Equities

Investment Strategy for Equities

Our investment strategy for equities is to take advantage of the capital appreciation potential presented by companies whose stock prices have temporarily declined and which are attractively priced relative to our proprietary calculation of their intrinsic value. This strategy is integrated into our investment decision-making. We independently research viable investment opportunities utilizing quantitative and qualitative criteria and financial modeling that we have developed over the years. Additionally, we recognize and consider macro-economic circumstances and market history as informative tools, and we endeavor to capitalize on the behavioral elements that influence the marketplace. Taking a long-term investment focus, we measure the risk and reward of buying and holding certain securities by applying the information we have gleaned from our quantitative tools and independent research.

Equity Portfolio Construction

Mispriced Securities. The starting point in our process is screening across various industries and market capitalizations to identify potentially mispriced securities. We search for anomalies, unexpected events, major dislocations, deviation from expectations, or anything that seems unusual in connection with a particular company. We believe the market is generally efficient, but with two noteworthy exceptions: it doesn’t absorb new information well, nor does it accommodate uncertainty easily. Investors dislike uncertainty and the result is mispriced securities. We accept uncertainty as long as we can apply reasonable numbers to a variety of possible outcomes.

Financial and Competitive Strength. We further screen for financially strong companies that have relatively low price-to-earnings, price-to-book and/or price-to-sales multiples, or comparatively high dividend or cash flow yields. We seek companies that have generated sustained profitability over time, that have a history of reinvesting profits for sustained growth or distributing profits to shareholders, and that occupy a secure, competitive position in their industries.

Intrinsic Value. The heart of our stock valuation methodology is our determination of a stock’s intrinsic value. We determine the intrinsic value of a stock by first calculating the present value of future cash flows based on reasonable estimates of sustainable corporate operations. We then integrate myriad other quantitative and qualitative proprietary metrics to reach intrinsic value.

Risk Management. We employ a number of structural elements in our investment process that we believe substantially enhance risk management and performance of our clients' portfolios, regardless of the market environment and direction. These elements include a company stress-testing process, a graduated purchase process, a stock "watchdog" system, and an automatic sale protocol.

Scenario Analysis/Stress Testing. Although we have long employed intrinsic value modeling using a range of assumptions, we have an enhanced stress testing component of our modeling. Our company screening process begins by identifying an investment opportunity set (for example, the companies included in the S&P 500). We then employ a proprietary valuation and ranking technique, which calculates each company’s intrinsic value under nine different scenarios. This improved regimen creates, through scenario analysis and stress-testing, a robust idea generation tool designed to improve stock selection and reduce downside risk in our clients’ portfolios.
Graduated Positioning. As value-oriented investment managers, we are mindful of “being early” risk. To address this risk, once we decide to purchase a security for client portfolios, rather than establish a full position at inception, we often “ease in,” beginning with a lower position and gradually increasing the weighting over time. We believe this approach acknowledges and addresses the tendency of value investors to be early.
The Portfolio Watchdog. Many investment management firms employ a system in which each analyst or portfolio manager has 100 percent accountability for his or her ideas. We think this approach contravenes human nature. Studies have shown that humans have tremendous loss aversion and often need assistance in identifying and dealing with mistakes. To address this behavioral deficiency, we have devised a supplemental measure of portfolio scrutiny that we call our “watchdog” system. The essential purpose of the system is to “blow the whistle,” or call attention to companies in which our initial investment thesis is not tracking. The benefit of this system is that the watchdog has no subjective attachment to a particular holding and thus can be more objective in determining whether a mistake has been made (or may be made), thereby reducing the possibility of loss occasioned by bias, subjectivity, or inertia.
Systematic Sale Protocol. Recognizing the fundamental importance of capital preservation in our clients’ portfolios and the impact on returns of an out-sized loss, we have adopted, as a tactical step to further our risk management strategy, a systematic sale or “stop-loss” protocol that injects additional objectivity into the management of any holdings that decline significantly in share price. Selling underperforming securities allows us to recalibrate emotionally and reconsider prospective holdings with less bias.

Willis Investment Counsel

710 Green Street
Gainesville, GA 30501

Phone: 770.718.0706
Fax: 770.718.0805
www.wicinvest.com
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