With much of the financial media fixated over the battle between retail traders and hedge fund managers, we thought we would take a moment to remind our clients of our approach to stock investing. At Cardinal Capital we take a value-oriented approach to investing. What does that mean? When we buy stocks, we are buying ownership in companies that we want to own for the longer term. As such, we think it’s important to determine how the companies are valued relative to historical price-value metric’s relationships and understand a company’s fundamentals before purchasing shares. Our longer term orientation allows us to look out further on the horizon to capture investment returns that are not pursued by those focused on the next data point for purchase or sale.
Our process begins with our model that identifies companies that are statistically undervalued based on the current stock price relative to historical valuation metrics. Our model implicitly assumes that price changes more than value. If the company is undervalued, then the stock price should adjust to reflect correct valuation within three to five years. Thus our model is systematic and unbiased in identifying stocks trading at discounts to their normal price value relationships.
We like companies with competitive advantages capable of sustaining growth and earning higher returns on invested capital. The process of answering these fundamental questions about future economic profits and sustainable competitive advantages includes carefully researching the company and its industry. This fundamental analysis is a key component of understanding the outlook for a company’s future profitability and competitive forces.
Sources of competitive advantages include brands, patents, cost advantages, superior share of market, pricing power, and strong customer relationships. A brand creates a competitive advantage if it increases the customer’s willingness to pay a premium for its product or creates recurring business. Think about this the next time you fork over extra dollars for a Starbucks coffee. Similarly a patent keeps competitors at bay and protects their investment in research and development for several years while the company generates revenue that enables returns on invested capital equal to or above its cost of capital. This is one of the reasons we like pharmaceutical companies with large patent portfolios and pipelines of late-stage products to offset inevitable future patent expirations.
Our objective is to construct portfolios that are made up of high quality companies acquired at attractive prices, well diversified by industry, geography and market capitalization, and that produce less volatility relative to the broad markets. Our long-term perspective improves risk control, minimizes trading costs and taxes (almost entirely long-term capital gains and dividends), and enhances overall performance results.
What are we doing in the current market environment? We continue to search for sustainable growth available at good value and deepen our understanding of both the businesses we own and those we would like to own in the future. Our task is to uncover companies capable of producing sustainable growth at great value hidden in any market.
We hope you and your loved ones are safe and healthy, and encourage you to reach out for any support you need. Thank you for your trust in Cardinal Capital.
