Large Cap: Systematically uncovering global large cap stocks
Our large cap investment universe consists of approximately 1,000 of the largest companies in the world that meet a $20 million daily trading liquidity threshold. We sort and filter this universe using several valuation methodologies, including our proprietary discounted cash flow model called The Trapeze Valuation Model or TVM™. Figure 1 illustrates Nike’s historical TVM™ (we did not own Nike in client accounts during the period shown). Our large cap investments typically have market caps over $5 billion at the time of purchase, but may include those in the $2-5 billion range.
Figure 1. Nike Inc. Dec 31 2001 – June 15, 2012
Small/Medium Cap: A treasure hunt
Searching for undervalued small and medium cap stocks is akin to a treasure hunt. Our portfolio managers and research analysts scrutinize securities utilizing information gleaned from myriad sources, including a universe of closely monitored stocks, filters and screens, outside research analysts, corporate regulatory filings, newspapers and periodicals, other like-minded investors and our diverse business contacts.
To assist our security selection, we draw on specialized independent research, such as a service that identifies sell-side analysts with the best track records and determines the “quality” of corporate earnings. We also subscribe to assorted research services to gain disparate market and macroeconomic perspectives.
Margin of Safety
We believe that securities purchased at a meaningful discount to their intrinsic values, with a “margin of safety”, should have lower downside risk. Buying a security at a large discount to its fair market value also mitigates the risk in our business appraisal. To minimize inherent business risk, we seek to purchase securities of strong companies meeting our fundamental criteria and to avoid those that have poor balance sheets or no earnings without the prospect for near-term earnings. We prefer companies with competitive advantages, barriers to entry or unrecognized valuable assets, and wish to avoid those where predictability is difficult. We are attracted to companies with lower than average operational, financial and valuation risk.
Perception of Risk
We strive to avoid permanent loss of capital. Investments typically experience temporary loss of capital from unwarranted short-term share price fluctuations. Often, illiquidity from an emphasis on smaller companies can contribute unduly to an outsized fluctuation in price, in our view, a temporary impairment of capital. From time to time, investments may experience permanent loss, though we wish to minimize this by avoiding companies we believe are overpriced and recognizing when a company’s business model changes adversely.
Short Selling Strategies and Option Strategies
For hedging purposes or for investment purposes to take advantage of market opportunities, we may use short selling strategies or option strategies to the extent such strategies are appropriate and permitted for a client’s account.
We believe that a value approach to income investing, which combines mostly high yield bonds, and periodically dividend-paying equity securities, can provide above average risk-adjusted returns. We typically seek securities which our analysis indicates are mispriced. We find these opportunities in a diverse group of businesses across North America which meet our criteria through investment and risk analysis.
For debt securities, we analyze credit risk, including interest coverage and asset coverage to mitigate the risk of permanent loss. Issuer fundamentals, including cash flow and asset valuation, are stress-tested for interest coverage, asset coverage and the ability to honour maturities.