We developed our proprietary Four Pillars process to create the highest probability that our results will be competitive, consistent and compounding. We find it self evident that successful long-term portfolio management requires the identification of businesses that are likely to have long-term success. Much like sculpting pillars from blocks of stone, our Four Pillars Process progresses by exclusion. And, much like stone pillars, each step in our process is an independent support to portfolio results.
Pillar 1: A quantitative screen that eliminates businesses that fail to meet our minimum requirements for profitability, trading liquidity, fiscal conservancy, shareholder friendly actions and growth (see below); We believe that there are measurable financial characteristics that separate enduring businesses from the broader market. Our quantitative screens reduce our opportunity set from over 10,000 companies to under 500.
Pillar 2: A qualitative review of each company’s consistency, reputation and business environment; We consider Porter’s forces to assess each company’s relative competitive position. We review each company’s historic revenue, margins and earnings and mathematically compare them to trend and to peers looking for businesses that exhibit consistency (see below). We review published reports on employee engagement, community involvement, customer ratings and “most admired” lists to understand the reputation of each business. This gives us an mosaic viewpoint about each company’s competitive advantages, operating consistency, and organizational character. The resulting Master List contains 100 to 150 businesses that have both the quantitative and qualitative characteristics that we consider necessary prior to considering a long-term investment.
Pillar 3: A traditional two stage earnings and cash flow discount model with two unique and proprietary viewpoints; We believe it is essential to develop our own in house estimate of fair value for each portfolio company. Our valuation methodology is designed to compare each business that survives our quantitative and qualitative Pillars on an apples to apples basis.
Pillar 4: Portfolio construction is an an opportunity to mitigate portfolio risk by managing exposure to independent variables such as interest rates within our portfolios; We use our trading correlation matrix to identify pockets of risk aggregation. We further manage risk by limiting exposure to individual securities, industry groups and sectors. For example, by policy we impose portfolio purchase limits on individual securities of 3% of total equities.
- We look for businesses whose revenue and earnings are expected to grow over the long run.
- We look for businesses that have sufficient market liquidity or trading volume.
- We prefer businesses that have modest levels of debt relative to their industry peers.
- We prefer businesses that demonstrate an excess of operating capital through dividends and by a reduction in shares outstanding.
Relative operational stability compared to peers and market; We prefer businesses that have appealing revenue, EBITDA margin and EPS stability as measured by the correlation coefficient of historical results regressed against the company’s trend. For example we would all other things held constant prefer a business that has grown its revenue at a consistent rate to a business that grows quickly one year and slowly the next. Our preference is based on our belief that consistent growers are more appealing when the economy and markets are in doubt.