Our Strategy

It is our experience and conviction that value investing is the sole approach that offers attractive returns and safety of principal (your invested capital) on a sustainable level. To reap the fruits this approach possibly provides we developed and apply a strict and disciplined value investing strategy.

Generally speaking what we look for are outstanding companies with a proven business model - shown by a strong and sustainable cash flow level as well as a rock solid balance sheet - that can be bought at a sufficient discount to its current price (Value > price). More importantly we want to make sure that we just engage in businesses that are not only able to turn their strategy into cash, but that offer sufficient resources to weather even the worst market crisis and have done so in the past. This is a vital part in our understanding of risk control.

It goes without saying that this strategy can only be pursued by conducting extensive due diligence, very detailed oriented work and following a high set of standards.

To act on the forefront of our own vesting we developed the so called “ARX Value Standards” that outline the cornerstones of our strategy and set the guidelines for what complies with our strict definition of a real value investing opportunity. It can be seen as minimum requirements or a checklist that makes sure that we always focus on what is really important and don’t get soaked up in the foolish game of today’s stock market: Value is all that counts!

 

 

 

  

 

“Investment opportunities are like buses: there is always another one coming.”

BUT to differentiate yourself from the competition in terms of investment returns, we don’t think it is a wise strategy to have a finger in every pie. You have to be very selective!

Excellent investment opportunities - in terms of providing compelling returns without putting the invested capital at risk - are hard to find and unfortunately present themselves only on an irregular basis.

The ARX Value investment principles are build to cherry-pick and to focus on only the best business cases - what we believe meets the characteristics of a true and lasting value opportunity.

A good starting point in this strategy is to define criteria that constitute excellence in terms of value and to narrow down our research on companies that show these qualities. Therefore we exclusively turn our attention on outstanding businesses or “ARX Businesses” as we call it within our firm.

But what really characterizes an ARX Business?

What we subsume as an ARX Business is basically a company that - under regular circumstances - is highly successful in its market, is constantly able to turn its success into profits for investors (high cash flows, high ROIC, an attractive dividend-yield, etc.) and possess intrinsic characteristics (durable competitive advantage) that allow it to continue doing so in the future.

Without exception we apply a demanding set of criteria that every business model has to pass and conduct extensive due diligence to make sure that what we would define as an ARX Business is not a one hit wonder, but performs on a durable basis.

The following illustration gives a general impression of some of the main characteristics an ARX Business stands for:

 

We believe that the key to lasting success is a durable competitive advantage (“Moat”). This is what sets a company apart from its competition and makes sure that the favorable characteristics can be maintained in the foreseeable future (like an insurance to protect against dilutive effects).

 It regularly is the prerequisite why a company’s business model shows an industry leading profitability, strong and sustainable free cash flows and thus the ability to build up a solid balance sheet structure.

  We really enjoy to get to the bottom of a company and to single out only these businesses that can provide a unique durable competitive advantage!

(The best business would be a business model so compelling that you would feel comfortable to own it forever).

 

 

 

Value is not a "flowery phrase" used to promote a certain investment style. Correctly measured it is the only viable dimension that allows us to reliably judge a business's worth and differentiate between a wise investment and plain speculation. Finding a company that shows real fundamental value and where the sources of value are identified to be solid and sustainable can be seen as a perfectly paved road to investment success. Not to mention that "value" functions as a safety net in case of unexpected events.

But what really determines value in a way that a conservative investor can truly rely an?

We look for sources of value that can't be easily manipulated and that are distributable to shareholders no matter what economic scenario we are currently facing:

1. The free cash flow a business model is able to generate on a sustainable basis, unaffected by one time favorable events.

We really follow the simple phrase "Cash is king"!

First cash is something you can simply count and rely on, not based on "hopes & dreams" and hard to manipulate by accounting gimmicks.
Second it gives businesses the freedom to grow and finance its operations/projects internally, without the need to depend on "double-minded" financial institutions. Especially in severe recessions when the market for external financing dries out, a portfolio of "cash flow strong" companies allows us (and yourself) to sleep at night. Our experience and empirical evidence show that businesses with sufficient cash flow power clearly outperform "Mr. Market".

Thinking about what drives a cash flow figure, we have a special aptitude for business models that proved to be highly profitable as well as capital light and where the positive cash flow is allocated in a way that it adds value to the company and thus for its shareholders.

2. Real asset value - the resources a company invested and that can be transformed into cash.

It is not only vital that a business is cash flow generative, but also that the free funds are wisely used. The employment of funds, called "capital allocation" is one of the most important aspects we look into. Excellent businesses employ their capital (e.g. investing in plants, new products and markets or such) in a way that it adds value, meaning that it allows for profitable growth and expansion in cash flow and return on capital. A counterexample would be the acquisition of a competitor that ties up a lot of capital, massively overpays for the expected benefits and eventually dilutes what an investor can get out of the new entity.

The resources a company uses to run its business and that are tied up as assets on the balance sheet can represent a solid source of value itself and regularly back up our cash flow approach.
It is important not to take the assets value as stated, but to analyze the characteristics of it. Most assets can only be sold in the marketplace ("turned into cash") with an appropriate discount or are "custom-build", so that there might not be a buyer for it at all - a misjudgment the "standard" investors regularly put their feet in.

Our approach is driven to only account for assets that can be realistically turned into cash or - in case we consider long term assets - where we have a high probability that an external buyer would pay a reasonable price for it. The sum of these verifiable assets, after subtracting all relevant debt, builds our "Real Asset Value".

Investments in high quality companies that trade well below their real asset value frequently turn out to be the most promising ones. There is another, well proven argument to follow the "Real Asset Value"-approach: Correctly calculated this number can be seen as a floor or a kind of "insurance policy" for what a company is worth. Just imagine the enterprise goes out of business and has to sell all its assets and pay back what it owes to debtors and such. Under this scenario we as equity owner do not have to end up empty handed, but fortunately receive the "real asset value" as residual payment.

 

 

 

"price is what you pay, value is what you get"

"Margin of safety" is one of the most powerful and important concepts within the ARX Value investment approach. Finding outstanding businesses (ARX Businesses) that offer attractive and sustainable free cash flows and/or high quality assets is just one part of the equation. The other part - at least just as important - is to decide what price to pay for the identified business.

We systematically determine the fair value of a company based on the sustainable free cash flows the business model can earn year over year (DCF-Valuation) and additionally, based on its "Real Asset Value". This is done with very conservative assumptions. We believe that past actions and the financial "status quo" tells more about the quality of a business than a "bloomy" guidance or the expectation to hit the next megatrend. In fact the experience from financial recessions taught us that it is more important to know what a business model can earn even in the worst economic downturn and to go from there.

Valuation is not an exact science and nobody has a "crystal ball" to foresee the future. All we can bring to the table is our extensive experience and knowledge coupled with our well thought-out investment approach and work as hard as we can. But this does not protect us from being wrong or simply being misguided by incomplete information from time to time. Here it is where the "Margin of Safety" concept comes into play:

We just invest into a company if we can buy into it for at least 30% below what we have calculated as its conservative "fair value"!

This follows a simple line of thought: Let's assume we value a business to be worth 100 €/share and took the opportunity to build up a position at 70 €/share. Now an unexpected event takes place that strongly challenges our assumptions and leads to a revaluation at 80 € (fair value -20% lower) per share. Even under this "new scenario" we haven't lost a dime as we were conservative enough to require a sufficient discount. Thus the "margin of safety" can be seen as a cushion for "black swans" (metaphor for events that come as a surprise) or as a kind of insurance policy. That is what we owe our investor: always put the safety of capital first!

The following illustration explains how the "margin of safety" concept works:

 

To require a discount of at least 30% is not only a way to always sit on the right side of the table, but also goes along with our very selective ("cherry picking") investment approach. If one puts in extensive work to identify both, an excellent business model in conjunction with an appealing valuation, there needs to be a sufficient payout! Thus all prospect portfolio investments should potentially offer a return of 40% or more over time, based on conservative assumptions.

 

 

 

Qualitative factors – so-called soft factors - of a company are the most difficult to analyze, though they can be one of the most influential factors for the success of an investment. Bad management can have a severe impact on a company's (temporary) performance.

• It goes without saying that we only consider an investment when the management strikes us to be honest and full of integrity.
• Involvement in lawsuits, justifiable bad reputation, megalomania and such are definite "no-go criteria".
• Long-term thinking, which clearly follows the well being of the business and adds value for its stakeholders and especially for us, its shareholders, is the way to go!

It is our conviction that financial performance - either good or bad - and the information given in financial statements tells a lot about the quality of a company's management. How capital is allocated, how the balance sheet is managed, what actions are taken to create growth or restructuring activities reveal so much about whether the management knows what they are doing or not. Additionally meetings with management and the degree of transparency tendered to shareholders are vital sources for us. It is not that a decision made by executives always needs to be right - everyone is fallible - but it is the way they handle the consequences that distinguishes good from bad management. You can take it for granted that the same is true for us.

 

 

 

Taken from the brilliant thinker Albert Einstein who listed five ascending levels of intellect ("Smart, Intelligent, Brilliant, Genius, Simple") we prefer to apply a simple set of rules to help us avoid common pitfalls that usually come along with bad investment results:

• We do our best to ignore the pschological games of today's stock market

As the stock market is not a rational "creature" and often moves up- and downward in an arbitrary way we just act when a real value opportunity is presented by "Mr. Market", definitely not when something is supposed to be "hot" or the next "megatrend" promoted by dodgy sources like the media or the so-called sell side. Patience is key!

• We base an investment decision exclusively on our own proven approach to analyse and value the quantitative and qualitative metrics of a company

It is important to do your own homework and if necessary to take a viewpoint that deviates from the general market view. "Standard information" is already reflected in today's stock market so there is no extra return available if you are not willing to go the extra mile in terms of detail and level of thinking. Deviate from the crowd!

• We always stay in our circle of competence. Avoid what you don't understand!

It is our conviction that there are natural constraints to the degree an educated mind can fully understand certain companies. Therefore we solely focus on the business models we cleary understand and where enough information is available to come to a sound conclusion.

• It's healty to stay self-critical and to constantly challenge your own investment cases.

It is clear that we act in a dynamic environment and no one has a crystal ball to predict the future. Adverse events can unexpectely happen and put your investment at risk. Therefore we are prepared to act decisively in case we were wrong and to gear our portfolio towards investments that have proven to weather even the worst crises.

• Transparency and an open communication are an integral part of our client policy

We always put our clients' interest first. This is not only true in a "clear sky" environment where it is easy to reach stellar returns, but also - not to say particularly - when there is a bumpy road ahead. Honesty and integrity are the groundwork for a lasting client relationship.

At the end of the day, we agree with what Warren Buffet once said...

"We don't have to be smarter than the rest. We have to more disciplined than the rest"