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Investment Philosophy

What Is Value Investing

"An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."
- Benjamin Graham, "The Intelligent Investor"

The "value investing" model, developed by Benjamin Graham in his texts, Security Analysis and The Intelligent Investor, is highly dependent on price. Security selection is therefore a process of identifying situations where companies trade at a significant discount to their liquidation or long-term going-concern value. This discount, defined as the "margin of safety," is critical in two respects. A large margin of safety component not only reduces the risk of a permanent loss of capital but also serves as the platform for significant future gain. Superior returns on investment often result when the marketplace ultimately recognizes the true value of the enterprise.

Value investing incorporates principles that have produced extraordinary returns for money managers through several market cycles over many decades. We have the experience required to successfully apply these principles to the selection of securities. We do not attempt to time broad directional swings in market levels, interest rates or exchange rates. We are not interested in annual benchmark comparisons. A study of the performance of successful value-oriented investment managers over long periods of time found they under-performed market indices 30% - 40% of the time. In other words, out-performing an index 60% - 70% of the time produced highly satisfactory risk-adjusted rates of returns for these successful managers.

Investment Approach: Unlocking Value

We employ a bottom-up stock selection approach, and invests in undervalued equity securities that are usually out-of-favor in the market. We select securities, one at a time, based on asset valuations, operating performance metrics and long-term fundamental business prospects. Unlike many investment managers, we spend a considerable amount of effort evaluating the downside risk of every investment.

If there are very few values to be found in a given period, we are comfortable holding cash, rather than placing money in speculative, overpriced issues. We will not invest in an overpriced market simply to become fully invested but will patiently wait for attractive situations to present themselves.

We think of a portfolio as an orchard of fruit trees. One cannot expect fruit every year from each species of tree. Investments can and often do have varied and unpredictable timetables to maturity. We believe a suitable time horizon for investment fruit to ripen for harvest can be three to five years or longer. Indeed, a key factor in realizing outstanding performance is having the discipline and patience to maintain time-tested principles and not abandon the orchard before the fruit has ripened.

We view the investment process as a combination of art and science. Each investment decision has both quantitative and qualitative aspects. While a novice can readily duplicate the former, the latter can only be acquired after decades of analyzing investment opportunities. A key element to outstanding investment performance is bringing these two factors together.

Value investing incorporates only one methodology for securities selection. While many consider it to entail less risk than some other approaches, it can produce returns below popular indices for multiple annual intervals. Value investing may result in concentrated portfolios and will not produce portfolios diversified by investment style. These potential risks must be considered by any investor utilizing the services of Petra Capital Management.