Our research driven process leads us to companies that trade below their underlying value.
The Walthausen & Co., LLC investment team believes that a consistent methodology to efficiently identify the most promising portfolio candidates is critical given the firm’s broad universe of small and small-mid cap stocks. Our bottom-up process is designed to address the fundamental issues of small to SMID value investing: a wealth of choices, a lack of liquidity, checkered operating histories and narrowly focused businesses. The team has developed, and used very successfully, a potent scoring system to identify stocks exhibiting characteristics which are likely to outperform over the next 1 to 2 years.
Once we have identified a potential investment, we rely extensively on mining available public filings and using this information to construct financial models. Our analysis focuses on understanding cash flow, how it is generated and used and the returns on invested capital. We believe that understanding these aspects helps us to understand the company, its likely earnings in changing conditions and the effectiveness of the management team. We are looking for companies that are selling at a discount valuation, where we believe they are capable of sustaining ample free cash flow. We look to determine whether management has an achievable plan for building shareholder value and a track record that suggests they are capable of executing the strategy. Management interviews are then conducted with portfolio candidates after we have developed a thorough understanding of the company. After a final determination as to the risks and potential returns associated with the company, the stock may be added to our well diversified portfolio if it improves the potential risk adjusted return.
Our sell discipline consists of 3 parts.
1. We look to trim positions back to a full weight after it has appreciated beyond a specific threshold. If the stock declines, the team reviews the thesis and determines if it is still intact. If it is, the team will wait for thesis confirmation and at that time may add to the position. If the thesis is broken we will look to exit the position.
2. When the team discovers an opportunity that exceeds that of an incumbent holding.
3. When there is a material degradation of return on invested capital. This is most easily articulated when company management significantly deviates from their stated strategy