We are opportunistic capital allocators who demand a "margin of safety."*
Over the years, it has become abundantly clear to us that the mainstream financial services industry is constantly selling stocks and bonds–day in and day out, rain or shine. This includes the vast majority of the mutual fund industry, Wall Street brokerage firms, and many others, including the talking heads on cable television shows. In contrast, Roumell Asset Management is an opportunistic capital allocator (OCA).
As an OCA investor, we sit patiently until an investment situation is presented wherein the odds of success are highly favorable relative to the risks. In the absence of such situations, we will stay on the sidelines invested in cash.
Straightforward And Sensible
Roumell Asset Management's approach can easily be compared to the children's game of tag. When you played tag as a child, a big tree was typically designated as home base, where you were safe and could not be tagged. Playmates wanting to motivate you to leave the tree would move from ten to twenty feet away, at which point the odds shifted decidedly in your favor to come off base without being tagged. Played perfectly, you could just wait, move away from the tree at the appropriate time, return safely, and then wait again. Conceptually, that's what we do. Our time away from the tree may be a month, a year, or several years, but the objective is the same: when our calculation of intrinsic value has been reached, we sell and return to home base, a.k.a. cash, and wait for another compelling opportunity to arise. In this way, it can be said that we stand apart from traditional deep value investors who typically subscribe to a strict buy and hold philosophy.
As an OCA investor, Roumell Asset Management has the luxury of doing nothing in the absence of compelling ideas where the odds are squarely in our favor. The vast majority of mutual fund managers are required to be fully invested at all times. In our approach to opportunistic investing, we emphasize understandable businesses with safe capital structures (i.e., not overly leveraged), managed by honest and competent people, and purchased at quantifiable discounts to our calculation of intrinsic value. Further, we are willing to focus our deep value bias to concentrate on our best ideas (again, unlike mutual funds, where a typical position is often limited to no more than 1%-3% of the portfolio).
OCA: The Rest Of The Picture
There are trade-offs to opportunistic capital allocation. First, OCAs, in general, and deep value-oriented ones like us in particular, can often be quite selective about price and miss reasonable risk/reward investment opportunities while they wait for better pricing. Second, in periods of overall rising market levels (whether those rises are the result of speculative bubbles or the confirmation of underlying fundamentals), OCAs may not fully participate. Index funds will likely provide superior returns in such times. Finally, OCAs may hold cash for extended periods of time. It is our belief that the opportunity cost of cash is more than offset by the ability to act boldly at particular points in time.
Roumell Asset Management excels at digging deeply into specific securities (bonds or stocks), assessing underlying value, and remaining highly disciplined about what we are willing to pay. We seek to practice our detailed bottom-up approach with an informed picture of economic trends. We follow statistics such as employment figures, savings rates, and consumer confidence, because such trends have a disproportionate effect on various industries (e.g., higher savings rates and lower income growth will likely result in fewer consumer goods purchases). However, we are not economic forecasters because we see little evidence that macroeconomic judgments translate into consistent and reliable investment results. For us, investing is about price versus value, plus patience, as it pertains to very specific securities purchased at very specific prices. Benjamin Graham stated, "The field of analytical work may be said to rest upon a two-fold assumption: first, that the market price is frequently out of line with the true value; and, second, that there is an inherent tendency for these disparities to correct themselves." No doubt, some markets offer more opportunities than others. In any event, the best way to manage overall economic or market risk is to simply remain highly price conscious at the point of purchase.
Further, we are not looking to mirror a particular index; such an approach can readily be found elsewhere. Rather, we are seeking to rigorously and relentlessly exercise our discipline and believe that over time we will generate a meaningful absolute risk-adjusted rate of return. That said, we cannot guarantee a certain level of return.
Roumell Possesses A Deep Value Bias
A company's public market security price may fluctuate widely, particularly over the short term. However, a company's intrinsic value is a much less volatile number as measured by what a knowledgeable strategic or financial buyer might pay to acquire it.
Our approach revolves around the belief that a company's assets and its enterprise value can be evaluated independent of the stock market. As deep value-oriented investors who think as business people, we pursue success by demanding a purchase price that represents a significant discount to our estimate of corporate value. Typically, we demand a 30% to 50% discount. The question we are most interested in answering is: Would we take this business private- at its current price-in a heartbeat?
Unlike some traditional deep value investors who only focus on identifying "hidden asset" stories, we are very much interested in finding growth companies. Such companies must be exceptionally well-capitalized and have quantifiable investment attributes that provide a measure of protection to the firm's valuation. Thus, we describe ourselves as having a "deep value bias" to highlight the fact that although we are rooted in underwriting balance sheets (what are the company's assets worth today), we are excited to find the right growth opportunities (what might the company's earnings be tomorrow). As in all of our investments, redundancy is very important to us. In other words, if one investment thesis fails to materialize there are other ways for the investment to work out favorably; i.e., a different product line, a monetizable business unit, saleable intellectual property, or perhaps an outright sale of the company.
How do we find such situations? First, we focus our attention away from the crowd. Our investments are often not followed or only modestly followed by research analysts. This means that the securities we purchase are less likely to reflect a "sales premium" resulting from Wall Street's selling machine. We like undiscovered ideas because they allow us to more fully leverage our in-house research process which is most often driven by company and industry visits and in-depth company analysis. We pride ourselves on having a rich and varied portfolio of key industry contacts to call upon as part of our research process. Second, we search for events in the market, in an industry or in a particular company that depress the publicly traded security price below our estimate of intrinsic value.
We typically invest in smaller and mid-sized companies because of our desire to find companies that are less followed by Wall Street and are more likely to be inefficiently priced. Nonetheless, we are all-cap equity investors.
Capital Structure Neutrality
Securities possessing deep value characteristics can be found in various asset classes, not just equities. Although the majority of press headlines are dedicated to the stock market's daily activities, we believe that, at times, corporate bonds can provide a superior risk adjusted return given their senior position in a company's capital structure. Therefore, we are impartial as to where in a company's capital structure we are investing. Our ultimate goal is to buy securities (common stocks, corporate bonds, closed-end funds, etc.) at a meaningful discount to our estimate of underlying intrinsic value. We believe that following such a flexible course increases the odds of providing our clients with compelling returns while reducing risk.
* "Margin of safety" is a term described in the writings of Benjamin Graham and David Dodd.
"Here’s our promise to those who entrust their hard-earned dollars to us: We will honor our relationship with you by investing right alongside you and by relentlessly pursuing investment opportunities that we feel have compelling risk/reward characteristics."