In the search for value, DCM identifies hundreds of potentially undervalued companies that deserve further examination. Often these companies are out-of-favor, with a stock price that has been depressed by recent bad news. In other cases, a company might simply belong to an unexciting industry that the investment community has largely ignored. Our job is to determine if the security in question is cheap or cheap for a reason.
To gain a comprehensive understanding of each of the businesses in question, we utilize a wide range of resources, from published financial statements to company visits. Our objective is always the same: to find and purchase shares of businesses that are selling at a significant discount to their true worth. Accordingly, we first apply the principles of the value investment philosophy to determine an estimate of each company’s intrinsic value. We then choose the most compelling opportunities for inclusion in client portfolios.
The investment process proceeds as follows:
- Circle of Competence – We focus on businesses we understand where intrinsic value can be reasonably estimated.
- Intrinsic Value – We then calculate an estimate (or range of estimates) for intrinsic value. Intrinsic value is defined as the discounted value of cash that can be taken out of a business over its remaining life. It is also the price a rational and knowledgeable businessperson would pay for a given company.The calculation of intrinsic value is the key driver of our investment process. Effective valuation of businesses demands true understanding of industry and company fundamentals.
- Margin of Safety – Understanding that our intrinsic value estimate is never perfect, we only invest in a company when its current stock price (market value) is substantially below our estimate of intrinsic value. The discount we require is typically 50 to 60 percent discount. This protects against the erosion of invested capital and allows for substantial returns going forward.
- Catalysts – We try to identify potential catalysts that will drive other market participants to rethink and reevaluate the company’s true value and thus encourage the market to close the gap between market price and intrinsic value. Time is one such catalyst and perhaps the most important.
- Active Ownership – We are very patient investors, but not inactive. Our holdings are constantly monitored for changes in the underlying fundamentals. We periodically review our intrinsic value estimates to verify that holdings continue to meet our expectations. Generally, once we have added a holding to our portfolios, we take on the role of a devil’s advocate. We constantly question our assumptions and seek out disconfirming information.Often we establish a dialogue with corporate managers to encourage the creation of catalysts (dividends, share repurchases, liquidation, sale of the company, spin-off, etc.) when appropriate. We may also present shareholder proposals for a vote or engage in other legal action when we believe it is in our best interest to do so.
- Sell Discipline – Disciplined selling is as important as rational buying. It helps reduce risk by avoiding overvalued assets. As a long-term partner in the businesses in which we invest, our portfolios have a relatively low turnover. However, because we focus our efforts on calculating intrinsic value, selling a stock is a relatively simple decision. When the market price of a stock rises to our estimate of its intrinsic value, we sell the stock.