We aim to create a portfolio of stocks that will not only potentially outperform the market over time, but will also help preserve principal in difficult market environments. Ours is a classic, value-driven strategy that focuses on out-of-favor companies that we believe are currently mispriced by the market.

We believe that reversion to the mean is the single most consistent and powerful force in investing. Whenever a company's earnings temporarily veer out of line with the norm, whether above or below, we can be reasonably confident that eventually returns will revert to their normal state. If earnings climb to above normal capacity, for example, we can anticipate that eventually competition will erode the excess returns. The same principle applies if returns fall due to an identifiable (and fixable) problem. As long as a company's business fundamentals remain strong, when the problem is resolved and operations revert to normal, earnings will follow. When the market as a whole fails to recognize future value in a stock that is experiencing temporary problems, the opportunity exists to take advantage of inefficiencies. The market focuses on the problems, often acting as if that situation will continue indefinitely. By doing our research, we can invest only in those whose problems are fixable, and focus on the future value.

The validity of our investment philosophy has been consistently demonstrated not only by 15 years of our own experience and in-depth internal research, but also by independent academic and empirical data.

How do you select stocks for the portfolio?

We start by performing an initial valuation screening on a universe of more than 1,000 large companies in about 20 sectors. Using proprietary models that we have developed over time, we rank those companies based on the combination – and weighting – of factors that historically have best predicted the future performance and level of valuation of each stock within its industry as well as relative to the rest of the stock universe. These factors include quantitative variables such as price-to-earnings ratio, price-to-book ratio, price-to-cash flow ratio, price-to-sales ratio as well as dividend yield.

How do you determine the weighting for each stock in the portfolio?

While we are comfortable with the stocks we buy, we acknowledge that we don't know which will be the single best performer. That's why, unlike many other portfolio managers, we weight all holdings in the portfolio equally, although we will deviate on rare occasion. Each company generally represents approximately 2% of total portfolio holdings, with a strict maximum of 5%. We may periodically overweight in a particular sector if our initial screening signals extremely low valuations that are confirmed by our due diligence. However, we limit the amount invested in any one sector to approximately 25 times the benchmark index weight in order to ensure adequate diversification. Any shifts in allocation are usually caused by the appreciation or depreciation of holdings. Periodically, we review the relative weightings to determine if we need to rebalance, taking profits in those that have appreciated and/or putting more capital into those that have depreciated, in order to revert to the original allocation.

How do you manage risk?

When it comes to undervalued stocks, the market already has low expectations. A stock is generally undervalued because it has experienced some bad news to which the market has responded by lowering the price. Because additional problems are expected, bad earnings reports or other news generally won't have as big a relative effect on the stock price. On the other hand, undervalued stocks enjoy a lot of potential upside movement. In addition, downside risk is limited by our flexible investment process, which doesn't force us to have exposure in a sector or industry where we have not identified a compelling valuation. Our process also leads us to emphasize stocks with high dividend yields, which can serve to help offset losses in the event they do occur.

When would you sell a stock?

We are patient investors and will hold onto a stock as long as the reasons we purchased it in the first place still hold true. Although we don't follow any time guidelines, on average we hold stocks for about four years. However, several triggers will cause us to consider selling a stock. We will sell a stock when it is fairly valued. We will also eliminate a holding from the portfolio if it begins to perform in a way that is counter to our expectations. For example, if the management fails to execute the business plan or dividend repurchasing strategy it had outlined. In addition, we regularly review our holdings, as well as other companies, and continually reevaluate where the best opportunities lie.