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Philosophy

Our philosophy encompasses our view of the equity markets, how best to profit from them, how to hold onto profits, and how we run our business.

Stock Market

We believe the stock market is reasonably efficient but emotional enough to provide opportunities for the disciplined investor. Because the market is complex, opportunities are best exploited with a systematic, quantitative approach. We use modern investment technology and academic research to complement the wisdom of classical investment thinking and analysis.

Investment Style

We are value-oriented but believe superior results are best achieved by considering value, management, momentum, and sentiment. Our work holds security analysis to be most productive when value is gauged relative to a company’s peers. As such, valuation within and diversification among industry peer groups constitute important aspects of our process. We focus on well-managed companies with quality cash profits, relatively low market valuations, positive price and earnings momentum, and favorable market sentiment. We optimize portfolios to diversify multi-faceted risks.

Implementation and Trading

We believe transaction-cost management is a vital component of the investment process. Transaction costs — the ultimate cost of implementing any investment strategy — are higher and more complicated than generally perceived. Controlling transaction costs is key to exploiting stock-market opportunities.

Management Management*

Investing is our only business. We are independent and owner-operated. We practice investment management in an atmosphere of candor and mutual respect, where patience and humor are the norm. We believe it is essential to forge a partnership with clients (and vendors). Detailed, frequent, and complete communication is highly valued. We aim to create goodwill that will help us endure unavoidable periods of subpar investment results.

Multi-Factor Valuation

We evaluate securities relative to their peers based on four categories of measures:

Value — We favor asset-rich companies with higher earnings compared to price. We compare measures from the balance sheet, cash flow, and income statement to pure and adjusted measures of market value. We derive ratios based on book value, gross profitability, bottom-line cash flow, and forecasted earnings. The lower the multiple — in other words, the higher the fundamental “yield” — the higher the expected return.

Management — We use numerous measures to gauge the longer-term prospects for a corporation: return on operating assets, the trend in sales growth, share repurchase, and earnings quality (as opposed to the earnings quantity we assess in Value).

Momentum — We measure momentum by observing changes in price and forecasted earnings. Relative price action and price stability are measured over the preceding year; industry and ecosystem momentum over the last six months. Earnings revision is our own concoction of the trend in analysts’ expectations about a company’s future results.

Sentiment — We study the buying and selling behavior of key investor segments. Insider trading, the level of institutional ownership, and the aggregate interest of short “holders” provide multiple layers of insight into future stock performance. We add yet another dimension of understanding by capturing the difference between the implied volatilities of a stock’s open calls and puts and the difference between its options-market and stock-market trading volume. We see the sentiment of these market players as a crucial clue in solving the stock-picking puzzle.

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*Hats off to the late Stan Calderwood (of Trinity Investment Management) for the description.