Our primary goal is preservation of capital (avoiding permanent loss of capital). If you are looking for a home-run hitter, we are not it. We focus on downside protection and a margin of safety. The best way to preserve and grow capital over a long period of time is to avoid large catastrophic losses. We are focused on growth, but compounding is interrupted and derailed by large setbacks. The "secret sauce" of wealth creation is tax-deferred compounding.
Investment return is determined by two variables:
I. Asset Allocation
II. Security Selection
Asset Allocation: the five assets available for investment:
Equity (business) investments: common stocks, private equity, venture capital, among others
Fixed income investments: municipal bonds, corporate bonds, sovereign bonds, CDs, among others
Real estate: public (REITs), commercial, agricultural, residential real estate, among others
Commodities: gold, silver, oil, among others
We prefer business investments, real estate, and fixed income as these assets produce cash flow, the central ingredient to valuation. We rarely invest in commodities or currencies as they do not produce cash flow and have offered lackluster, long-term returns. In fact, the US dollar has depreciated 95% since 1913. We will, however, hold cash when asset prices are high.
Security selection: we follow a disciplined, patient approach to security selection. We use individual stocks and individual bonds for most portfolios. We may also invest in equity or fixed income mutual funds and index funds.
Our Equity Philosophy:
Stocks are fractional interests in businesses. Our objective is to buy solid businesses when selling below our estimate of intrinsic value. We prefer to buy a wonderful business that can compound and hold forever. In order to buy something for less than its intrinsic value, we must first calculate intrinsic value. We define intrinsic value as the present value of future cash flows generated by a company and paid to its shareholders over the holding period of the business. We calculate intrinsic value and buy the business only when an adequate discount or “margin of safety” can be achieved from the security’s market price. We search for businesses with the following characteristics:
A business we can understand with sustainable, growing cash flows.
A business with significant barriers to entry, recurring cash flows, and high returns on invested capital.
A predictable business in which the past is a reasonable guide to the future. We ask: is technology disrupting, helping, or hindering?
A business with able and properly incentivized management that are shareholder friendly, have ownership in the firm, and a history of solid capital allocation.
A business that is undervalued (price is what you pay, value is what you get).
A business that serves a purpose and creates a win-win for all stakeholders, including customers, employees, and shareholders.
Fixed Income Philosophy:
Bonds have fixed upside and 100% downside so we are not interested in "stretching for yield" to pick up an extra half percent. Our objective is preservation of capital and our focus is on return of capital. We purchase bonds from issuers with strong financial statements and high interest coverage ratios. We buy and hold until maturity and use a laddered approach to hedge interest rate risk.
All strategies are tax-efficient. Our equity portfolio turnover is 10-15%.