Investment Process

Equity

Our approach to stock selection is a "bottom up" style. We are concerned with identifying individual businesses that we expect to grow and thrive over many years. We are aware of broad economic developments, but our actions are not driven by macroeconomic forecasts. Likewise, our investment decisions are not made on the basis of stock market forecasts; we are, in fact, highly skeptical of such prognostications. We concentrate, instead, on specific business opportunities that we find in the equity markets.

We have a rigorous selection procedure that is applied consistently to candidates for purchase. We examine four primary criteria to determine the suitability of a particular company.

• We identify companies that have been successful in areas that produce wealth for their shareholders. We believe that success is a habit and, therefore, restrict our candidates to businesses with a persistent record of building earnings and financial power.
  
  
• We consider only companies that we believe have a unique business position that will produce decisively higher than average returns. Such companies must have a long history of generating consistently superior returns on assets as a concrete demonstration of the durability of their market advantage. Such high returns must have prevailed for at least five years, and, in the vast majority of cases, our candidates have produced such returns for more than ten years.
  
  
• Before we consider a stock, we examine its balance sheet, income statement, and cash flow statement carefully. We will only buy into a business that is soundly financed. We will not consider companies whose accounting is complicated and difficult to understand.
  
  
• We learn as much as possible about the management of the companies we buy. We expect to hold most of our investments for years, so we want to be in business with people we respect. We examine how they communicate with shareholders. We also look for clues to management's devotion to the business. For example, do they have significant personal wealth invested in the company? Will they repurchase shares when it makes sense? Are they fair and balanced in setting management compensation? Have they had a habit of success and honesty in their careers? As part of our investigation, we attempt to make direct contact with management either through personal meetings or investor conferences.

When we are satisfied that we have identified a suitable enterprise, we add it to the list of companies that we monitor carefully for purchase. We buy a stock only when it is available at a price that we believe will produce the returns we seek on our common stock investments. Our hurdle rate is 15%, a rate that doubles capital every five years. The desired price is determined using quantitative techniques developed over many years.

The economist Keynes observed "Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally." Convention often justifies the price of a stock by simply comparing it to other stocks — a risky proposition in most cases. In addition to such analysis, our technique also demands that a stock's potential return compares favorably with other types of investments, particularly bonds. We do not want to fail conventionally or otherwise, so we let common sense lead the way in our analysis.

We believe that if we conduct our research intelligently and apply it in the market place shrewdly, we will outperform most investors and produce returns superior to the Standard & Poor's 500 index while assuming less risk.

Fixed Income

We limit our fixed income selections to corporate, U.S Treasury, government agency, and municipal securities rated "A" or better by the primary rating agencies. We do not speculate or attempt to enhance fixed income returns by buying lower quality bonds. When structuring a portfolio for new accounts, we ladder maturities of equal amounts of bonds with a final maturity of approximately fifteen years. As the early dated issues mature, we reinvest the proceeds based on our view of the prevailing rate of inflation, our view of the forces that affect inflation, and our opinion of bond prices in light of these factors. We also work to improve returns by shifting between corporate bonds, U.S Treasuries, government agencies, and municipals. Occasionally, we will use special knowledge of a corporate situation to exploit mispricing, though we will not sacrifice quality to do so.