Visibility vs. Vision
Our investment approach ensures that our long-term strategic vision for a company is in line with the first two pillars of our investment philosophy of a strong financial position and the ability to grow. Valuation, the third pillar, where we buy only where we see 30% or more upside to our assessed fair value (AFV) is important, but set only once the first two pillars are met. We first ask ourselves does the company have a long-term plan that makes sense? Would we do anything dramatically different if we were in charge? Or stated another way, is our vision for the company’s strategic direction over the next three to five years in line with management? If not, and management is eroding value with mis-aligned strategies and poor capital allocation decisions, we will not invest.
Once aligned with the longer-term vision for a company to create value, we then analyze whether the company has the resources to execute its strategies, including the ability to absorb the inevitable bumps that will surface along the way. We start our financial analysis with the Balance Sheet, ensuring that the company has the financial wherewithal to invest as necessary, without comprising the capital structure of the company by adding too much debt or expensive external equity financing. We want our management teams focused on executing their strategic vision, not fighting short-term financing issues.
We continually track progress against strategic vision by analyzing quarterly earnings reports, presentations, peer company actions and broader market developments. This consistent, diligent monitoring of business trends stands contrast to short-term focused hedge funds and quantitative trading strategies that focus almost entirely on how the most recent snippets of information, such as Earnings Per Share and Revenue growth, differ from that a consensus sell-side expectation. It is not the absolute level of these results that matter to shorter term strategies, but the difference vs. the forecast and the resulting opportunity to trade a short-term bump or decline in shares.
In our view it is irrational to trade a company’s stock on the difference from a point consensus estimate caused by normal short-term swings in business cadence, that could be driven by factors as basic as weather, normal raw material price fluctuations or even customer shipping schedules. Our longer-term approach has already asked the question of what is the impact of normal business variables on profitability, cash flow and capital allocation, and how our management teams are prepared execute successfully through any potential volatility they will likely encounter over a three- to five-year period.