The Partnership looks to invest in a concentrated portfolio of great companies, purchased at attractive valuations and held for the long term while employing no debt or leverage.
Great companies. A great company has the following characteristics:
1. The ability to earn above average returns on tangible equity (20% or higher).
2. A sustainable competitive advantage that prevents returns from eroding. Sources of competitive advantage include low cost operations, high barriers to industry entry, network effects and strong brands.
3. Low reinvestment needs relative to its cash flow from operations.
4. A shareholder oriented management team which does not waste money on overvalued acquisitions or growth for growth's sake but instead returns excess cash to investors when appropriate.
The key to above average investment returns for shareholders is not how fast a company will grow or how large of an impact it will have on society, but how strong and durable its competitive advantage is. Air travel, semiconductors and the internet all have had a tremendous impact on society but very few companies in those sectors have been rewarding investments. It is companies with durable competitive advantages such as Walmart (low cost operator), Coca Cola (brand name), and Microsoft (network effects) that have provided the greatest returns to shareholders. Understanding and assessing the quality and strength of a company's competitive advantage is the key to investment success and the most important criteria the General Partner considers when analyzing potential investments for the Partnership's portfolio.
Attractive valuations. A combination of a great company purchased at a very high price makes for a mediocre investment. The General Partner will seek to purchase shares in outstanding companies only when they are experiencing some form of temporary distress and are thus available at low valuations. Purchasing shares at low valuations does not guarantee success but it substantially reduces the risk of loss and provides two ways to win on an investment: improving business fundamentals and increasing valuations. As a general rule of thumb, the Partnership seeks to invest in securities with a high probability of doubling in value in three years or less. If such opportunities cannot be found, the Partnership will hold cash and wait until a suitable opportunity presents itself.
Concentrated portfolio. Investment managers who are overly diversified cannot be expected to outperform the market because their portfolios largely mimic the market indexes. Outperforming the market is possible only through carefully selecting a few great investment opportunities. In addition, it is not possible for an investment manager to have the same level of knowledge about two hundred securities in his portfolio as he can have about twenty. Therefore, the General Partner generates investment ideas through bottoms-up research and concentrates the Partnership's portfolio in the few very best ideas available. Under normal circumstances the portfolio is expect to consist of twenty or fewer securities.
Long term focus. Being short term focused requires constantly coming up with great ideas for reinvesting capital. Because great opportunities are truly few, a short term focus pushes many investment managers to invest in sub-par ideas instead of waiting for the right opportunity. As a result, a short term focus is detrimental to long term investment performance. The General Partners plans to purchase and hold securities for as long as possible, generally a period of several years. The Partnership will dispose of securities only if they become grossly overvalued or if substantially better investment opportunities become available.
No debt or leverage. A highly leveraged investment strategy has no room for error and can lead to large permanent losses. An investment manager who loses 50% of his portfolio must make a return of 100% just to get back to break-even. Therefore, avoiding large permanent losses is essential in maximizing long-term investment returns. Because of all these reasons, the Partnership does not use leverage for its investments and seeks companies with low levels of debt relative to their assets and cash flows.