Broadly defined, our interests lie with smaller companies and special situations. Our investment premise is that the universe of lesser-known companies is largely inefficient. Within this vast pool, there exist varying degrees of valuation and investor neglect – companies dominating unrecognized niches, nimble innovators, emerging franchises, as well as many small troubled companies that will not survive. Our efforts are thus two-fold: determine which companies represent under appreciated value, while isolating flawed businesses and bad companies getting worse.

We believe proprietary research yields a competitive advantage. In the search for opportunities, we closely monitor changes taking place within particular industries, product innovations, economic plans, legislative actions, shifts in demographics and even social attitudes. Often the companies that we find attractive are not widely followed by the investment community. Our work, therefore, must be both pioneering and perceptive, grounded in carefully measured assumptions.

Teamwork
Teamwork is an important component of our investment method. We pool our expertise and contacts to crosscheck and refine ideas. The intellectual breadth and diversity within our group means the companies we target are examined from many angles and considered under various scenarios. The more imaginative, persistent and vigilant we are as a team, the better our results should be.

Valuation
We believe proper valuation is the key to superior performance. We are rigorous in applying valuation criteria that determine a fair value for our companies, regardless of sector, industry or the optimism or pessimism of the environment. Conventional wisdom assumes that securities prices at any moment of time are in equilibrium, i.e., priced correctly. Our underlying assumption is that the present market price is often wrong. Our focus is on a company’s prospects for growth and improvement. Time is an important component in our work, as securities are valued according to the likelihood of certain expectations materializing over time. Like the market, we anticipate. We project trends in earnings and cash flow to come up with future values for our companies that we view as reasonable relative to our expectations.

Our style is forward-looking – that is, we attempt to make timely purchases of growing companies and to be opportunistic towards those experiencing significant change. We tend to invest early, hoping to capture the full trajectory of a company’s success. Winners here provide the high compounding returns we seek. Alternatively, we’ve found our mistakes may prove far less costly if we paid a fair price up front.

An ever-changing environment
We are a team of brokers and Investment Advisors who manage money for our clients on a discretionary basis. Diverse in business experience and perspective, we take a research-intensive, generalist approach to evaluating securitiescompanies. Our client portfolios reflect the best opportunities we find, assembled stock by stock, and balanced to control risk. Because we aim for capital appreciation, we don’t restrict ourselves to sectors or market caps, preferring instead to focus on industries and businesses experiencing significant unrecognized change. As a group, we share a core belief that thoughtful and persistent research coupled with disciplined risk-taking will yield outsized returns over time.

Volatility, risk and short selling
Our accounts are inherently volatile. We view this volatility as a market phenomenon. Risk is the potential for capital loss. We don’t believe risk can be removed from the investment equation and still allow us to deliver high returns We chose instead to better understand our investment risks and mitigate them through detailed due diligence and a disciplined short selling strategy.

Short selling allows us to focus on our principal strengths—distinguishing between fundamentally promising, undervalued companies and overvalued ones with deteriorating fundamentals. We meet with a lot of managements: some are neither realistic nor forthright about their business prospects, while others are unfocused or simply naive. Less seasoned companies are easily herded into mistakes by investment bankers.

We have also noticed that weak managements tend to reproduce the errors of the past with remarkable frequency. Poorly run companies, short-lived consumer fads, credit-financed booms, product obsolescence (and the corollary theme of new products swiftly becoming commodities) are all fertile areas for short selling. A likely candidate will have an income statement or balance sheet that defies basic economic laws, a convoluted financial stratagem, years of capitalized expenses, or a geometric appetite for cash, but not enough revenue to cover expenses. We initiate short positions after our financial legerdemain reveals something seriously wrong.

While short selling is complementary to what we do, it is not without risk. In the majority of our accounts, we employ margin. This means we borrow money to buy or sell stocks—a practice that’s commonly viewed as taboo. We view margin as increasing your dollars at work – it increases the potential for both gains and risk. Importantly, this unconventional facet of our program enables us to initiate short sales—literally, the sale of stock you don’t own—to reduce risk from our long exposure. Selling something that doesn’t belong to you is a counter-intuitive notion not widely understood, despite the long history of this practice in the financial community. It can be, at times, a risky proposition.

How short selling works
The process works like this: brokerage firms are permitted to lend shares to one another for their clients’ accounts. (This deposit creates interest income for the lending broker, who shares this with us, but we do not pass it on to our clients.) When we identify a company we deem vulnerable, we borrow shares from these brokers to sell, and if our research bears out, repurchase them at a lower price. Sometimes we misjudge – if so, we cover it at a loss. It’s also possible that a powerful, unselective market runs our short positions against us, forcing us to buy back shares at escalating prices. That market’s strength will likely boost our long positions, too, but there’s no guarantee. Thus, we are always vigilant, recognizing that the theoretical risk of a short position is infinite.

As investors, we constantly evaluate our risks. Have we missed a crucial aspect of a company’s business? Is there a change in fundamental outlook? Are we giving sufficient weight to a new opportunity? We sell (or cover a short sale) when we determine that we haven’t properly calibrated a business risk, or when a far better risk reward opportunity emerges. Our optimization process means that every stock earns its place in the portfolio – if it doesn’t, it is replaced with a stronger alternative.

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