Arguably the most important factor in selecting an investment adviser is the firm’s investment philosophy. Clients should understand and be comfortable with the way the adviser thinks about selecting stocks and risk management.
Simple, Yet Difficult
Inkwell’s investment philosophy is based on the teachings of legendary investor Benjamin Graham, and is easy to understand but difficult to implement. While it is simple to say, “Buy low,” the time when stocks become the cheapest is usually when things seem to be at their direst. And “sell high” may seem like a good idea on paper, but it can be difficult to let go of a stock that seems to be on a never-ending upward trajectory. An investor can easily become his or her own worst enemy.
Therefore, Graham devised strategies to increase an investor’s odds of producing satisfactory returns. We at Inkwell have studied these concepts, tested them in our own portfolios, and professionally observed their use in client portfolios. Our academic background and investment experience has allowed us to develop the skills and temperament to be able to implement them in a variety of client portfolios.
Bottom-Up & Fundamental Research
Inkwell’s approach to security analysis is bottom-up and fundamental.
Bottom-up analysis involves searching and analyzing individual companies to find securities to build a portfolio. This is in contrast to a top-down approach where a macroeconomic forecast drives security selection.
Fundamental analysis involves analyzing the financial statements (income statement, balance sheet, and statement of cash flows) and competitive position of a company. This is in contrast to technical analysis, where decisions on which securities to buy are based on examining charts of historical price performance.
Intrinsic Value Is At the Heart of What We Do
Inkwell seeks to buy stocks that it believes are selling at a discount to their intrinsic value. In determining intrinsic value, Inkwell considers different factors, such as discounted cash flow analysis; historical valuation of the security; historical valuation of comparable businesses that have been sold in recent transactions; and asset values based on the total value on the company’s individual parts minus its liabilities.
Simply stated, Inkwell primarily seeks to buy the stocks of great companies selling at attractive prices. These are companies characterized by sustainable competitive advantages, which generally exhibit superior returns on capital, strong balance sheets, and consistent free cash flow. In buying these stocks, Inkwell will typically seek a discount of at least 20% to 25% of estimated intrinsic value.
Additionally, Inkwell would seek to buy the stocks of companies of lesser quality, provided that they can be bought at a higher discount to estimated intrinsic value. In buying these stocks, Inkwell will typically seek a discount of at least 35% to 40% of estimated intrinsic value.
Thoughts on Risk
We primarily think of risk as the likelihood of losing money. While investments in stocks, fixed-income securities, and mutual funds are subject to investment risks, including the loss of some or all of the principal amount invested, there are two important tools that help us work to minimize these risks:
1. Margin of Safety
We believe that high risk comes primarily from high prices. Benjamin Graham, the father of “value investing” wrote:
In the old legend the wise men finally boiled down the history of mortal affairs into the single phrase, “This too shall pass.” Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto “Margin Of Safety.”
To elaborate, Inkwell insists on an appropriate “margin of safety” in each aspect of its investment program. If Inkwell believes a stock to be worth a certain price, it will not purchase that stock for a client unless it is selling in the market at some discount (or “margin of safety”) from that price. If it turns out that Inkwell’s original analysis was faulty in any way, that margin of safety should lessen the risk of loss on the stock.
2. We “eat our own cooking”
We invest our own personal portfolios in the same way we manage client portfolios. We personally practice what we professionally preach. You may be surprised to learn how few investment managers follow this simple dictum that not only ensures that the manager will act with his clients’ best interests in mind, but also incentivizes him to act with due care when selecting investments.