This is the second piece in our Broyhill Letter Highlight series, highlighting our thoughts on what differentiates Broyhill as a value investor over the years. You can access other posts in the series here.
For those who would like to revisit our letters in full, we will also be gradually sharing them to our Research Studio throughout the series.
Value investing is simple, but not easy. The math behind most of our decisions is not rocket science. Investment techniques can be easily taught. Consistent application is far more challenging. As Seth Klarman stated in Margin of Safety, “The hard part is discipline, patience, and judgment. Investors need discipline to avoid the many unattractive pitches that are thrown, patience to wait for the right pitch, and judgment to know when it is time to swing.”
Investing is all about expectations. To generate excess returns, you must have a view as to why future fundamentals will be different than expected. If they are not, even a company with terrific fundamentals can be a poor performer. Conversely, a company with terrible fundamentals can be a great stock. Stocks do poorly when they disappoint. The flip side, is that they do quite well when they surprise to the upside.
When purchased at the right price, even a melting ice cube can offer a refreshing return. The liquidation of peers, acquisitions that consolidate market share, and cost cuts often leave the last man standing with quite a nice stream of recurring cash flow. We focus on those situations in which expectations are so low that the odds of a positive surprise are in our favor. In other words, we focus on the fallen that are likely to be restored.
Low expectations don’t guarantee good outcomes. But when the bar is set low enough, positive surprises are much easier to come by. That seems a lot easier than depending on perfect execution to get more perfect. To do this, one must remain comfortable holding the view that the market is wrong, that price is a liar.
To produce better-than-average results, you need to own a different portfolio than the average. This remains true at Broyhill. What also remains true is that we don’t look like the average value investor, either. This is by design. Value investing at Broyhill is more than just buying low P/E or low P/B stocks. We are actively seeking businesses that trade below fair value with catalysts on the horizon to highlight that value.
In challenging market environments, we gravitate towards event-driven situations that are less susceptible to fickle investor sentiment. In the context of an increasingly volatile investment climate, a well-defined catalyst, like an acquisition, can provide a more predictable range of outcomes without depending on the vagaries of the market or the unpredictable mood of investors. As a result, these investments can decrease portfolio duration and volatility, reduce downside in bear markets, and provide attractive risk-adjusted returns.
We take comfort in knowing that we don't own the market. Rather, we own a concentrated portfolio of good businesses trading at attractive prices, with multiple ways to win.
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