How do we research the ideas?
1) Review of filings and conference calls
We start out by analyzing public information such as financial filings with the Securities and Exchange Commission, press releases, and conference calls with management. In addition to analyzing the numbers, we examine corporate governance and look for signs of accounting red flags. This helps us get up to speed and do our homework prior to interviewing the management.
2) Interviewing management
We firmly believe that interviewing management is an indispensable part of research. These conversations fill in the gaps from simply reading the filings, such as company’s history, culture, and outlook on the future. And we get to know the management. Are they the sort of people we can trust? Are they conservative? Optimistic? Knowledgeable? Boastful? We strive to invest in companies with management that we respect and admire.
Following companies for years and regular conversations with the managers allow us to develop a rapport with them and pick up subtle clues about the company’s prospects that would be indiscernible to analysts less familiar with the company.
3) Building a model
A model is only as good as the inputs. First Wilshire does not use complex quantitative algorithms. Instead we focus on nailing down the fundamental assumptions. What would be the growth for next year? What about the gross margin? We piece the puzzle together by talking to management, analyzing the company’s prospects, and surveying industry trends. However, there are always risks, uncertainties, and unknowns, so the puzzle is never complete. No model is infallible; instead we allow a margin of safety. In a bad case scenario where the business does not perform as well as reasonably expected, would the company still be undervalued at the current stock price? If yes, then we have our margin of safety.
4) Detective work
Recent corporate frauds and investment scandals have further demonstrated that investors need to be good detectives when making investments. In our research, we consider the company’s auditor and try to assess whether we can trust the numbers. Where possible, we corroborate the story, as detailed by management and the filings, with other research, such as testing the product, getting a disinterested third party’s opinion, or doing channel checks.
We have visited many companies. We are hands-on investors – we like to touch and feel the product, use the service, see the factory. By visiting companies we can gauge their culture, level of activity, sophistication of their plants, and employee morale. Also it strengthens our relationship with the management.
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