It’s not easy for a stock to make it into a Prospector portfolio. In short, making it into a Prospector portfolio is a long, rigorous process … as it should be for any active manager. While no stock arrives at this destination through the exact same course, we strove to give interested prospects and clients a peek at the stock selection process in a recent Q&A.
The answers below reveal how we source new ideas, review them, and eventually, exit the position:
How does your team generate new ideas for your strategies?
Ideas can come from many sources. We find some ideas at industry conferences or company meetings, or by researching a new company when a management team we have previously invested with comes on board. Our analysts also maintain a valuation sheet that uncovers new, attractively valued ideas. Finally, quantitative screens can also uncover stocks with attractive characteristics that we end up researching further. Some of our common screening metrics include free cash flow yield, statutory data filing screens, growth screens to uncover outliers, and geographic screens based on zip codes to identify regional risks. Many of our investments are companies we’ve known for decades and have owned before, and thus are able to come to a conclusion more quickly than companies we are less familiar with.
How does an idea eventually make it into a portfolio?
Once we find a company we are interested in, an analyst prepares a 2–3 page report that includes the investment thesis, and several components we require before any investment: a balance sheet analysis, cash flow analysis, a description of management incentives and ownership structure, and the company’s estimated private market value. That analyst or portfolio manager then serves as the “quarterback” covering the idea, getting answers to questions the rest of the investment team has.
If the idea remains attractive, we will then get to know the management team — often either through a phone call or face to face meeting. If all our portfolio managers agree that the stock is attractive, it makes it into one or more of our strategies. Appropriate position size is determined, with higher-conviction ideas weighted more heavily. Positions are added to or trimmed based on opportunities the market provides. From there, we review holdings as part of our “daily huddle,” a half hour to one hour meeting where we go over all the recent, topical news or issues surrounding stocks in our portfolios.
When do you reduce or eliminate a position?
Stocks exit a portfolio for one of a few different reasons. Typically, we sell the stock because our assessment of intrinsic value is reached or the company gets acquired. We may also exit a stock if we see a better idea, new research challenges our original investment assumptions, or events at the company violate our thesis. An example of the latter would be a portfolio company making a large acquisition largely funded by debt.
The questions and answers above were part of a Q&A designed to give interested clients and prospects more transparency into the investment process at Prospector Partners. The full Q&A was composed based on the questions we are asked most frequently. To learn more about us, and our unique approach to value investing, we invite you to read the full Q&A.