Currently, earnings are growing as the company has anniversaried the change in its sales model and the new products have gained traction in the market. Revenue growth has also accelerated to high single digits from the previous low single digits. The company has several promising growth opportunities in both new product areas and international markets. The balance sheet is healthy and the company has a very good history of investment returns and strong management.

The current year earnings estimates are for $3.20, and the stock is in the high $60’s. It doesn’t appear to be particularly cheap on that basis, but we believe, with all the opportunities the company has, that in three to five years the normalized annual earnings could approach $5, which does make it quite appealing. Moreover, since clinical lab testing is not linked to the vagaries of economic cycles, the stock would be attractive even during tough macro economic situations.

Q:  How do you build your portfolio? What is the benchmark against which you are measured?

A: We construct the portfolio from the bottom up. We do not make any fixed allocation to specific sectors. We are also not bound by companies’ market caps as long as there is sufficient liquidity in the stock. We take each case on its merits.

Similarly, we do not manage the portfolio to be weighted like any index. We are, however, conscious of market weights and we do not significantly overweight or underweight any sectors unless we have good reason. We believe, in the long term, the S&P 500 is the benchmark against which we are measured.

The portfolio is well diversified. We own around 60 stocks in 25 main industry groups.

Q:  What is your buy and sell discipline?

A: It is not easy to find companies that meet all of our criteria. We normally avoid companies we believe are in a secular decline. We do not invest in any company that, by our analysis, cannot grow earnings for at least two years. Reasonable valuation on normalized earnings is vital. The companies we invest in are not necessarily cheap on current earnings because the earnings are depressed. What is a key to us is that they fix their problems and they get back to a normal or a higher earnings level in three to five years. If we believe they can do that, and valuation is reasonable for that earnings level, then we will invest in the company and expect that the market will reward it at that time. We are not a deep value strategy where we think if something looks very cheap on its assets, we will invest in it. Rather, we believe that earnings growth is the catalyst needed to unlock undervalued assets.

One reason we sell is that a company fixes its problems and achieves a few years of earnings growth and performs well. Even though we may still like the company, at this point it is no longer representative of our strategy so we sell and reinvest the proceeds in a company that is currently having problems.

Another reason to sell is that the original problem cannot be fixed and causes continued earnings decline. Our research may have led us to believe it was a temporary phenomenon but if it turns out to be otherwise, we will sell the stock. We will also sell if significant new problems crop up that we did not foresee.

Q:  What kinds of risks do you monitor and what do you do to mitigate them?

A: We think our investment strategy is innately risk averse. Our focus is on companies and industries that are having difficulties. Usually the stocks have suffered so a lot of the risk has already been sucked out. That explains why we didn’t buy the internet companies when they were all doing great and selling at very high valuations. We did not buy the housing stocks in the last several years when they were soaring. We are only now starting to look at that area, where many of the stocks have fallen 60% to 70%. Furthermore, we typically monitor companies for several quarters or even years before investing in an attempt to ensure that the problems have been fixed. In essence, the strategy that we use limits our risk, augmented by our research and diversification.