Q:  What is your investment philosophy?

A: We believe that earnings change in a company is the driver of its market price and that the change has a longer life span than most investors are willing to wait for. We believe that investors pull out too early when there is positive change and too late when it is negative.

We are always looking for the highest level of gain from stocks that perform well and are inclined to wait longer than others. However, for declining stocks, we are cautious and sell as soon as the trend starts. That is, we “run the winners” and “sell the losers.”

Q:  How does your philosophy turn into an investment strategy?

A: We are looking to invest in high quality companies going through a long-term positive change that would last at least a year or more. Our fund’s target is to outperform the benchmark by 2% to 3%.

We construct a portfolio of companies that are leaders in the sectors in which they operate. Our concentrated portfolio has forty names in it and we believe that it is hard to add value with many more stocks than that. When we sell a company we pick another company in the sector and always tr y to have exposure to a variety of sectors. We do not like to favor one sector over the other.

Q:  How is your research process conducted?

A: The research process is carried out by a team of sector managers. Each idea or stock is taken through a multiple screening process to determine business quality, company value, earnings growth and change in the company or sector. We screen about 1,300 stocks in North America alone.

We screen six different factors: business quality, which is the measure of balance sheet health; market value using price earnings ratio; earnings growth using forward-looking earnings per share; positive or negative change using consensus earnings per share revisions, and share price momentum. We also review history of insider buys and sells to determine what the level of management or directors’ interest is.

The change-related factors are the most dominant in our way of thinking. For every stock, each of the factors is scored +1, 0 or -1. The best stocks are the ones whose total score is +4 or +5. We then conduct a detailed company research. We model each stock for the business evaluation and prepare research discussion note.

An example of such analysis will be the hotel management company Starwood Hotels & Resorts Worldwide Inc., which has a highly leveraged balance sheet and typically scores a -1 on valuation metrics. However, we know that this company has a strong cash flow and it is selling assets to reduce its debt and pay cash back to shareholders.

Q:  How do you go about analyzing the companies?

A: Our detailed company analysis is specific and subjective. In quality, we look at the quality of the management, the quality of the product portfolio, and barriers to entry in that market place. To measure value, we use price to earnings ratio in screening but in detailed research, we could use asset valuation or price to book value.

In the previous example of Starwood, we think the asset valuation provides us a better view on the company. Our research process thus aims to get a view on growth under different assumptions and on revenue outlook where we think we see the stock differently. When we are looking to evaluate a change in the company we are primarily looking to understand earnings revisions and forces that drive these changes. The earnings revisions are one of the better indicators of long term change that we are looking for.

For every stock we buy, we have to sell another that we already hold. And when we buy a stock we set a dollar price target we think it can achieve over the next 12 to 18 months with a clear rationale for why we think it can achieve that: either because the earnings are going to exceed our expectations, or because the stock rating is likely to be revised higher.

Q:  What is your buy and sell discipline?

A: We only sell a stock when we have a better idea to replace it with. We constantly review our forty stocks and continually set and monitor our price targets for each stock. When we reach 95% of the price target in a stock, we review the stock and either the price is revised higher and we continue to hold the stock. Or, if we think that the stock is fully valued based on our original analysis, we sell the stock.

For every event in a company, we decide and evaluate if this change is positive or negative. An example is Apple Inc. The company performed poorly in December 2006 due to a report that chief executive Steve Jobs was being investigated for an ‘options backdating’ scandal. The stock became very weak but the fundamentals and underlying operations remained intact, with outstanding Christmas sales. This in our opinion was not a negative change and we held onto Apple.

Q:  What do you consider a negative change?

A: We consider changes to be negative when, for example, a company’s quarterly earnings decline, when the company changes its business strategy dramatically, when debt on its balance sheet grows or when a company makes expensive acquisitions. We are watching 40 stocks in the portfolio daily.