What we do isn’t magic, it’s work. It isn’t conceptually difficult to understand. It is, however, very difficult to execute.
There are three tenets that, together, drive Disciplined Growth Investors’ philosophy.
The Power of Big Ideas – “Big ideas” are investments in companies that have a realistic probability of generating outsized returns for shareholders. Think appreciation of 10, 20 or even 50 times an initial investment. These companies often share certain key traits – a clarity of mission, huge addressable markets, management teams that balance the interests of all stakeholders and, most importantly, a sustainable competitive advantage. These businesses are admittedly rare, but the potential rewards are substantial.
Disciplined Buyers – Finding a great business is only half the battle. Having the discipline to only purchase these companies at a price below their intrinsic value increases the likelihood of an attractive future return. And to be perfectly honest, we simply hate paying too much for a stock.
Patience – We think in terms of years and decades, not months and days. Outsized financial returns do not happen overnight. Success is typically a tortuous path, one that requires ample patience. We are willing to look foolish in the eyes of the market in the short-term, as long as the fundamentals of a company are sound. Experience has taught us that value creation will inevitably be rewarded.
A sound investment philosophy requires a rigorous process to be successful.
Idea Generation – There are no “magic” screens or filters that neatly isolate promising investment candidates. It requires looking under a great many rocks. Successful idea generation is the ability to recognize a great growth company when you see one. The knowledge gained from long holding periods, as well as a systematic examination of our winners, losers, misses and near misses has sharpened, and will continue to sharpen our ability to identify raw potential.
Value Assessment – Our research process concentrates on one critical question, “What is this company really worth?” To answer it, we must first develop a comprehensive understanding of the business. We use that understanding to build a detailed financial model and to estimate normalized earnings today, as well as seven years in the future. Next we apply a time-tested valuation methodology, one derived from the teachings of Benjamin Graham, to make our assessment of intrinsic value.
Portfolio Construction – When it comes to constructing portfolios, stock price volatility is the gift that keeps on giving. We exploit price volatility to purchase great businesses when they are temporarily “on sale” for reasons that we believe will have a minimal impact on the long-term value creating potential of the business.
Our risk management process is designed to mitigate the risk most devastating to investors – a large, permanent loss of capital.
Know What You Own – The Golden Rule of risk management is to know what you own. If we cannot develop a comprehensive understanding of the business and the industry in which it operates, we have no basis for owning that company. Period.
Margin of Safety – We look to build a margin of safety into our purchase price. We start by using a reasonable set of assumptions in our financial projections. Then we bolster that margin of safety by employing a challenging hurdle rate—a relatively high expected return over time. A challenging hurdle rate reduces the initial purchase price, which hopefully results in an acceptable return, even if our growth assumptions prove faulty.
Intelligent Allocation of Capital – The first two elements of our risk management process help to limit the number of mistakes that make their way into the portfolio. The intelligent allocation of capital is designed to avoid compounding potential mistakes. By allocating incremental capital toward positions that meet expectations and away from those that don’t, we essentially starve mistakes out of the portfolio.
There are more detailed discussions about our investment philosophy and process in the “Insight” section of the website, as well as in our book, “Benjamin Graham and the Power of Growth Stocks.”