[Venn diagram in the upper right hand corner]
The Fund’s managers consider the following guiding principles to be sacrosanct in our investment evaluation process:
Circle of Competence
We remain within our circle of competence by…
- …only investing in businesses in which we understand the core economics
- …being disciplined about what we do and do not know, while working to prudently expand our circle
- …only “competing” when we feel we have a competitive advantage in an investment
- … always examining the psychological factors at work in investing to avoid fooling ourselves
- …challenging each other
Business
We invest in good businesses that are understandable and predictable. In our estimation these businesses are characterized by the following:
- High barriers to entry (“moats”) that produce sustainable competitive advantages
- Attractive, outsized returns on capitals
- Strong “real owner-earnings,” which we define as free cash flow generated after all interest payments, taxes, working capital requirements, and maintenance capital expenditures
- Conservative balance sheets and approaches to accounting
We assess these characteristics for each of our potential investments through fundamental, bottoms-up analysis. As part of the process and in addition to our analysis of these companies’ financials, we spend significant time talking with suppliers, competitors, customers and management to produce a full and well-rounded picture of each business. Only with this level of in-depth research do we feel comfortable producing a competent assessment of any company’s intrinsic value.
People
We carefully evaluate management team to ensure each business has trustworthy, capable managers who think and act like owners – and who demonstrate this commitment by investing a substantial portion of their own net worth in the company. For us, this “owner” mindset means these managers are focused on…
- …maximizing long-term shareholder returns rather than being preoccupied with tangential issues like today’s stock price, next quarter‘s earnings, public relations, market share, revenue growth, etc.
- …efficiently and profitably allocating capital and marginal free cash flow among available alternatives (dividends, stock buybacks, or expansion).
- …providing shareholders with transparent financial statements based on straightforward, easily understood accounting.
Price
We only buy the security of a company if it is trading at a large discount to a conservative appraisal of its intrinsic value. This “margin of safety” serves to prevent permanent capital loss when we make a mistake and may provide outsized returns when we are correct.
We generate our conservative appraisal of each company’s intrinsic value through the following process:
- Adjust stated financial results for all “real” costs, including maintenance capital expenditures, interest, stock options, off-balance sheet, and pension liabilities
- Account properly for non-cash charges like depreciation and amortization
- Project real owner-earnings into the future and discount them to the present using a rational hurdle rate