Our investment process starts by doing a massive amount of reading. We subscribe to numerous newsletters, industry journals, and other proprietary research. We also run investment screens to find companies with certain attributes. We don't start the day with the goal of finding something to buy, if that is ones mindset you will probably find something but I would bet it's not a terrific investment. In fact we might go for a couple of months before we find a new investment idea that meets our criteria.
Once we find an opportunity we research the company thoroughly. This includes reading annual reports, listening to past conference calls, and finding other research that may help us in making a cogent decision. Does the company have a competitive advantage? Why is the stock undervalued? Is it due to outside influences? Is it due to factors controlled by the company and if so why won't it happen again? If we don't understand the company we will move on.
After gathering all data we will do a series of valuations. Our valuation approach is based on the Columbia University graduate school model. The first thing we look at is the reproduction value of the assets. The value of the assets is a more solid metric than the earnings of a company and in many instances can be a source of safety if something goes wrong. We then run a valuation based on the earnings power value of the company. We pay close attention to what the companies "normal" earnings power would be. Typically we would want to purchase a stock at a discount to both these values. Purchasing a stock at a discount to its true value gives us a margin of safety which I believe is absolutely critical in investing. Price is the most important factor in investing. You must be disciplined about price or you will not be successful.
Other valuation techniques might be used such as private market value. In other words what are willing buyers paying for similar businesses. What are the sustainable cash flows of the company? Sometimes the financial statements mask the true potential of a business.
We also look at qualitative issues such as are insiders buying the stock? How much ownership does management have in the company? Do they have a good track record?
In the past we have found value in out-of-favor blue chips, cyclical stocks at the bottom of a cycle, overlooked small caps, companies selling at a discount to net cash, companies selling at a discount to its breakup value (sum of the parts basis), turnaround plays, and spin offs just to name a few.
We sell a position when it reaches it intrinsic value. We might also sell positions for portfolio reasons, to take tax losses, or to reduce risk in a portfolio. We try to balance gains with losses to keep our clients tax liabilities as low as possible.
After we have done research on a company we will keep a file on it regardless of whether we purchase it or not. The market may give us an opportunity in the future to purchase the stock at a discount to its true intrinsic value and we will already be familiar with it. At any one time we study not only what we own but companies we would like to own just in case the market gives us a good price one day.
At CSH we eat our own cooking. I have most of my investable assets in the companies we buy for our clients and I disclose my personal holdings on a quarterly basis.