John Huber practices a disciplined value investment style in the tradition of Graham and Dodd. His investment approach has been influenced most by Ben Graham, Warren Buffett, Walter Schloss, and Joel Greenblatt. Read more about his investment philosophy below…

At Base Hit Investing, we have two primary investment goals:

  1. Protect our capital by minimizing the risk of permanent loss of principal.
  2. Compound our capital at rates of return that are far superior to the average result measured on both absolute levels and relative to the market averages when measured over long periods of time

I believe that a sound investment operation is one that achieves both of these goals in that order. Lest we forget, the greatest investor in the world repeatedly said that there are only two rules of investing:

  1. Rule #1: Don’t Lose Money
  2. Rules #2: Don’t Forget Rule #1

Rules to invest by, indeed. It is absolutely crucial that we focus on protecting our capital first and foremost. To achieve these goals, we need to have a concept that is logical and proven to be successful, and then we need to create a strategy to capitalize on this concept, and a process to execute our strategy. This is what we intend to work on consistently at BHI. Investing is an art, science, and always an exciting work in progress.

Investment Philosophy

Objective

At my firm, we have a simple objective: to compound our partners’ capital at high rates of return over long periods of time with minimal risk of permanent loss of principal.

To do this, we focus on maintaining a margin of safety by only investing in significantly undervalued securities, as measured by our conservative estimates of either:

  • The rate at which we expect the investment to compound over our holding period, or
  • The price that a private buyer would pay for the entire business

Strategy

Our general strategy is to make meaningful investments in high quality, predictable businesses that can be expected to grow intrinsic value at high rates and that are currently available at cheap prices.

Investing in undervalued stocks of high quality businesses allows our investment returns to come from two possible sources:

  • The internal results of the business (the operating results)
  • The market’s “revaluation” of the business (multiple expansion)

Our approach involves thinking of each investment as a business owner would. When I buy a stock, I imagine that I’m buying 100% of the business and retaining management, which helps me to think more about things that impact the long-term value of the business and less about things that impact the short term fluctuations in the stock price.

As owner-minded investors, we prefer to make investments that have the following attributes:

  • Simple, predictable businesses
  • Consistent profitability (high returns on capital and free cash flow)
  • Favorable long term prospects and reinvestment opportunities (compounding ability)
  • Shareholder friendly management
  • Significant value (cheap price)

General Investment Tenets

Our investment strategy is a well-known formula, but to successfully execute it, we find it helpful to adhere to the following principles:

  • Think like a business owner
  • Think independently and maintain a patient, disciplined, long-term approach
  • Invest in businesses that are easy to understand
  • Focus on avoiding mistakes and reducing risk—“Margin of Safety”
  • Invest only in significantly undervalued securities
  • Focus on businesses that are compounding value
  • Make meaningful investments

We believe that a conservative, disciplined, patient approach to buying significantly undervalued stocks of high quality companies that are growing shareholder value is the best way to achieve our goal of compounding our capital at high rates over the long-term with minimal risk.

8 Responses to Investment Philosophy

  1. Simari says:

    Dear John,

    I am an Italian investor and I follow the value principles to invest.
    I read your website and first of all my compliments for the great work.

    I would like to ask some questions if possible,
    first of all, the conceit behind the ROA or ROIC it’s the best way to select companies, from my point of view, at same time the price we pay it’s probably most important than that.
    How we can determine the right price or the “true” intrinsic value of a company?
    I use a Free Cash Flow model but the problem with that is hat I cannot know if the company will be living in 20 years from now.

    Kind Regards and thank in advance for the answer.

    G. Simari

    • John Huber says:

      Hi G. Simari,
      Thanks for the comment. I’ll have some further discussion on the topic of Compounders, Return on Capital, and Intrinsic Value and how those relate to each other in a 2 or 3 part post series soon.

      But very briefly, the process of determining the intrinsic value of a business is an art form. There are no rigid rules that you can use to plug data into a spreadsheet and hope that it spits out the value for you. I’ve looked at a lot of different models over the years, including many DCF’s, and I’m usually skeptical of most of these types of models. On page 4 of his owner’s manual, Buffett says that the value of a business is the “discounted value of the cash that can be taken out of a business during its remaining life.” This implies that a DCF model is the proper method of determining value. However, he goes on to say on page 5 that “the calculation of intrinsic value, though, is not so simple”, and that “two people looking at the same set of facts… will almost inevitably come up with at least slightly different intrinsic value figures”

      He implies that it’s an art form, and determining the present value of all the future cash flows of a business involves looking at all different aspects of a business’s DNA including its historical financials, its profitability, the stability of its operating history, the balance sheet, evaluating its competitive position, and its management team, among other factors–all weighted and compared to the current price.

      So it’s an art form, and it takes practice.

      One thing to keep in mind–some businesses are much easier to value than others. As Greenblatt says, start with the businesses you know how to value. For practice, read a book called Analyzing and Investing in Community Banks and then go out and read a few annual reports of tiny community banks–which are fairly transparent and relatively easy to value. Or pick an industry that you have some expertise in and begin reading some annual reports of businesses in those industries. Pick simple things–I recently read a 10-K on a business that sells hot dogs and has a nice competitive position in that niche. It’s easier to understand–and value–a business that has been selling hot dogs for the past 96 years than it is to value a business that sells pharmaceuticals (at least for me–others might have an advantage with drug companies, or software, or oil and gas, etc…).

      So if you’re going to value individual businesses, you have to understand that business. As Greenblatt says, if you don’t understand it, move on to the next one. There are 10,000 stocks in the US, and probably over 50,000 world wide in developed markets. You only need to find a minuscule percentage of them to allocate a portfolio to.

      Also, value investing comes in many different shapes and sizes, and if you choose not to value individual businesses, there are alternative measures such as quantitative investing in the Graham or Schloss tradition, or even Greenblatt’s “formula”. This quantitative approach values the basket as whole, removing the need to value each individual business. It relies on the law of large numbers, similar to the insurance underwriting business. I personally enjoy reading about those types of strategies, and the results from Schloss are absolutely phenomenal, but I prefer to think of the stocks in my portfolio as fractions of businesses, and thus I endeavor to understand them and value them individually.

      Anyhow, valuation is an art form, and it takes practice. Just like practicing the piano, you’ll get better the more you practice. And the best way to practice is to just start reading reports. Over time, you’ll begin to understand the different metrics that are important for each business, and you’ll be less inclined to use hard and fast rules (ROIC above X, P/E below X, etc…) and more inclined to think inquisitively about the business and its operations.

      The last thing I’ll mention: over time, as business owners our results are tied to the internal results of the businesses we own. A business that is growing intrinsic value over time will reward us as owners. Over the longer term, quality is the most important determinant of our results as equity owners. A business that can compound value over time at 12-15% annually will create fabulous amounts of wealth for the owners of that business.

      So quality is crucial for long term owners. BUT, valuation is the most important determinant (or at least as important) over the shorter term (say 1-3 years). If you overpay–even for great businesses–you’ll have to wait a long time for your investment returns to “catch up” to the internal compounding returns of the business. Conversely, if you buy a great business that compounds value at 12% per year–if you can buy it at a discount to its fair value, then your returns will generally exceed the business’s results in the early years of the investment.

      The market is a weighing machine, and over 3-5 years, it tends to weigh things properly. So valuation is an absolutely crucial factor over the near term.

      This turned into somewhat of an impromptu essay, but I hope this helps…

  2. steven davis says:

    I don’t go hunt companies. I hunt for industries. And from there I go pick companies using these 3 criteria.

    1. P/E ratio – must be less than 10. Normally, I prefer P/E ratio of less than 5.
    2. EPS for the last 2 quarters must be positive.
    3. I don’t care about the book value. But prefer the book value to be less than 1.

  3. Simari says:

    Hi,

    first of all, thanks for the answers.

    I have been studying to find the right compromise in the value search,and as you know it’s a tough task.
    Waiting for the post series in the near future as you wrote at the beginning of your reply I would like to ask you if there are past posts or you have any thoughts about the internal compounding returns, as to compute it, if it’s released from the company etc…
    I always thought it was more important to consider the ROIC.

    Thanks a lot

    Giannicola Simari

    • John Huber says:

      Hi Giannicola,

      Feel free to search through old posts. I discuss the concepts fairly often.

      As for intrinsic value compounding, I think the following generally explains how I like to think about compounding: if we use earnings power as a proxy for gauging intrinsic value, a business will grow (or compound) its earning power at the product of two factors: the amount of capital the company can retain and reinvest, and the rate of return it achieves on that incremental investment.

      It’s simply: the incremental ROIC multiplied by the reinvestment rate. In other words, a business that retain and reinvest 50% of its earnings, and can achieve 20% return on the incremental capital it invests will compound its earnings power at a rate of 10% annually (50% x 20%). Similarly, a business that achieves 10% ROIC and can reinvest 100% of its earnings will also compound earning power at 10% annually.

      The first situation is more desirable simply because 50% of the earnings (the part that isn’t reinvested in the business) can be distributed to shareholders via buybacks or dividends, or potentially used for acquisitions. So capital allocation is a very important factor when considering the overall company. But the enterprise itself will compound value at a rate that depends on the ROIC and the reinvestment rate.

      I view this very general measure as a proxy for intrinsic value growth. It’s a back of the envelope way to determine how a company is growing the value of its business. And again, capital allocation can add or subtract from the overall intrinsic value of the company depending on how adept management is at allocating the capital that isn’t reinvested in the business at the given ROIC.

  4. Simari says:

    Hi John,

    Thanks for the answer.
    I understand your metric for the future, but how to evaluate if the price now it’s right or under/overvalued ?

    I mean, there are metrics as P/E, P/B and model as DCF but in your experience is there an objective and reliable method to compute the intrinsic value of a company?

    Thanks in advance

    Regards,

    Giannicola

  5. Venkat says:

    Thanks for the effort much appreciated. I was looking for investment checklists for value investing and came across this site. Further I just got walloped by investing in VHC an IP troll after it went down 60%. After investing it went down by another 50%. So this quest.

    I remember my lessons after 2000 internet bubble lost so much that I gave all my money to financial advisors only to see it grew so slow it was not worth it. How does one get good at maintaining discipline and focus on process than end results. How did you do it?
    Thank you

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