We invest according to the following principles:
- Invest in businesses that possess strong balance sheets, wide profit margins and earnings that are less sensitive to economic activity. Such businesses sell products that are more non-discretionary in nature, are purchased with high and recurring frequency and have a limited number of substitutes. A slower growth economy carries greater risk of negative shocks, and when such shocks occur, the stock prices of our businesses may be volatile but their earning power remains intact.
- Invest at a low multiple of sustainable earnings power. The advantages of this are twofold: (i) it requires no growth in earnings to produce a satisfactory return to investors given that the earnings yield will be significant, and (ii) investing in growing businesses with high earnings yields (or low P/E multiples) may not protect against periods of extreme volatility short-term but has always been a wonderful way to protect and grow capital over the long term.
- Focus on return on invested capital. On average, our holdings pay out only a portion of their earnings in dividends so it is critical to determine management’s incentives, philosophy and track record in allocating excess capital. Where they have utilized retained earnings for buybacks or acquisitions, our management teams have created more value than they would have by simply paying out all of their income in the form of dividends.
- Invest in companies that produce abundant free cash flow. From a defensive standpoint, these businesses continue to do well when banks and capital markets become jittery because they are not at the behest of either. In a slow growth economy, they have a major advantage in that they can use their free cash flow to augment their organic earnings growth through acquisitions and share buybacks and are better positioned to increase their market share.
Given the aforementioned characteristics, the earnings and intrinsic value of our holdings are considerably more stable than their stock prices.