active value

search & idea generation

We search broadly and continually for new investment ideas. We screen the stock markets using time tested investing criteria such as low price to earnings, high return on equity, low debt and low price to book ratios. We read about interesting companies in books, magazines or on the internet. We occasionally look at companies mentioned by family and friends. We follow and sometimes blatantly copy the investments of fund managers we admire. We pick up on ideas in discussions with fellow investors and we may pick up the occasional investment from a newsletter. We try to avoid sell-side research coverage. In all this we try to be cogniscent of the limits of what we can comprehend and we do not invest in companies we do not understand. We try to keep things simple and can usually explain our investment ideas in a few short paragraphs.

We are only looking for less than a hand full of good investment ideas per year.

Finding interesting companies

undervalued

  • low growth, low P/E, low M/B
  • company is a diversified operation that is being traded at a discount to total value
  • unprofitable divisions are suppressing the total value of the company
  • the company is ‘off the radar’ because it’s placed in the wrong sector

under-researched

  • the company has little or no analyst coverage
  • information about the company is hard to obtain
  • the (analysts) perceptions about the company are erroneous or misunderstood

undesirables

  • the company is dominated by negative press; e.g. poor corporate governance, poor corporate performance
  • financial Distress, Bankruptcy
  • industry Problems (Bad Loans, Regulatory Threat, Overcapacity)

obscure

  • small Capitalization
  • spin-offs

value analysis

Once we have identified an interesting company we conduct a financial analysis. We start by analysing the financial data of the company using a minimum of seven years if available. Initially we focus on the balance sheet as it is the least prone to accounting manipulation. We look at the assets. Companies with high levels of debt should be avoided and we like companies that are not capital or asset intensive. Next we focus strongly on cash flows as they are also less likely to be the subject of accounting manipulation and is the real life blood of any company. We like companies that generate a lot of free cash flow. We look for sustainable earnings power and rejoice if we find evidence of a franchise.


review & decision

When we feel we have an interesting find we work through a check list which we have put together over the years of reading and practical experience. The check list allows us to quickly identify where we have to dig deeper into the financial statements of the company. Should a company pass our checklist we read through the annual, interim and quarterly financial reports to get to know the management and the business of the company? We revisit key issues and make sure there are no personal biases working. Only when we are satisfied with all of the above do we invest.


monitoring & risk management

We focus on our best ideas and do not believe in diluting them down with inferior ones and thus invest in a concentrated fashion. However, as no one can foresee the future development of security prices and as we want to limit the loss of capital as far as possible. Our portfolio therefor typically consists of between 20 to 30 securities. Securities are bought when they offer an attractive discount to underlying value. Selling takes place when we believe a security is fairly valued or if the proceeds can be invested in a more attractive position. Although this seems a simple strategy it is remarkably difficult to execute.

We define risk as the permanent loss of capital. The popular concept of equating risk with the inevitable short-term movements of the market seems counterintuitive to us. We may buy more of a security when offered to us at a lower price. We believe that buying a security that is trading substantially below its intrinsic value is the best way to eliminate risk.

Even though we believe in concentrated portfolios we seek diversification; e.g. by industry, market capitalisation and type of investment. We do not use leverage. We are quite simplistic when it comes to hedging, derivatives and other exotics; capital structure comes down to two things: 1) equity, where you own part of a company, and 2) debt, where you lend money to a company. We share the view that everything else has been invented by Wall Street to confuse you and generate fees.

If after all of the above we still find ourselves on the wrong end of the trade then patience is our default strategy. If we are still convinced about our original premises and have no better use for our capital we will trust our judgment that the stuck was worth buying and that in the end the anomaly will be dissipated. However this is probably the most difficult one to defend.