Our singular devotion to traditional investment in stocks and bonds means that we exclude all sorts of other lately popular and exotic vehicles such as venture capital, private equity, commodities and derivatives. The portfolios of our various clients will have a large number of stocks in common, but the portfolios are nevertheless tailored according to our clients' specific objectives, income requirements and risk profiles. With this careful, traditional philosophy practiced for many years, we are steadfast and accomplished in our endeavor to deliver long term value for our clients.
THE SEVEN CORNERSTONES OF THE UNDERHILL INVESTMENT PHILOSOPHY
We are an All-Cap manager, tending to shift our emphasis to where we find value, be it large, mid or small capitalization companies. Being an All-Cap manager we do not confine our investments to boxes like large cap growth or small cap value that may become overpriced for long periods of time.
We describe ourselves as GARP investors (Growth At a Reasonable Price). We are growth oriented but we do not buy growth stocks at any price just because the story is exciting. The latter approach has been tried and found wanting. A great deal of performance derives from keeping the price one pays for a stock, the denominator, low. By doing that, the numerator, the amount the stock can appreciate, has more potential upside. Keeping the denominator low also reduces quantitative or market risk. More on that topic will be discussed in a later section. We are not so doctrinaire toward growth stocks that we don't occasionally buy so-called value stocks or depressed cyclical companies' stocks when the price is right and we can see change coming.
Since we focus on 13-15 above average American companies we can find at "our" price, we can afford to be very selective, using only our best ideas. We do not have to reach for marginal ideas in order to "fill out" a portfolio. We can be quite selective. By focusing our research on a few outstanding companies, we can spend the time to know our portfolio companies well. We believe managers of over-diversified mutual funds or portfolios with 50-100 stocks have an almost impossible job keeping up with that many companies, while simultaneously researching new ideas.
Our turnover is low because our holding period is generally several years. High turnover of 50%-100% is also typical of many managers and makes focusing on any one company very difficult. Such high turnover results in excessive commissions and frictional costs that tend to erode capital and performance.
We are old fashioned, bottom up stock pickers in that we use fundamental research which relies mostly on our own work and network of contacts. We visit and speak with various companies around the country, and their respective competitors, suppliers, and customers. We are not market timers, nor are we top down thinkers, although we do pay attention to the macroeconomic picture and to shifts in government regulation. Historically, market timing has performed poorly verses individual stock selection. To exit markets adroitly, and to reenter on a timely basis is an ideal that is rarely accomplished. However, many American fortunes, including the majority of those in the Forbes 400, have been achieved by buying and holding a few great companies for many years.
Typically, our top holdings have an average return on capital (net income divided by the total of long term debt and shareholders' equity) of over 20% and an average operating profit margin in the high teens. Well over half of our portfolio companies have little or no debt. We believe we have saved our clients a lot of money over the years by avoiding companies with leveraged or complicated balance sheets, another advantage of closely following a few outstanding companies.
Our highest investment priority is to preserve capital, that is, not to dent principal as it can take years of growth to make up a year or two of negative results. Of course we want to build capital over time which we seek to do by not overpaying for a few outstanding companies. We seek to identify superbly managed, unique businesses, with limited competition, sound balance sheets (usually debt-free or nearly so), and plenty of free cash flow, that retain their edge over the competition.
We like companies with proven track records, durably high returns on capital, high barriers to entry, and the kind of management with which you would enjoy working.
With this careful approach, practiced for many years, we hope to outperform the general market averages, not every year, but more often than not. No one, not even Warren Buffett, outperforms the market every year, but to do it over time is our incessant goal. When available at reasonable or bargain prices, such firms as described above provide the core of a portfolio that becomes a long term weapon in what the legendary E.F. Hutton broker Gerald M. Loeb called "the battle for investment survival."