Our mission is to make sure your portfolio can grow while riding out whatever financial terrain lies ahead – including the worst. To do this, we built IMA on value investing principles outlined by Benjamin Graham and popularized by Warren Buffett. Of course, we added a twist of our own.
The All-Terrain Portfolio You Need for Any Economy
Built on the 6 Commandments of Value Investing
- Treat stocks as
businesses, not widgets - Have a long-term
time horizon - The market is your servant, not your master
- Leave room for error in your buy price
- Fear permanent loss of capital, not volatility
- Expect stocks to revert to fair value
- Active Value Investing
We don’t trade – we invest.
Traders have the short term in mind, so they treat stocks more like widgets than actual businesses.
The problem is rooted in the instant liquidity of US markets. This seduces many - an investor (including fund managers) into acting like a trader and focusing on the short term.
We take Warren Buffett’s approach by asking ourselves, “Would we want to own this business if the stock market was closed for 10 years?”
This makes factors like valuation, cash flows, competitive advantage, return on capital, balance sheet, and management extremely important in our analysis.
Built on the 6 Commandments of Value Investing
I. Treat stocks as businesses, not widgets
We don’t trade – we invest.
Traders have the short term in mind, so they treat stocks more like widgets than actual businesses.
The problem is rooted in the instant liquidity of US markets. This seduces many an investor (including fund managers) into acting like a trader and focusing on the short term.
We take Warren Buffett’s approach by asking ourselves, “Would we want to own this business if the stock market was closed for 10 years?”
This makes factors like valuation, cash flows, competitive advantage, return on capital, balance sheet, and management. Extremely important in our analysis.
II. Have a long-term time horizon
It’s impossible to predict how a stock will be priced in the short run. However, the flow of money into mutual funds and hedge funds is driven by recent performance, so Wall Street is obsessed with the short term.
This punishes stocks when their immediate future looks unattractive, and creates an opportunity to buy them at a cheaper price.
This gives a competitive advantage to those who look at the long term.
At IMA, all of our models focus on what the company will be worth in 3-5 years, based on its earnings power and cash flows. We then bring that future value forward to today at a discount rate, to see what we want to pay for this company right now.
III. The market is your servant, not your master
The market prices stocks on a daily basis, but it doesn’t value them on a daily basis. It only values stocks in the long run (a matter of years, not months or days).
If you know what a business is really worth, stock fluctuations are your friend.
For example, if our research shows a stock is worth $1, then if its price falls from 50 cents to 30 cents, the company can now buy back a lot more of its stock at lower prices, and we have an opportunity to increase our position.
That’s why spending a lot of time doing research helps us understand what a stock’s value is and enables us to rationally and calmly take advantage of price fluctuations.
IV. Leave room for error in your buy price
At IMA, we build models of businesses and stress test them to arrive at a worst-case scenario valuation.
But unexpected things still happen. That’s why our valuations include a margin of safety, in case we’re wrong.
External events have more impact on lower-quality businesses than higher-quality ones. So our margin of safety will fluctuate depending on business quality.
V. Fear permanent loss of capital, not volatility
Value investors don’t view volatility as risk; they embrace it and try to take advantage of it.
Volatility is only scary for those who don’t know what a company is worth. For those who do, the difference between business value and price provides an opportunity.
In determining a business’s value, we estimate its long-term future cash flows and convert that value into today’s dollars. This gives us an approximation of what the business is worth now.
We then build models so that we can try to “kill” the business. We look at known risks and try to imagine unknown ones; we try to quantify their impact on cash flows.
This process helps us to determine the margin of safety that the business requires. Combining it with our valuation, we arrive at our target buy price for the stock.
VI. Expect stocks to revert to fair value
If a stock is significantly undervalued for a long time, this undervaluation eventually gets cured.
It could happen through share buybacks or by the company’s paying out its earnings in dividends, thus creating yields that the market will not be able to ignore.
The company’s competitors could also realize that it is cheaper for them to buy the company than to replicate its assets on their own.
This reality that undervaluation will not last forever is paramount to value investing. If we do a reasonable job at estimating what the business is worth, then, at some point, the stock market will price it accordingly.
VII. Active Value Investing
We have added to the standard value investing approach with the following principles:
We are not traditional buy-and-forget-to-sell investors. We have strict sell criteria in order to remain “active” buy-and-sell investors.
Given elevated market valuations and fragilities in the global economy, our margins of safety are even higher.
We value stocks based on what they’re worth, not what they used to trade at in the past.
We don’t time the market, as this strategy largely relies on luck and can’t be put into a repeatable process.
We’re not afraid to hold cash if we cannot find stocks of sufficient quality.