Embracing an absolute value philosophy
At the heart of the Absolute Value philosophy is the principle that price and value are not one and the same. Market exaggeration, oversimplification, and neglect, as stated by Graham and Dodd, go a long way to obscure an investment’s true value. The goal of Absolute Value investing is to discern an investment’s inherent worth despite the noise and emotion of the market.
Many of the securities within our universe have been neglected and have fallen out of favor, which provides the potential to open substantial gaps between value and market price. Over time these deviations are noticed by the marketplace and begin to converge. Absolute Value seeks to create gains for its shareholders through the market’s recognition of value.
“Evidently the processes by which the securities market arrives at its appraisals are frequently illogical and erroneous…Most of them can be traced to one or more three basic causes: exaggeration, oversimplification or neglect.” – Benjamin Graham and David Dodd Security Analysis
Footprints absolute value investing
To manage price risk, we identify companies that are out of favor, distressed, or unpopular under the current market conditions and are selling at or near their tangible book value (1 times book value). As a comparison, the average tangible book value of the S&P 500 companies sell around 5 times book value.
We determine if the company is experiencing a temporary setback or if it is permanently damaged. The FAMR research team peels back the layers of each potential company to discover what may have caused the decrease in value.
In computing a company’s absolute value, we assess a multitude of variables, including management’s competency and experience, earnings potential, free cash flow, current debt, replacement cost and sector fundamentals.
After assessing a company’s absolute value, we then determine if enough disparity or gap exists between our assessed ‘Absolute’ value and its current market price. This gap represents our margin of safety.
Once we begin investing in a company, it may take 6 to 9 months to acquire the level of exposure we seek.
We step out of any given position for various reasons, with fair valuation of the company as our target. It may take up to 48+ months to achieve fair valuation.
The footprints research process
Securities at or below book value:
Our first step is to source companies selling close to their book value per share (price-to-book ratio). Then we determine if it has been mispriced in the market.
Attractive margin of safety:
Fits quality profile:
A key factor to the successful turnaround of a company relies on its executive management team. We evaluate each team’s experience, incentive, and commitment to turning around the company.
Appropriate capital structure:
Our decision to purchase a company’s stocks or bonds depends on our assessment of risk versus upside potential. We may even purchase both capital structure of a company.
Once we have made a decision that a company meets all of our investment criteria, we set a target purchase price that reflects an attractive margin of safety.
It may take us 6 to 9 months to accumulate the level of exposure we seek in any given security.
The footprints cultivation phase
Once positions are added to portfolios, we continue to cultivate relationships with management, conduct ongoing research on market, industry and sector metrics, and monitor the overall viability each company’s turn around.
At any given time, we may sell part of a position or liquidate the entire position for various reasons. Our goal is to achieve price appreciation of each position to the level we originally assessed its absolute value.