We believe that in order to be an “investment”, an asset must be able to produce cash over time. That leaves us with only three distinct categories of true investments: real estate, fixed income securities, and businesses. For each of these asset classes, an investor can estimate what the asset will earn over time (including any rate at which they believe the business will grow) and decide a price they would pay for those future earnings. In our opinion, everything that lacks the ability to create real value (including commodities, precious metals, and currencies/cryptocurrencies) is pure speculation. We do not believe the average investor should speculate with their savings as the odds of success are closer to those in the casino.
Assets in each of these three categories has a different means of producing cash, thus adding value to the asset. Real estate can produce rental income; fixed income securities (bonds or other debt securities) carry a stated rate of return that is as reliable as the issuing entity; and a business can produce earnings from operations. Our expertise lies in investing in businesses for our clients, which we do through the stock market (an auction place for pieces of businesses). When we evaluate businesses to invest in, we focus only on tangible factors: the quality of the company and its earnings/growth potential. Once we have confidence that we know these characteristics within a range of certainty, we simply wait for the stock price to reach a point where we think it makes sense to buy.
This is the foundation of a strategy called “value investing”. Today many investment managers out there are practicing it in different ways. What we feel distinguishes our process is searching for what we call learning “learning organizations”. In our research on businesses we try to find certain qualitative factors we believe predict success over time. Learning Organizations are unique businesses, led by thoughtful and intelligent people in such a way that they are structured to bring the best out of each employee in the organization. The qualitative factors we look for in businesses are:
- Integrity – Does management (and in turn the company) consistently act in an ethical manner? Are they up front about setbacks? Do they rest on their laurels during prosperous times?
- Long Term Focus – Is the business being managed with the next few decades in mind? Or just the next few quarters? The pressure on Wall Street is to prioritize quarterly earnings – what short-term investors can often equate to “shareholder value” – over the creation of substantial, long-term value.
- Purpose and Passion – Just as humans need to breathe, a business needs to make money. But does anyone live with the sole purpose of breathing? Of course not, and we believe a business should be the same way. We believe when the purpose of a business is not the generation of profit, but rather to serve a societal need. Then employees are more engaged, the business makes better long-term decisions, and shareholders eventually benefit. Making money should be more of a means to an end.
- Employee Empowerment – We like businesses that give as much decision-making authority as possible to the lowest-level employees. These businesses don’t believe in bad employees, only poorly designed systems. When a worker sees a better way to do their job, they should be motivated to experiment without fear of failure or retribution from management. This is key to creating a culture in which employees take pride in their jobs and their contribution to the business’s purpose. Over time, we have seen this results in better performance through increased operational efficiency, cost savings by elimination of middle management, and growth from more innovation/better decision-making.
- Teamwork – Employees are encouraged to share information with one another, avoiding “silos” between divisions. This can create more efficiencies in new product cycles and strengthen supplier relations as they communicate across divisions to create/effectively market new products or venture into new markets.
- Disciplined Capital Allocation – We believe one of the key roles of a CEO is to manage the cash of the business, and we usually avoid companies that eliminate their operational margin of error by taking on large amounts of debt.
Everyday we dig up as much information as possible on these companies, their competitors, and potential new companies that satisfy our unique criteria. Once we believe we have found one, we wait until the unpredictable public marketplace offers us an attractive price to pay for based on our estimate of the business’s current and future cash flow stream. Then, we try to hold its stock for as long as the company fits these criteria, thus allowing these great companies to compound our money over time. Ideally, this holding period is forever.
Long-term investing can also be tax efficient because we avoid frequent realization of capital gains. At the same time, our investors still can enjoy the benefit of liquidity. Whenever an investor needs to draw money, they can sell a portion of their shares at their own convenience, without having to sell out entirely or work to find a buyer, as can be the case with real estate and fixed income.
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