Each week our Python software combs through the financial statement trends of hundreds (sometimes thousands) of publicly-traded securities, searching for the optimum combination of competitive advantage, financial statement strength, improving financial performance and value. Each company is compared against thousands of others. Then, through interviews and reading, we research the drivers of those emerging trends. We publish weekly on the most favorable situations uncovered.
The premise of this research is that growing, low-debt companies with expanding margins and improving capital turnover that sell at reasonable values in relation to free cash flow, dividend yield and long-term relationship to book value, outperform no-growth or shrinking companies with lots of debt, contracting margins, declining capital turnover, and high prices in relation to intrinsic value. Over time. Of course, anything can happen in any single day or week. In fact, in the short term, illogical things are continuously happening, driven by emotion and enthusiasm. Emotional swings are an intelligent, patient investor’s ally. By emphasizing facts instead of conjecture, our research capitalizes on those swings.
In particular, the software focuses on:
- Positions in the portfolios of the ten U.S. portfolio managers with the best ten-year records. We’re particularly interested in positions owed by more than one of the ten “master investors.”
- Companies with a demonstrable competitive advantage as evidenced by long term return on equity, quality of earnings, debt levels and trends, and capital expenditure growth in relation to free cash flow growth. We're market cap ambivalent. We're just as interested in $5 billion companies as in $5 million companies.
- Companies in cyclically-depressed sectors or industries with strong balance sheets and high average return on assets. Sometimes this means investing in the lowest-yielding companies, REITs, or royalty trusts, in the highest-yielding sectors. We place a premium on quality, particularly out-of-favor quality.
High growth stocks.
High-yielding securities including junk bonds, convertibles, royalty trusts, master limited partnerships, REITs and preferred stocks. We have a slight bias in favor of no-debt, high-yielding companies.
Investment grade bonds.
Companies selling at particularly low prices in relation to book value with emerging positive financial statement trends.
Cumulative preferreds in arrears.
Companies with outstanding warrants
- Potential short sales — companies selling at premium prices in relation to free cash flow and book value with deteriorating financial statement trends.
The first step of our research — the "Moneyball" step — is the search. The Python software we use was created in-house. It utilizes credit analysis ratios employed by Moody's and Standard & Poors, with additional influences from the Piotroski F-Score, the Altman Z-Score, and Graham & Dodd's Security Analysis, but with more emphasis on trend than on current situation. The return on capital/equity DuPont model as applied by General Motors in the first half of the last century also plays a role.
The emphasis of this research:
trend, as opposed to current condition, although both are considered, and in the case of companies with no trend of improvement or deterioration, the assessment focusses on current condition
free cash flow, as opposed to reported net income
quality of earnings (growth rate of free cash flow as compared to growth in debt, capital expenditures, receivables, inventory, payables and S,G&A). Only the highest quality companies can grow with minimal capital expenditures and without increasing debt
the intrinsic value of the company's common stock (calculated several different ways including free cash flow adjusted for growth, and historic relationships of price to free cash flow. long term average yield -- if any -- and book value per share)
no emphasis on EBITDA because, as Buffett and Seth Klarman have repeatedly pointed out, EBITDA assumes that depreciation and amortization are not real expenses. They are. Visit here for more.
The final step in the preparation of our reports is the interviews of anyone with an informed perspective: major shareholders, current and former directors and executives, competitors, suppliers and customers. We stress that we are not looking for confidential information but rather an understanding of a particular company's competitive position, what is unique about the company, what is causing the fundamental changes that a particular company may be experiencing as evidenced by its financial statement changes and trends.
In addition to the narrative description of our findings, What's Interesting reports contain links to graphs of financial statement trends so that they can be reviewed and understood in a glance. We strive for simplicity, clarity and brevity in our reports.
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For more on the analytical approach of Roderick MacIver & Co. Inc. see Methodology.