What do we look for?
Our investments should demonstrate many of the following fundamentals:
Sharp focus on valuation: Low valuation relative to assets, earnings potential and cash flow is the primary factor in an investment decision.
Currently profitable: We look for companies with long operating histories of revenues and earnings. Turnaround situations are a notable exception. We strive to avoid startups or biotech-type companies that are currently losing money while promising a future payoff. We value a company based on current earnings or near-term projections as opposed to distant future prospects.
Balance sheet strength: Low debt levels relative to assets and equity. Strong balance sheets help companies finance working capital and growth and survive economic shocks.
Growth: We look for companies that can grow earnings 15% or more in the intermediate future. These are often companies in emerging industries or growing niches. We would consider a slower-growing company at a very attractive valuation.
Industry: Industries with sound economic fundamentals. We prefer companies in industries that are growing. While it is possible to find gems in declining industries, it is usually not wise to swim against the current. Also, stocks in growing industries are more likely to get recognized by other investors, resulting in a quicker return on our investment.
Management: Strong, trustworthy management. We interview management to see if they are the type of people we respect and want to work with. We look for management to be knowledgeable, trustworthy and honest as well as capable and energetic. When things are going badly, we want the management to be upfront about it and recognize mistakes, and when business is going well, we want them to recognize the risks and rein in exuberant expectations.
Cash flow: Reported earnings mean little until converted to cash in the bank. We look for companies with strong cash flows after accounting for reinvestment in the business. We do not like industries that require consistent large capital investments. High level of receivables relative to revenues is another warning sign suggesting that the company may need to raise equity or debt in order to fund working capital needs. This is a common pitfall of numerous Chinese companies.
Strong competitive position: A strong competitive position can be achieved with scale, patented technology, domination of a market niche, or control of a distribution channel. Such companies can grow revenues and margins even in bad times and possibly dominate their industry.
Undiscovered: If there is little or no analyst coverage, it may be that the company is overlooked by mainstream investors. It may also mean the stock is undervalued. It is easier to find value in an undiscovered company than one widely covered by the analyst community.
Insider ownership: We like management to have a significant stake in the company such that management’s interests are more aligned with shareholders’. However, we are cautious when management owns too much because there is a danger of management running the firm like their private company.
No lawsuits/regulatory risk: Long-lasting lawsuits drive down the valuation of the stock for an indefinite period of time. Government’s regulatory action is difficult to time or predict. Thus we typically avoid companies that are fighting a lawsuit, benefiting from legal loopholes, or facing impending regulations.
Research and Development: Companies that consistently bring innovative products to market are more likely to maintain their competitive advantage in the future. Such companies tend to exhibit growth and high margins.
Few or no externalities: Externalities are costs that are not accounted for in the sale of a product. For example, pollution is an externality of producing certain chemicals. Cigarettes cost a customer more than the price of a pack. We try not to impose moral judgment – our goal is to make money for our clients. But our experience has showed that these costs can unexpectedly come back and break the company, sometimes in the form of government regulation or a public backlash, so they must be considered.
Investor Relations: Active and honest investor relations efforts, including conference calls with analysts, conference presentations, responsive management and a designated contact for investors. Investor relations efforts increase awareness of and demand for the stock, helping other investors recognize the stock’s value. We avoid companies that are insincere, promotional, and focused on the short term. It is important that they are open in discussing their challenges and opportunities, as well as their strategies to address both.
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