Patrick Kaser: How do we put ourselves in the best position for consistent, long-term success? Recognizing that we’re not going to beat the market in any given year, but if you have a good process and if you implement it well, that’s going to give you the best chance for a positive, long-term outcome — defined as beating the market.
Wally Forbes: So, you’re aiming for long-term results rather than short-term results. What is your basic approach?
Kaser: We’re first and foremost a value manager looking for undervalued situations. We generally look for undervalued companies with strong balance sheets and strong free cash flow that is sustainable in a variety of market environments. And then, hopefully, a quality business that’s growing earnings, returning capital to shareholders, and at a low valuation. So there are a lot of things that we want put all together.
The reason we look for these things is that if we have a company that has strong free cash flow in a variety of economic environments, we then have sustainability. We know that the dividend is safe, for example. We know they have options either to reinvest, to buy back stock, and opportunities to grow the business because ultimately the market does pay for future earnings.
And the other thing that free cash flow gives us is a margin of safety. Very few companies with strong balance sheets and sustainable free cash flow go bankrupt. We joke that you can’t spend EBITDA (earnings before interest, taxes, depreciation and amortization) but you can spend cash flow. And we take risks very seriously, so we don’t determine value based on future earnings forecasts.
Earnings forecasts are built on assumptions that will invariably be wrong. It’s just a matter of magnitude as to how wrong they are. So, we determine the intrinsic value of the company by looking at a company right at this point in time and not buying into some story about future growth.
Forbes: So you’re not projecting growth in earnings or dividends or otherwise. You’re looking at it as it stands?
Kaser: Yes. We want things that are cheap right now. Growth is a bonus for us. So, we determine value by looking at the present or looking backward. One mistake I think investors have made in the past few years is that too many people look into the rear view mirror to determine risk.
Take for example, financial stocks — specifically companies like banks and life insurers. People look in that rear view mirror, and they say, “Wow, this is a scary group.” But, generally the next crisis is very different from the past crisis.
And generally companies, like people, learn from their mistakes. So, looking backward is generally not the right way to evaluate risk. Risks should be analyzed on a forward-looking basis. What’s going to kill this company in the future? What are the competitive risks going forward?
Forbes: But you’re not predicting or trying to project earnings as such?
Kaser: No, we’re not. We don’t try to model earnings, but we do try to think about future risks. We look for value right now and ask “what could destroy that value going forward?” Sometimes things are cheap for a reason. What we do at Brandywine Global is try to manage risk through a collaborative process.
We don’t have a culture where an analyst comes to the table with an idea and whether or not we buy that stock idea is based partly on the analyst’s presentation skill. In other words, we don’t want to get talked into an idea just because someone has good presentation skills.
So everything that we buy, we’re generally going to have two or more analysts looking at that idea, independently, doing original work on the company, and then getting together and comparing notes. We think that helps us to manage the risks, helps us avoid groupthink and some of the other biases that, when you get two people working together, you might have. And it delivers better long-term results for our clients.
Forbes: So you do things without projecting earnings, per se, but by trying to evaluate risk as a business risk or risks from external sources?