There are 7 pillars of our investment philosophy which form the foundation of our investment process.


Long-term perspective.

        We view investing as a marathon, not a series of sprints. We prefer to be measured over a five year horizon but believe that three years is a minimum for judging our performance. The great-grandfather of investing and Warren Buffett’s mentor, Benjamin Graham, observed, “In the short run, the market is a voting machine (influenced by popularity), but in the long run, it is a weighing machine. ”Stock prices in the short run may react to world news, rumors, analyst recommendations, forced selling by institutional holders facing redemptions, or speculative buying by momentum-driven investors – all of which has little to do with the underlying ability of the company to continue generating cash flow or its related underlying value. In the long run, however, stock prices track closely with earnings and cash flow. For example, McGraw Hill stock has returned 11.6% per year for the 30 years ended April 2006, compared to the 11.7% compound return for its earnings.


Stocks represent an ownership interest in a business.

       Because stocks can be so easily bought and sold in computer-generated trades, many are tempted to treat them as faceless trends on a chart. At Lateef, we view stocks for what they are: an ownership interest in a business led by managers who view us as co-owners. We do not sell a company just because news headlines trumpet a macro-economic or political concern. We do not use market timing tactics. We do not move to cash, use derivatives, short stocks, hedge, or use arbitrage. We focus on the business fundamentals that dictate the ability of the company to generate higher cash flow and a related higher intrinsic value.


Focus on absolute returns.

        We believe the best way to make money is: first, not to lose money. Risk, in our view, is defined as losing money. Period. Risk is not monthly variability of performance versus an index. We know that to recover from a 50% loss, an investor must double his money just to break even.
       There are two risks that we try to minimize: price risk and business risk. Price risk is the risk of paying too much even for a terrific company. For example, investors who bought General Electric in 2000 were still underwater by almost 50% in 2006, even though earnings almost doubled during that six-year period. Business risk is the risk that the competitive advantage a company once enjoyed will erode or crumble altogether, resulting in a permanent loss of capital. We invest a great deal of time in order to assure ourselves that competitive barriers surrounding the businesses we invest in are high, and that the prices we pay include a margin of safety to minimize downside risk.


Stock prices do not always equal value.

        We are sometimes asked if we employ a stop-loss limit on our investments. A stop-loss rule has been used by some investors as an insurance policy. For example, if a stock drops by 20% from cost, they automatically sell so they still have 80% of their capital. They sell for fear that the stock might drop much further,but panic selling locks in losses. At Lateef, we try to understand what is causing a stock to drop in price. Intrinsic value is a relatively stable estimate of what a business is worth based on its discounted future cash flows. It is not uncommon for a stock to vary by as much as 50% from its high and low price within a year. We try to capitalize on the inevitable disconnect between a company’s intrinsic value and its stock price.


Opportunistic investment approach.

       We believe in investing in the most outstanding businesses led by terrific managers at attractive prices – regardless of the size of the company. Many other money managers are locked into a “style-box,” such as large-cap growth or small-cap value, and must remain invested in this box even when there are few or no compelling values in that segment of the investing universe. Our ability to preserve capital during the challenging years of 2000–2002 was a direct result of our flexibility to invest where it made sense to do so. In March of 2000, the Value Line index of 1,500 equally weighted companies (more representative of mid-cap companies) was trading at 13x earnings, compared to the S&P 500 index (market-cap weighted and dominated by large-cap companies), which was trading at 30x earnings. Clearly, the opportunities were in mid to smaller sized companies, and we made the switch.


Concentrated Portfolios.

       We are conservative without necessarily being conventional. Our portfolios typically have between 15–20 companies. This focused approach has three clear advantages. The first advantage is that our winners make a real difference in performance. If a stock doubles in a portfolio of 50–100 companies, the impact on performance will be small. While concentration can be a double-edged sword, our track record has proven that carefully selected companies bought at prudent prices with limited downside risk can result in sound portfolio performance with less volatility than the market. Although our portfolios are relatively concentrated, we rarely own more than two stocks in the same business. The second advantage is that our focused approach allows us to leverage our intensive research into our very best ideas. Warren Buffett has said, “Diversification is a hedge for ignorance.” The third advantage is that our long holding period generally results in a good relationship with management, which is important to us as we prefer managements that think of investors as business partners.


Low Portfolio Turnover.

       Our annual turnover averages about 25%, which means that we hold stocks for about four years. This turnover reflects the ongoing process of trimming oversized weights and selling certain stocks in favor of more compelling ones availed by normal market volatility. A 25% turnover in a 15–20 stock portfolio means that all we need are three to four new ideas per year. This allows us to wait patiently for the most attractive opportunities. Furthermore, taxes can be one of the greatest obstacles to building capital, and our low turnover produces attractive after-tax returns.