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Our Investing Discipline (GB @ GV = GI)
Great Businesses @ Great Valuations = Great Investments
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Great Businesses
EDMP, Inc. utilizes an investing formula that is logical, understandable, and embraces both growth and value disciplines as we search for great businesses that are also outstanding investments. Quite simply, our formula for investing success (GB @ GV = GI) is based upon the fact that over time market prices and earnings align. We show how the company’s stock price aligns with earnings over time and how returns correlate to business growth. However, there are periods when the market either overvalues or undervalues the company. These periods of undervaluation offer the astute investor the opportunity to purchase the stocks at a discount. Likewise, the uninformed investor could overpay during other periods.
The long-term relationship between earnings and market price holds true for individual equities. Therefore, our strategy is based upon investing in great businesses that have been, and are positioned, to consistently increase their earnings over time, and are trading at or below their True Worth™. We focus on earnings growth because as our research demonstrates earnings ultimately determine long-term investor returns. While we prize companies that have a track record of consistently strong earnings growth, we realize that overpaying for these great businesses can negatively impact expected returns. Therefore, we focus our efforts on purchasing shares of these great businesses when they are trading at or below their True Worth™. We believe that over time this strategy of focusing on great businesses that are trading at great valuations will result in long-term great investments.
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@ Great Valuations
Great investing opportunities occur when the shares of a great business are trading at or below its True Worth™. Since many great businesses are prized by investors for their consistent earnings growth, they often trade above their True Worth™. As a result, we must use great insight, patience and discipline in purchasing these companies at a price that is equal to or below the True Worth™ of the business.
We have found that valuation and earnings growth are the only true predictors of future returns. When you know the True Worth™ of the companies in which you invest, you can buy them when they are cheap, sell them when the price is too high and keep your emotions from contaminating the process. Since investors often overpay for companies with a proven history of increasing earnings, it is extremely difficult to locate great businesses that are trading at a discount to their True Worth™. However, by utilizing or research, which scans thousands of companies, our team of talented and experienced analysts are able to spot these rare investment opportunities.
Much of the turnover in our portfolios is driven by valuation changes. When companies become seriously overvalued, we either trim our holdings in the stock, or sell the entire position. A combination of experience, estimated future earnings growth and the availability of other attractive investments enter into the decision making process. Since the opportunities to purchase great businesses at a discount are so rare, our portfolios tend to be concentrated in 20 to 35 stocks.
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= Great Investments
The end result of investing in great businesses that have the characteristics we seek at a discount to their True Worth™ we believe to be a portfolio of stocks delivering index beating returns over the long-term cycle of bull and bear markets, a key objective for any investing strategy. As we noted earlier, managing the portfolio in a manner that both protects and grows wealth is vital in order to outperform over time.
We take a long-term approach to the market because we realize that it is possible for the stock of a great business to trade at a discount to its True Worth™ for years; however, experience has shown that eventually the stock’s True Worth™ will be realized by the market.
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The EDMP, Inc. Investing Model
Our strategy is based upon investing in great businesses. When investing in great businesses, it is important to remember several key points:
- It takes time for a business to grow to become a great business.
- Great businesses have a track record of consistent earnings growth over time. Furthermore, earnings growth is expected to continuet for the next three to five years.
- Great businesses are not perfect companies . . . they do not remain great forever. They operate in a dynamic and highly competitive global business environment where change is a constant. As businesses change, management teams come and go, and the competitive landscape evolves, some businesses quit being great.
- While other businesses have great years, great businesses tend to have great decades. These firms are not one-year wonders whose earnings soar and then collapse. Great businesses are built upon a solid base.
- Great success brings with it an even greater challenge . . . defying the law of large numbers. As a business grows in size, it becomes increasingly difficult to grow earnings at double-digit rates. As a result, mega-cap companies often see their earnings growth slow to low double-digit or even single-digit rates. Eventually earnings growth rates of these businesses begin to mirror the growth of the overall economy, making these firms less attractive investments.
Great businesses differentiate themselves from other businesses because they possess many of the following characteristics:
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These are the important characteristics of a great business.
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Forecasting is the Key
EDMP, Inc. bases its entire investing rationale upon the undeniable fact that earnings and cash flow determine market price and dividend income in the long run. Therefore, it only logically follows that reliably forecasting future earnings growth is crucial and the key to long-term investing success for our clients’ portfolios. We approach forecasting future earnings growth from both the macro and micro perspective.
The Macro Approach
To forecast future earnings growth with any degree of accuracy, it seems logical to place great emphasis on recognizing major future investment opportunities. Therefore, the research staff at EDMP, Inc. continuously seek and analyze major macroeconomic trends. First, we study and monitor demographics. The consumption patterns of the various segments of our population are knowable and thus provide clues to potentially profitable businesses.
For example, we believe it is important to recognize and understand the economic impact of our population’s current bi-modal distribution, namely, the “graying of America” and the “baby boomer generation.” Understanding the consumption tendencies of these and other demographic segments allows us to make informed forecasts as to the future health of several industries that will serve these large and growing markets.
We are constantly searching for information and knowledge regarding the rapid advances in new technologies, scientific breakthroughs, and creative ideas that portend the advancement and possibly the birth of new industries and their accompanying profit opportunities. Although it is our firm’s policy not to invest in new technologies too early because of higher risk, we feel it is important to recognize them early and develop a knowledge base and assimilate the data to prepare for future investment opportunities. This macroeconomic approach greatly facilitates the forecasting process.
The Micro Approach
Ultimately, it is the individual security or stock selection that produces long-term returns. Therefore, we have developed an extensive information-gathering network on each company we follow. We obtain research on hundreds of corporations, and from brokerage houses and research oriented securities firms. Consensus earnings forecasts from the nation’s leading and most reputable analysts are collected and evaluated. Then, our own fundamental in-house analysis is prepared which provides us reasonable earnings estimates on each company we follow. Once established, we continuously monitor and update our earnings forecast to stay current.
Conclusion
We cannot escape the obligation to forecast -- our results depend on it. Our forecasts are not prophecy. We do not guess. We do not play hunches. We calculate reasonable probabilities based on all factual information that we assemble. Analytical methods are then employed based upon our underlying earnings-driven rationale, providing us reasons to believe that the relationships producing earnings growth will persist in the future.
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