Also, we bought Apple’s stock three years ago, which was quite early. We had very healthy return on that stock and we held Apple for more than two years. I believe that the stock jumped six or seven times from our purchase price.

These are examples of stocks that might not have made it into the portfolio for subjective reasons. The prior experience, the analyst estimates, and the general feelings about them were negative at the time. Our objective process, however, allowed us to identify them early because they met our criteria. Often some of our best holdings with the highest returns have been exactly the companies that investors would have avoided based on emotions or misconceptions. This underscores our confidence in the unemotional ranking system that we use to grade some companies.

Q: What would you do when, after selling a stock, it still doubled and tripled? Also, would you reconsider stocks that you have sold if they meet your criteria later?

A: We don’t really worry about what happens to a stock after we sell it because, usually, we’ve replaced it with a company that ranks higher and more closely fits our criteria. As long as we’ve held the stock at least for a year and, we have made longterm gains, we’re very confident when we finally do replace the stock for a better opportunity.

Of course, we would reconsider stocks in certain cases if they were to screen in our top 30 at the times we are rebalancing. We don’t think that the companies necessarily go straight up year after year. Often they get a bit ahead of themselves, and then flatten out. If they’re the type of companies that keep growing, they may pick up in the following year.

Q: How often do you change or modify your screening process?

A: The original screening process is almost identical to the current one as we have made only minor improvements. We make changes only after we test something over an extended period of time and we know that it significantly improves our process.

We are looking constantly for ways to improve the process, and we run many different tests, scenarios, and stress tests to determine whether a change might add value. So far, in almost every example we’ve looked at, there has not been enough value added to offset the additional risk, the volatility, or the transaction costs involved.

Q: What is your buy and sell discipline?

A: We put the portfolio together from the results of our screening process and we build it with equally-weighted stocks. We may make changes to the portfolio at the end of the year to take tax losses. We would replace stocks if there’s a takeover or significant changes in the company that we bought. We wouldn’t buy companies that are in the process of being acquired or companies for which we know that a takeover is imminent.

Later, when we re-run and re-rank the universe, we look for the stocks with the highest growth opportunity. If a stock screens well again at that point, we will cut it back to an initial position and continue to hold it. But if it doesn’t screen well, we’ll replace it with something that potentially has more upside. So selling stocks is typically the result of finding better ideas.

Q: In the high-growth universe, there is a point when the companies start to miss the earnings expectations. What do you do in those situations?

A: As I said, we would give our holdings at least a year and we wouldn’t be worried if they missed the estimates in a quarter. All the companies, especially the fast-growing companies, occasionally miss expectations, but that doesn’t make them poor companies. If our evaluation of the other characteristics tells us that there is a good chance for the company to be back on track in the next quarter, we’ll remain committed to that company.

More importantly, we have valuation factors embedded in our ranking system. So we invest in companies where the valuation is not too extended and the expectations aren’t too lofty. When executing the trades, we also use technical overlays to limit the risk and make sure that we’re not paying too much even for undervalued companies.

Q: How do you approach the risk control? What type of risk do you monitor and guard against?

A: We believe that our risks are mitigated at the portfolio level by having enough diversification. The equal weight means that no company has an overwhelming effect on the portfolio. Through our process, we tend to find the more healthy companies, so we aren’t too worried about the stock-specific risk.

The sector risk is mitigated through the limit on the number of securities in one industry, which results in maximum industry exposure of approximately 16.5% at cost. We also monitor our holdings for changes, such as takeovers, to make sure that we still own the same companies that we initially purchased.

Q: Generally, the fast-growing companies depend on their product cycle. Do you spend a lot of time in understanding the product cycles or you rely mostly on the financial performance?

A: We look primarily at the financial performance. When we look for positive earnings changes, we may find a company that’s moving from negative to positive earnings, and it doesn’t require a great deal of time to know that they’re well into the product cycle.

Our criteria also include relative strength over different time periods, and we can identify if the relative strength is starting to wane, if it is steady or increasing. So our process tends to eliminate the companies for which the relative strength is becoming a problem. Since we are looking at the earnings two and three years out, if the product cycle is starting to fade at the end, it will be factored in the valuation of the company.