Investment Philosophy
Philosophy
"Rule number one: don’t lose money"
"Rule number two: never forget rule number one"
Warren E. Buffett, Chairman of Berkshire Hathaway
Our investment philosophy is based on the investment principles of value investing, developed by the finest investors of all time – principally, Benjamin Graham and his disciple Warren Buffett, along with other outstanding investors such as Philip Fisher and Peter Lynch.
In the words of Ben Graham himself, “value investing consists of applying common sense to decisions about assigning capital”.
The following points define some of the basic characteristics of value investing:
- Distinguishing between price and value. Price is what is paid and value is what is obtained.
- Over the long term, price and value converge. In the short term, market volatility gives rise to inefficiencies that may be a source of opportunities to buy.
- The real value of a business is its intrinsic value. In other words, the current value of all the cash flows generated by the company over time, discounted at a rate that is appropriate to the risk.
- A company’s ability to generate free cash flow over the long term and on an ongoing basis is very important.
- Equally important is the efficient allocation of generated cash flows to investments with attractive returns in relation to the assumed risk.
- Investments should only be made in companies that are well known to investors with a good track record of results and an honest and competent management team.
- A company's most important intangible asset is the possession of a long-term competitive advantage (leadership in the market in which it operates, a recognised brand, negotiating power, etc.).
The key is patience and doing one's homework well. Over the long term, company share prices tend to revert to their theoretical value. Buying companies at a 25-35% discount against their theoretical value should generate capital gains in the long term. It is a matter of waiting.
"All we want is to form part of companies that we understand, that are managed by people we like, and that have an attractive price in keeping with their future prospects."
Warren Buffett - Fortune, 21 December 1994
In practice, everything comes down to a fundamental, precise and exhaustive valuation of the investment target company.
Businesses with good free cash flow generation that are inexpensive in terms of their basic value, that are leaders in their respective sectors and that have significant competitive advantages enabling them to grown and obtain above-average net margins are the kinds of companies in which we feel comfortable investing.
Behind every investment decision is an extensive and far-reaching process of research and investigation of the companies we buy. This process covers sector analysis, competition, suppliers, customers, competitive advantages, and the strengths and weaknesses of the company, etc., along with a detailed analysis of the company's annual accounts and its cash flow forecasts. Corporate value is obtained by updating cash flows generated at the required discount rate, duly adjusted for the risk involved.
As a result of the value investing analysis, the price we are prepared to pay for a company is the price that is below its intrinsic value. The difference between the theoretical value and its share price is the margin of safety.
Recommended bibliography:
- Berkshire Hathaway annual reports, from 1977: www.berkshirehathaway.com/letters/letters.html
- The Warren Buffett Way. Robert G. Hagstrom. Published by Gestión 2000
- Security Analysis. Benjamin Graham and David Dodd. Published by McGraw-Hill
- The Intelligent Investor. Benjamin Graham. Ed. Harper & Row
- Common Stocks and Uncommon Profits. Philip Fisher. Ed. John Wiley & Sons
- One up on Wall Street. Peter Lynch. Ed. Simon & Schuster
Company Valuation Manuals:
- Valuation: Measuring and Managing the Value of Companies. Tom Copeland, Tim Koller and Jack Murrin; McKinsey & Co. Published by John Wiley & Sons
- Damodaran on Valuation, Security Analysis for Investment and Corporate Finance. Aswath Damodaran. Published by John Wiley & Sons
- Valoración de Empresas. Pablo Fernández. Published by Gestión 2000
