People
Since we are long-term investors, we realize in order for our investments to tip the scale at the end of the day, collectively, the people running the business will make a critical difference. While we do believe employee integrity, company environment, compensation amounts and methods, and management experience are important, we believe the largest impact we can have as analysts is to analyze a management team's cash allocation skills.
Bondholders receive coupons and reinvest them. In contrast, stockholders may receive a portion of their "coupon" via dividends, but much of that "coupon" is reinvested by management. Thus, we look for management that allocates cash objectively, much as we would choose to allocate our clients' capital. As we see it, management has essentially five options, which we call GARDD (or guard):
- Grow and/or protect the existing business through maintenance capital expenditures, cost reduction, R&D, positive NPV projects etc.
- Acquire business that provide synergies, but do not overpay to prevent “selling the synergies away”
- Repurchase their own stock at value prices
- Dividends
- Debt pay down or build up cash
Therefore, we analyze managements' ability to “guard” our businesses cash flows. Too often, we see management teams that make annual reports and conference calls solely an exercise in optimism, and therefore these mediums of communication only reflect the skill of the company's public relations department in creating false impressions. Instead, we focus on the cash flow sheet. We're more concerned with what management has done in the past than with what they claim they will do in the future. As Dr. Phil likes to say, “The best predictor of future behavior is past behavior.”