Well defined purchase criteria - Using a fundamental investment approach, we screen for companies that meet our well-defined purchase criteria. Investments are made in companies that exhibit many of the following characteristics:
- Low price-to-sales
- Low price-to-earnings (current or normalized)
- Low total enterprise value to EBITDA
- Low price-to-book value
- Total debt less than shareholders' equity
- Out-of-favor or consolidating industry
- Market position or technological leadership
- Stagnating or declining stock price
Discount to private market value - Candidates for inclusion in the portfolio will typically trade at a significant discount to our estimate of their private market value. To guard against the risk of loss, portfolio candidates must exhibit the ability to prudently finance their on-going business activities. To determine a company's upside potential and downside risk, we perform a financial review that includes an analysis of historical and current profitability, liquidity, leverage, and asset management. The financial analysis is supported by an examination of industry prospects and the firm's competitive position. In addition, we may contact management regarding their willingness to consider value-enhancing activities, including merger and acquisition transactions.
Conservative projections - Next, we project the company's earnings power, cash flow generating capability, and financial condition. Private market transaction values and profitability characteristics of comparable companies are utilized to determine the company's fundamental earnings potential over the next three years. For inclusion in the portfolio, a company's three-year earnings potential must provide a minimum projected return on market value of fifteen percent (for example, earnings potential of $1.50 per share on a stock with a current price of $10).
Future market value - Sell targets are assigned to each company in the portfolio that typically represent a 50 to 100 percent increase from the market value at the time of initial purchase. An estimate of the future market value of a company is determined by assigning what we view as a conservative multiple (8-13x) to the company's earnings potential in the third year of ownership. These sell targets are continuously monitored and periodically adjusted as business and investment conditions change. Periodic reviews may produce an upward or downward adjustment of the sell target or result in a decision to remove the position from the portfolio.