Decision-Making Process

Multi-factor Valuation

We evaluate securities relative to their peers based on three categories of attractiveness:

Value — We favor asset-rich companies with higher earnings compared to price. We examine price-driven measures at various points on the balance sheet and income statement: ratios based on book value, sales, a composite of operating earnings, and our own concoction of 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 effectiveness and outlook of management: return on operating assets (looking back up to five years, with emphasis on the more recent past), earnings quality (as opposed to earnings quantity, which we assess in Value, above), forecasted long-term earnings growth, the trend in sales compared to assets, net share repurchase, and insider trading (purchases receive greater emphasis than sales).

Momentum — We measure momentum by examining earnings revision, relative price and volume action, price stability, earnings surprise, and short interest. Earnings revision is our own formulation of the trend in analysts’ expectations about company earnings one year hence. Relative price and volume action are measured over the preceding year.

Each component of attractiveness varies in influence, determined by a stock’s industry, size, and growth characteristics. Forecasted-earnings yield, for example, is a better indicator of value for pharmaceutical companies than for producers of hardware technology; estimate revision is more powerful among small-cap issues than large-cap; and price-to-book and price-to-sales illustrate how growth comes into play (both are more powerful predictors of future stock prices among relatively lower-growth stocks).

We derive an all-in excess expected return for each company. All-in means we boil our multi-factor valuation down to a single number; excess suggests above (or below) the level of the market; expected indicates forward-looking. Each stock’s summary measure of attractiveness carries across all of our strategies.