Our Investment Philosophy

Warren Buffett

“Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.”

- Warren Buffett, 1974 Letter to Shareholders

Principles

Three principles are fundamental to our investment process. We do not expect these principles to change over time as they will guide us through all market and economic environments. Adhering to these principles in our security selection process defines our discipline. The three principles are patience, objectivity and preparation.

Patience

Charlie Munger once quoted Jesse Livermore as saying, “the big money (in investing) is not in the buying and selling but in the waiting”. Patience is a fundamental principle in achieving investment success. The business of constantly analyzing company financial results, reading daily news events and watching stock prices move around for 6 ½ hours a day can create the feeling that you should take action more frequently than is warranted. It is important to have determined in advance exactly what companies you are interested in owning and exactly what price would get your attention. Then you wait and you watch. To paraphrase Warren Buffett, ‘investing is like baseball; you are at bat waiting for a fat pitch that is in your sweet spot except in investing there are an unlimited number of pitches and no called strikes’. The ability to do nothing and let the tough decisions go by is an intelligent investor’s advantage. There are no extra marks for degree of difficulty.

Objectivity

According to the Standard and Poor’s “Index Versus Active Funds Scorecard For Canadian Funds Report (Q4/2009)”, only 7.5% of active Canadian Equity portfolio managers beat the S&P/TSX Index over the last five year period (ended December 31, 2009). This result has been relatively consistent over time. In the investment business there are many professionals that provide advice to professional money managers. While a great deal of information (some factual, some opinion) is disseminated by the investment analysts working for Bay Street and Wall Street firms, there is also a bias towards activity. It goes without saying that activity is how investment dealers get paid via trading commissions and securities underwriting. As a result, many portfolio managers source their ideas from analysts. Some of these ideas may be good and some may be bad but the most important fact is that these advice providers do not manage any money for clients. They suffer no financial loss from poor decisions. Our investment decisions will come from ideas that have been sourced independently and originate from our own body of knowledge.

Preparation

The next time you look at the listing of stock prices in the newspaper have a closer look at the 52 week price range of a handful of stocks. You will notice that it is not unusual for a stock to fluctuate 30%-100% in value in a one year period. The long term value of a business generally does not change by 30%-100% within a one year period. Violent swings in stock prices are there to be exploited by a prepared investor. To take advantage of the violent swings in prices requires you to be prepared in advance with your entry price, the price at which you would buy more and the price at which you would sell. A great deal of effort is expended in calculating our valuation ranges that determine our buy and sell points. On many occasions, the stock market will be reasonably valuing companies. During those moments when the market is overvaluing or undervaluing a business, it is important that the basic research is already completed so that you can quickly react to the offers that are presented. In many cases, these opportunities last only a brief time before they are recognized and exploited by others and then disappear. Having the work completed in advance of these moments enables us to act quickly and decisively when the opportunity presents itself.

Portfolio Concentration

Our investment process leads to a relatively concentrated portfolio. Academic research suggests that there should be a minimum of 10-20 holdings to be considered adequately diversified. The majority of mutual funds own over 80 holdings and the S&P/TSX Composite Index holds over 200. The critical factor in determining if a portfolio is adequately diversified is not in the number of securities but rather the number of factors that will influence the performance of the underlying investments. For example, a portfolio of 25 holdings in the oil and gas sector combined with 25 holdings in the oil and gas service sector is not adequately diversified as one single factor, the commodity prices of oil and natural gas, has an inappropriate level of influence on the overall value of the portfolio. Being diversified by factors is much more important than simply the number of securities.

One of the best forms of protection from the permanent destruction of capital is choosing a high quality business. We believe that a concentrated portfolio of great businesses will be much less risky than investing in 125 mediocre businesses.

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