, but over time people have gravitated to certain areas of expertise. Moreover, most of these companies have problems that fit into a few specific patterns, and this carries across all industries. Problems typically arise from general economic conditions, industry-specific conditions or company-specific difficulties.

For instance, in the case of macro events such as a recession most companies will face tough times. Sometimes it is industry-specific as in the case of the paper industry where business conditions are tough in North America and Europe as people continue to cut paper use.

Company-specific problems can be due to any number of reasons. It can be the result of poor management, problems with an acquisition, distraction due to pursuing areas other than core business, a missed product cycle, or overly aggressive growth leading to lack of control.

In most cases one need not be an industry expert to figure out the problems and understand if the company can overcome them. When we need more in-depth industry information we can access broker research and talk to other companies in the industry. We also find that sometimes too much detailed industry knowledge can obscure the forest for the trees.

Q:  Can you give some examples of companies or industries under your radar that you are still monitoring?

A: The entire housing and related industries are currently having significant problems that are going to persist for some time. We are monitoring many interesting companies in that area that display the long term characteristics we are looking for and at some point we will make investments in that area. We are not ready to go there yet.

Q:  Can you give a couple of specific examples of your portfolio holdings?

A: One of our larger holdings is Beckman Coulter. It is a leading provider of clinical lab testing equipment and consumables. Earnings declined because it changed its sales model on some of its expensive systems from a sales to a lease model. Beckman was also updating its product line and associated spending on R&D and marketing had impacted earnings. Our research concluded that the earnings weakness was temporary.