Six founding principles

Many years ago, the partners struggled with the same issues that confront all investors:  how to best manage one's wealth.  From many conversations, we identified some fundamental investment truths that became our six founding principles:

1. 1.  All of our money . . . .

   • We believe that an investment manager with a broad, unconstrained mandate such as ourselves, should place substantially all of their personal financial assets in the same investments as their clients.  That is exactly what we have committed to do and, as you know, this is relatively rare.

2. 2.  . . . . for a long time.

   • In making investment decisions for Turtle Creek, we take a long term view.   An extended time horizon is important because we have no control, in the short term, over the price that others will pay for our assets.  As long as we are comfortable with our investments, we really do not care what happens to the price in the shorter term.  Many times, after we have made an initial investment, the price of that investment has continued to decline.  So we have done what any rational investor should do:  purchased more of the investment at ever lower prices, confident in our belief that given enough time, the traded price of the investment would ultimately recover to reflect intrinsic value and, time and again, this has proven to be the case.  A long term view and the absence of short-term pressure to maintain a certain unit value are very liberating.  As odd as this sounds, we actually welcome a decline in the price of an investment (so long as it is not caused by a negative change in the underlying business) because such a price decline affords us the opportunity to buy more.

3. 3.  Abhor lazy money

   • This principle was really one of the drivers toward the creation of Turtle Creek.  It might be more accurately stated as “abhorring money that is periodically active but then neglected for long periods”.  At various times, before the creation of Turtle Creek, the founding investors would find themselves with excess cash and would ‘look to invest it’.  It struck us as a frighteningly inefficient way to invest:  looking for a good investment only at that point in time simply because you have some cash.  We determined that a far better vehicle for investing would be a continuously optimal portfolio to which each investor could periodically contribute or withdraw capital as their needs dictated.

     Perhaps the term lazy money is a little misleading.  Our goal is to ensure that Turtle Creek is always smart money inasmuch as it is striving to achieve a constantly optimal portfolio.  Even though an investor may make an excellent investment, they do not appreciate that the investment process is dynamic and never-ending.  Over time, the price and fundamentals of their investment will undoubtedly change as well as that of their other investments.  Unless rigorous and persistent analysis is brought to bear on these changing factors, then we would classify this as lazy money.

4. 4.  Abhor over-diversification

   • One of the consequences of modern portfolio theory has been an obsessive pursuit of greater and greater diversification to the point where some investors attempt to have their financial assets spread over an exceptionally large base.  Simply put, it is impossible to outperform the market when you are diversified to such an extent that you become the market.

     Obviously some degree of diversification is appropriate.  But what's often missed in this discussion is that once you own 20 to 25 companies in industries unrelated to each other, with each company facing its own unique opportunities and challenges, you are substantially as diversified as portfolios containing hundreds of companies.  And if you know these companies very well, you can construct a higher quality portfolio with a larger discount to intrinsic value than the overall market.  This is exactly what we do and it is this approach which lowers the overall level of risk for our portfolio.

5. 5.  The only value is the present value of future cash flows

   • During the depression in the early 1930’s, a legendary investor, Bernard Baruch, became so disillusioned with the ever lower levels of the stock market that he ‘threw in the towel’ and argued that the only value of a stock is the price that someone else will pay for it.  Most investors believe this and spend their time and efforts attempting to divine the direction of the stock markets or individual stocks; to ‘read the mind of the market’.  John Maynard Keynes likened this phenomenon to being a judge at a beauty contest where you weren’t trying to pick the prettiest contestant, but were trying to guess which contestant would win by guessing how every other judge would vote, recognizing that every other judge was doing the same thing, and with many of the judges taking this to a third, fourth or fifth iteration.

     It is the rare investor who approaches the market by recognizing that a common share is a direct ownership right to a specific proportion of all future cash flows of a corporation.  Approached in this way, however, the market can be seen for what it is:  simply a place where you can buy or sell portions of companies.

     We do not wish to give the impression that we give no heed to the stock market and the relevance of share prices at any point in time.  We actually believe that the market does a reasonable job of valuing companies most of the time.  Sometimes, however, the market gets things very wrong making it possible for us to earn particularly good returns.

6. 6.  Prices will fluctuate around value

   • We acknowledge that this is not so much a principle as it is an observation; but it is such an important observation that it forms one of the major tenets of our investment approach.  If there is one thing that we can confidently predict, it is that share prices of publicly traded companies will fluctuate.  Often these fluctuations are severe and abrupt.

     We follow a simple approach:  unless the price decline has been caused by a fundamentally negative event for the company which causes us to lower our view of its value, we are happy to purchase more of the company at ever lower prices.  A share price decline is one of the great tests for an investor.  If you do not wish to buy more of the company, are disappointed in the price decline and wonder if you should sell, then you never should have owned it at the higher price level.  We regularly ask ourselves:  if a given share price was to drop, would we be happy to buy more?  If the answer is no, then we should be reducing the position now.  And just as we buy more when a stock declines, we sell some when a stock increases in price.  Taking advantage of fluctuating share prices is a bonus above and beyond our core approach of owning good businesses for the long term.