History has shown that, over time, the best way to protect and build capital is through the long-term ownership of outstanding businesses.
We define an outstanding business as one that, at a minimum, meets the following criteria:
- Understandable business model
- Predictable prospects over the long term
- Strong financial position with little or no debt
- Consistently growing cash flow in excess of that required to maintain the business
- High returns on net invested capital
- Effective, honest and shareholder-oriented management
We evaluate these criteria as if we were buying a private business.
Unlike most investment industry practitioners, we do not equate risk with volatility. Rather, we assess risk as the likelihood of permanent capital impairment.
We will purchase shares of a company only after we have formulated a solid opinion of its intrinsic value and only if the price is below that value. We call this difference (between price and true value) the margin of safety. Unless we can quantify it, we do not buy.
As the figure below illustrates, a stock purchased with a margin of safety reduces downside risk while increasing upside return potential.
Figure 1
At any time the number of outstanding businesses available at an attractive price is small. Consequently, our portfolios tend to be fairly focused (typically 15 - 20 companies).
In an ideal world we would hold our investments forever. Long holding periods provide the advantage of compounding capital on a tax-free basis.
As stewards of family wealth operating in the real world, prudence necessitates that we consider selling shares if:
- a significant adverse change occurs in the nature of the business, its competitive environment or its management
- the market price substantially exceeds our estimate of the company’s true economic value
- an investment with a significantly better risk/return profile presents itself or
- we recognize that our initial assessment of the company or people was incorrect
Notwithstanding the demonstrative long-term benefit of owning equities over bonds, some clients need to balance their portfolio by owning some bonds. In such cases, we purchase high quality issues – Government of Canada bonds and high grade corporate bonds.
