At Barnett & Company we believe it is typical in the world of investing for perception to change faster than reality. We recognize the wisdom in buying investments that are believed to be the ones other investors will want to own in the future and avoiding those that are over-popular in the present. This approach sets our investment philosophy apart and categorizes us as value managers. In the greater scheme of things most fund managers are known as either growth or value types. The terms are misleading since one cannot have value without growth nor growth without value. What they do imply is an investment managers approach to investing.
Growth managers tend to look primarily at the big picture in anticipating the next investment fad or fashion, paying less attention to the current price and specifics of a stock. Growth investing can be characterized as momentum investing in that growth managers try to buy stocks that are increasing in value faster than the overall market and then attempt to sell before they turn down. By contrast, value managers tend to approach investing more from the bottom up. By screening for certain attributes the value manager attempts to discern the case that can be made for purchasing a given stock. A stocks investment value is viewed as a cushion for any downside it may exhibit. Its upside is determined by looking at a number of other factors that are not currently priced into the stock.
Today, for example, many investors tend to focus primarily and perhaps obsessively on earnings forecasts when deciding what to buy. The health of a company, as evidenced by its balance sheet, is often overlooked.
At Barnett & Company we believe the health of a firm is a very important factor in determining the risk associated with an investment. Even if a company has strong earnings prospects, it may not have the strength to survive if it fails to realize those prospects in a timely fashion. Healthier companies are more likely to have the staying power needed to correct problems when they occur and to take advantage of opportunities that may not exist at the time their future earnings are forecast.
Through a process of screening large numbers of stocks using public information and proprietary databases available by subscription, Barnett & Company looks for companies with both positive prospects and low current valuation relative to those prospects. We then evaluate the financial health of the company offering the stock, using a number of additional screening tools. Finally, we perform qualitative analysis by perusing the companys SEC documents and testing for attributes that would have an adverse effect on stock ownership. For appreciation-oriented accounts, the end result of these efforts is a collection of stocks that we believe merit investment consideration. When several stocks in a given industry make the list, we narrow them down to the one or two companies in the group that we feel are the best prospects for appreciation.
The bottom-line goal when buying a stock for appreciation is for it to double its value in three to five years. Even if this objective is not realized, the goal itself tends to focus thinking on long-term potential rather than on short-term trading. Such focus is especially helpful in situations where long-term capital gains taxes are desired.
In investing for both current income and appreciation, Barnett & Company deploys a more modest goal for price changes, since a material portion of return comes from cash flow. We use the same balance sheet analysis in bond investing that we use in stock screening, although the criteria are different since bondholders do not usually participate in a firms earnings appreciation as stockholders do. In bond investing, our analysis centers around the issuers ability to meet its coupon payments, repay its principal and, should the bond become impaired, return its investment in reorganization.
The types of bonds we use again depend on our clients needs: income desired, risk tolerance, and the amount of funds available for investment. We recommend bonds of medium grade for the client who needs relatively high amounts of income from his or her investments, if the investor is willing to accept the associated risk of default that comes with such investments. Clients who need lower amounts of income or who have a lower tolerance for risk are directed to investment-grade or government bonds.