Q:  What’s your investment philosophy?

A: We want to own a select list of businesses that have expanding or growing markets and purchase them when they trade below their intrinsic value. Fundamentally, we look for companies that sell goods and services that over the next three to 10 years will be more relevant in our lives than they are today. We look for a catalyst that can reflect company’s fundamentals in the next one to two years.

We are socially responsible investors. We look for companies that have good corporate governance, strong ethics and reputation, and companies that are good corporate citizens with good environmental records. We think those companies combined with secular tailwinds, reasonable prices, and rigorous research can outperform benchmarks and give investors appropriate returns over time.

I believe that over the long haul the U.S. economy has a tendency to grow 2% to 3% a year when measured after adjusting for inflation which ranges between 2% and 3%. If a company can’t grow its revenues on a nominal basis between 6% and 8% a year, it’s probably not relevant to our society and to investor community in terms of investment return over the long haul. We are looking at what top line growth a business can produce over a 3 to 5 to 10-year period and how that looks versus the long-term economic trends. That helps us determine the stock valuation.

Q:  How does the U.S. economy growth translate into corporate profit growth?

A: We believe that if the goods or services the companies sell are more relevant over time, they should be able to improve margins on higher sales volume. If a company has at least 6% to 8% revenue growth it should translate into an earnings rise of 8% to 10% leading to intrinsic value growth of 8% to 10% a year. We are trying to identify businesses that can increase their intrinsic value at least 10% a year.

Companies in different industries lead to value in different ways. We do long-term 10-year discounted cash flow projections and we sum up what the intrinsic value of a business is. Then we create a 1-year, 3-year and 5-year price target out of that process and determine where the intrinsic value is today and where it can be 3 to 5 years from now. Then, we risk adjust the prospects to determine the upside versus the downside. We are looking for two to one ratio for the upside to downside risk on companies that can generate 10% IRR.

Q:  How is your research process organized?

A: We have a team of six analysts organized by industries. They have a list of companies in their universe which they filter through. We separate the winners and losers and then we have valuation parameters on how the industry is valued, and investigate which companies are valued at a premium and at a discount.

We filter the companies to find out which opportunities look best within their industries in terms of potential discounts, intrinsic values-growth rates and secular tailwinds. Then, we identify the most attractive stocks in those industries based on IRR adjusted for risk.

We typically spend 4 to 8 weeks per investment before it’s included in the portfolio. We talk to managements, customers, competitors, suppliers and industry consultants. We then use a very rigorous 5-step process of going through fundamentals, financials, and management rating. We look for catalysts and, finally, we evaluate the upside and downside risk.

Q:  Could you illustrate your research process with an example?

A: To start with, we believe that there’s tremendous secular growth in energy and the global demand for natural gas and crude continues to rise. So, we wanted to find companies that have the best secular growth dynamic, the best and the lowest cost reserves and the way to turn potential reserves into probable and approved reserves. That led us to invest in companies like XTO Energy, which has the lowest cost reserves and a tremendous pipeline of drilling prospects. Moreover, it has great owner operator management and it was trading at an attractive valuation when we first bought it.

We collected a select list of energy companies like XTO, which can not only generate great earnings today, but can replace reserves at the lowest costs. These companies have management teams that are proven to find more reserves and do prudent acquisitions. Moreover, their owner operators have access to capital. These are companies that have good balance sheets and reserves in politically stable areas and can grow these businesses over the long haul.

Q:  How do you build your portfolio in terms of diversification and sector exposure?

A: We tend to be in the large cap category because of our preference for companies that pay dividend. We don’t overweight an industry more than two times the S&P 500 benchmark and we don’t underweight an industry more than 50% of the S&P benchmark.

I discuss with my analysts what the current news flow in their sector is and what are the secular trends and the different industry dynamics. I also travel and attend most major industry conferences every year. It’s a very interactive research process built on contacts, relationships and rigor.

Q:  Some investors call themselves ‘relative return’ investors, while others are ‘absolute return’ investors. Do you classify yourself into either of these categories?

A: If you don’t beat the S&P 500 over time, you are probably not going to stay in this business very long. We just look at absolute returns. If you buy a really good business with 15% to 20% or higher return on capital, if you buy a company that is going to grow faster than the economy, if you buy a company that you think can hold its margin structure at least flat or grow it over a 5 to 10-year period and if you buy a company with a solid management team, this by nature should help you outperform the market.

Q:  Could you give a historical example of a buy decision you have made using your research process?