We were recently talking to a fellow investment manager and somewhere in the conversation - quite nonchalantly - they mentioned that we weren't really value investors. I laughed at the comment and asked why they thought that was the case. They stated (and I paraphrase here) that essentially we were growth-at-a-reasonable price investors because we didn't invest in true value companies. They went on to say our companies were too successful (measurement wise), had not suffered recent operational or strategic crises, and were too richly valued to be considered truly "value" stocks.
This gave me great pause as I truly respect and admire this individual's insights and investment prowess. Are we well and truly GARP investors? Has all that time spent reading the great investment gurus' writings and creating valuation models and tools been a waste of time? I have always believed much like Buffett that all investing is value investing. Anything else is speculation, and I’m pretty sure we haven’t been speculating all these years.
In our definition, equity value investing is purchasing shares of a corporation in which the markets have created a significant variant between the price of the stock and the intrinsic value of the company’s shares. Nowhere does that require investment in net-nets, cigar butts, or turnarounds. Nor does it mean a company must have a low PE ratio, low price to sales ratio, or other “value” measures (though they may include one, some, or all of these attributes). I happen to believe that strong fundamentals such as return on capital, rock solid balance sheets, and high profitability provide significant downside protection of our investments. For Nintai, the defining factor is the discount to intrinsic value. Without it, we simply will not invest. To me that puts our investment style in the value investor camp.
Edward Huang said that every single person has a different perspective when looking at the same thing. We couldn't agree more. At Nintai it is a frequent event to find significant disagreements about a possible investment opportunity. During this process we look to find an investment that meets Seth Klarman (Trades, Portfolio)’s description of Buffett “buying great companies at great prices”. Our internal disagreements always center on the two descriptors: great companies and great prices.
At Nintai we have a relatively set criteria for defining a great company (see our article on our investment criteria here): high ROA, ROE, ROC, little/no debt, significant FCF, and a competitive advantage in the marketplace. The tricky part is defining a great price. We use a proprietary hybrid DCF method to get to a value per share, but generally defining what is a great price is relatively subjective. Our recent purchases (SWI, CBOE, CLCT, CPSI) we believe represent great companies at great prices. We expect to be owners of these businesses for the long term and are excited to see them grow for many years to come. We don’t believe we paid excessively for growth but rather obtained an adequate margin of safety in each respective investment case.
Seeking Value Today
The reason we bring this up is two-fold. First, we sometimes find individuals and institutions can get too caught up in creating a definition for value investing. Attempting to set strict criteria can blind us to opportunities which - in the long term - might provide significant returns. In addition, it can block out means and methods that might provide us with valuable tools in our hunt for value.
Second, we are frequently asked about finding investment opportunities in today’s market environment. With our recent purchases, we still remain at a roughly 20% cash position. As value investors, we simply cannot find that many opportunities in today’s market. That said, we currently have two companies on our watch list that intrigue us and could be added to the portfolio if either their intrinsic value grew or their price per share dropped (or both would be best). Neither would be considered a Ben Graham value stock – they are quite profitable, generate high returns, have no debt, and have a generous amount of cash on the balance sheet. Management are great allocators of capital. They clearly meet our criteria as great companies. Unfortunately they aren’t valued as great prices. If the gap between the value and price widened more we would certainly be investors.
Linear Technology (LLTC, Financial)
The first stock is Linear Technology. Linear Technology designs and manufactures standard high-performance analog (HPA) integrated circuits for an immensely diverse customer base spanning industrial, automotive, communications, and high-end consumer electronics. Linear is a cash-generating machine. Lothar Maier, CEO, has kept a laser focus on sticking with products and clients who are willing to pay for quality. The company generated 38% ROE, 28% ROA, and 58% ROC. The company converts roughly 40% of revenue into free cash. It has no short or long-term debt and roughly $570M cash on the balance sheet. It’s product, processes, and expertise provide the company with an extensive competitive moat. It currently yields 2.8%. Obviously a great company. The only problem is that our estimated fair value is $44/share or a 7% discount to intrinsic value – not a great price. So we wait.
United-Guardian (UG, Financial)
Our second company is United-Guardian. The company through its Guardian Laboratories Division manufactures and markets cosmetic ingredients, personal care products, pharmaceuticals, medical and health care products, and specialty industrial products. It also conducts research and development, primarily related to the development of new and unique cosmetic and personal care products. The company generated 28% ROE, 25% ROA, and 61% ROC. The company converts 32% of revenue into free cash. It has no short or long-term debt and roughly $6M cash on the balance sheet. It currently yields 4.2%. While down roughly 23% over the past year, the stock still only trades at a 7% discount to our estimated fair value.
Neither of these companies would be held up as the model value stock. With PEs of 20 and 22 respectively they certainly wouldn't be considered cheap by traditional value investors. By using multiple measurement tools it is likely several value investors would come to the same conclusion – neither company provides a satisfactory investment opportunity. However, at Nintai we keep an eagle eye on two things – the company financial criteria and its price to value ratio. We care little about PE or PEG ratios. While different than a more traditional value model we all get to the same finding – neither provides an adequate margin of safety at this time.
Conclusions
We don’t think having strict quality criteria makes Nintai any less of a value shop than low turnover or PEG requirements. Our main focus – from the beginning of investigating a potential investment until its sale – is the disparity between value and price. There are many roads to the Forum but all take you to Rome. We think there are as many methods to value investing as there are roads leading from the Italian countryside to center city. We avidly read about other value investors’ methodology because we know we can always learn more about what makes a successful value investor. In the end, that’s what makes this such an interesting career. We wouldn't want it any other way.
As always, we look forward to your thoughts and comments.
