Market Buzz - What to Look for in a Stock - Key Traits

Earnings and Cash Flow – Show Me the Money

The first thing we do when applying our criteria to potential investments is say, “Show me the money.” At
minimum, our criterion requires that a company be generating current cash flow and earnings from normal
operations to qualify for our research. Anything less would be speculation. No matter how great a story
sounds or how promising a proprietary technology or product may be, we would not consider coverage on a
company without existing profits. The reason for this is simple. The transition from pre-revenue, pre-profit,
into a sustainable, cash flow positive company is long, arduous journey that presents immeasurable risks.
Companies with no revenue or earnings have not yet proven to us (or the market) that they have the ability
to become sustainable, value-generating entities. They rely on a continuous infusion of capital (from issuing
additional shares or debt) which is used to pay expenses (such as management salaries) and ultimately dilutes
the shareholder’s ownership of the company. Profitable companies at the very least have demonstrated that they
have the ability to generate real economic value. By limiting yourself to investments in profitable entities, you
automatically avoid a great deal of the risk in the stock market that kills most investors. If there were a single
piece of advice we would give individual investors, it would be to stick to companies with a proven ability to
generate significant profitability.

Strong Business Prospects

More than just the cash flow today, we are also concerned about the cash flow tomorrow. In fact it is tomorrow’s
cash flow that is going to drive the share price. A company with strong growth prospects is not only in a good
position to maintain their current level of earnings but also to grow earnings over time. Sometimes this growth
is steady and incremental and sometimes it’s explosive. It can also be short-term in nature or it could potential
extend throughout the foreseeable future. Understanding the business prospects of the individual company,
its products or services, and the industry in which it operates, gives you better visibility as to whether or not
earnings and cash flow is likely to grow or decline in the future and by how much.

Healthy Financial Position

The financial position is the foundation that supports the business. We assess this health largely through
analysis of the Balance Sheet. Just like a person, a company has both assets and liabilities. Assets are used by
the company to generate revenue and cash flow. Liabilities, such as debt, represent outside claims on the assets
and obligations to make payments in the future. Too much debt on the balance sheet reflects a higher level of
risk and more susceptibility to outside forces such as a weak economy, constrained capital markets and interest
rate fluctuations. The ideal balance sheet for us is one with a mountain of cash and little to no debt. Although
these types of opportunities are available, we also recognize that some companies (particularly those in capital
intensive industries) can responsibly utilize debt to generate an attractive and relatively safe investment return
for shareholders. The objective in this area is to manage risk by sticking to companies that maintain acceptable
levels of financial leverage (debt).

Effective and Responsible Management with Significant Share Holdings in Their Own Company

Everyone has heard that they should invest in companies with strong management teams, but what exactly
does that mean? What constitutes a strong management team? Analyzing management can be one of the more
difficult steps in the research process. It means more than just getting along with the CEO. For us, we look
not at what management is saying but what they are doing and what they have done. Analyzing management
involves looking back as far as you can and tracking the correlation of what they have said they were going to
do with what they have actually done. Have they made targets and met them? Have they managed the company
prudently? Do they have a demonstrated track record of generating real economic value for shareholders?
Perhaps most importantly, do they hold significant shares in their own company – aligning their interests with
you as a shareholder?

Value – What You Pay for What You Get

Our fundamental philosophy is deeply rooted in value. The phrase “a great company can be a terrible
investment” cannot be overemphasized. We are not necessarily looking to buy the cheapest companies. We
are looking to buy great companies for attractive prices. Rather than focusing on the share price, we analyze
the intrinsic value of the underlying business, based on cash flow generation and overall risk, and discover
opportunities to purchase strong businesses at prices significantly below their intrinsic value. This method of
investing requires both discipline and patience but has been demonstrated to achieve substantial results when
applied effectively.