Concentrated Portfolio Approach
Limiting the number of holdings is a critical part of our investment approach and serves as an important sell discipline. Our US portfolios typically contain 15-20 stocks and the Global portfolios contain 25-30 positions. Every day, W.P. Stewart is evaluating every position. When a new holding is introduced to the universe, it forces the team to challenge the conviction level of all of the existing stocks in the portfolio.
Valuation model
We use a valuation model that is based on our internally generated five year earnings projections for each of the universe companies. This appraisal technique systematically examines all relevant factors, such as the quality of assets, consistency of earnings growth, ability to finance growth without high levels of debt, strength of product line, competitive position, capability of management, inflation adaptability, and many others. It enables us to apply our estimates of future relative market valuations to the growth in earnings to judge a total projected value per share in five years time. By discounting this projected value using a risk adjusted discount rate, based on the risk free rate and perceived individual stock risk, we can evaluate the degree of over or undervaluation reflected in the current share price and hence identify the stocks in our universe which appear most attractive.
Importantly, this drives our buy and sell discipline, with holdings from our universe only bought when valuations are well below our appraisal of fair value of the discounted estimated earnings stream. Holdings are sold when our price objectives are exceeded and are often reduced as the price moves towards this target. Finally, to ensure that our focus remains on absolute risk, target returns are constantly compared to risk-free returns.
By using this very transparent approach to valuation, our portfolio managers can constantly challenge the assumptions and price targets for holdings in the portfolio. Notwithstanding its discipline and proven effectiveness, our appraisal method is not reliant upon a set of rigid formulae. Ultimately it is driven by judgement, which is the reason that we place such high emphasis on having proven and experienced investment professionals.