The investment principles that guide our approach to money management have been derived from distinct but complementary sources. These include:
Henry H. Armstrong – When Henry founded the firm in 1983, he had already spent 8 years as a trust officer at Union National Bank, where his views on investing took shape. “We looked at trust investments every week,” he said recently, “and you could see that the Bank had done a superior job on the basis of buying quality companies — a slice of America, we used to say — all of which possessed good earnings potential. Eventually, the market rewarded these superior companies and our trust customers benefited financially. So when I started our firm in 1983, my fundamental belief was that the price of a stock was somewhat less important than the quality of a company. We were, in other words, far more interested in the underlying value of a business than we were the price of a company’s stock at any given time. This approach was based on a long-term perspective which ignored fads and current economic circumstances. Unfortunately, banks and most other investors no longer follow this approach.”
The first test to Henry’s philosophy occurred on “Black Monday” (October 17, 1987) when the Dow Industrial Average lost 22 percent of its value ($500 billion). “Naturally, there was concern. Many investors were swept up by the emotion of the moment and began to sell. But I advised our clients to stay with their investments as long as the earnings potential of our portfolio companies remained strong. We stuck to our principles, protected our clients from selling pressures, and weathered the bad times. The results have been quite satisfactory.”
Benjamin Graham – In many respects, Henry’s philosophy mirrored the approach of the great investment thinker, Benjamin Graham, whose focus on the spread between the intrinsic value of a company and its stock price provided the intellectual framework for some of the most successful investors in Wall Street history. Several of Graham’s core principles have had a major influence on our firm’s thinking about investments, including:
- Graham advises investors to think of themselves as owners of businesses, not speculators or traders of paper stock.
- Investors must at all times resist the emotionalism of the market and base investment decisions on sound analysis of the business. This discipline is especially critical during market downturns because, as Graham argued: “The investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage.”
- Graham warns investors to be wary of stocks that have become too expensive even if these companies have strong fundamentals. The future value of an investment is, he noted, a function of the price paid for it. Accordingly, Graham emphasized the importance of patience until suitable buying opportunities exist.
Warren Buffett— Perhaps no investor followed Graham’s thesis as well as his celebrated disciple, Warren Buffett, whom we have visited in Omaha each year since 1991 as stockholders of Berkshire Hathaway. Buffett, and his partner, Charlie Munger, have debunked the conventional wisdom of Wall Street (the importance of beta, the benefits of diversification, etc.) by building enormous wealth through a simple and direct methodology which we find very compelling. Buffett and Munger argue that:
- Companies that have enduring competitive advantages — sell a product that is needed or desired; is not overly capital intensive; dominates its market; possesses stockholder-oriented management, etc. — is a “franchise” that will stand the test of time.
- Once the stock of these superior companies have been purchased, Buffett recommends “inactivity” — holding on to these investments for long periods of time. “Lethargy bordering on sloth remains the cornerstone of our investment style” he says.
- Market volatility, which is almost universally decried on Wall Street as periods of high risk to investors, is actually a welcome development because “a wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses.” In other words, the prudent investor will be looking for opportunities to buy when the emotionally-driven market is losing value.
- Instead of the conventional strategy of diversifying, Buffett follows the counterintuitive strategy of concentrating his portfolio, thus minimizing risk by “requiring us to be smart only a very few times.” According to Buffett: “If you are a know-something investor, able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term comparative advantages, conventional diversification makes no sense for you.”