Risk Management

Risk Management

We view risk as the possibility of permanent capital loss. We seek to buy competitively entrenched, well-managed businesses trading at deeply discounted prices in the public markets to generate superior long-term absolute returns and minimize the risk of permanent capital loss.

We take action at each step of our process to mitigate risk

The following diagram outlines our discipline.

  • Security Selection

    • Follow rigorous investment process
    • Mitigate risk primarily via security selection criteria
  • Portfolio Construction

    • Size positions at 5% (18-22 names)
    • Generally limit industries to 15%
    • Generally own < 15% of a company
    • Hold cash when securities do not qualify
    • Add/trim to improve P/V and quality
  • Ongoing Monitoring

    • Analyze company specific risks
    • Test for macro exposures and other stress points
    • Impose position size ranges by name
    • Assess dispersion by mandate
    • Review individual portfolio’s holdings

We buy at a deep discount to appraisal

A significant discount between a stock’s price and what we believe is its intrinsic value should help protect capital from significant loss while giving us the potential to generate substantial returns.

The chart below illustrates this concept. We buy a business at $20/share, which is 50% of what we believe is its $40 appraised value. Because we believe it is a superior business with skilled management, our appraisal increases at 12% per year through cash earnings growth and free cash flow reinvestment. If the stock price reaches the value we seek after five years, we will have earned 29% per year. As the graph shows, a higher P/V paid for a stock means a lower return. The graph does not reflect performance of any particular security. Actual investment performance and returns are not guaranteed.

We sell based on changes to key investment criteria

Our process incorporates a long-term investment horizon, multi-year holding periods, and low turnover. We sell when:

  • Price approaches current appraisal
  • Risk/Return profile can be improved substantially
  • Business' earnings power is permanently impaired
  • Management proves incapable of building value and replacing leadership is not feasible