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Horan Capital Management focuses on a disciplined, research-driven strategy. We look at each investment through the eyes of a business owner, evaluating companies individually based on their long run potential. Our team looks at investment ideas from a bottoms-up perspective, paying particular attention to value created not only by future cash flows, but also from existing balance sheet assets that may be under-appreciated. By paying strict attention to quality and price, we believe we can best serve to protect and grow client capital.
We believe that investment risk should be considered before investment reward, and that risk is best controlled by focus on business quality and price paid. When assessing business quality, we look for:
Financial strength, highlighted by conservative financing, readily ascertainable assets, and high cash flow relative to fixed costs.
Enduring, understandable business models, stemming from dominant brands, scale advantages, and exclusive patents and processes.
Shareholder-oriented management teams, that focus on transparency and value maximization via excellent return on capital or, when called for, return of capital.
Business growth, resulting from free cash flow generation and prudent, sensible, reinvestment by management.
To achieve growth in capital, we also pay particular attention to the price paid for investments. It is critical to remember that, quite literally, price paid defines an investor’s return potential. As part of our research process, we develop intrinsic value estimates based upon what we believe a private market business owner would pay for a company in entirety. Only when investments can be bought at a sizable, risk-adjusted discount do we consider purchase.
PROCESS
Idea Generation
The managers monitor and discuss current and prospective investments daily. The team’s portfolio managers serve as analysts and are responsible for idea generation. Investment ideas are uncovered via proprietary screens and maintenance of watchlists containing stocks we want to own but have not yet reached our purchase price targets.
Investment candidates are thoroughly researched using a team approach to evaluate business quality and intrinsic value.
Portfolio Construction
HCM concentrates our best ideas to achieve capital growth. We believe wide diversification, as a risk control measure, mitigates upside potential because outperforming stocks are held in very small weights. Portfolio concentration, on the other hand, allows us to focus squarely on our very best ideas so that portfolios benefit meaningfully from price appreciation.
Stocks are held in roughly equal initial weights. While portfolios are generally non-diversified, managers pay attention to risk aggregation and will not concentrate more than 25% in one industry.
The portfolios are not mandated to be fully invested at all times. When there is an absence of attractive investment ideas, the managers will raise cash rather than risk capital loss by holding richly valued investments. Similarly, new accounts may take a few months to get invested, depending on the prevailing market environment.
We consider portfolios to be fully invested when the stock component is 90-95% filled, except in times of overwhelming opportunity. Having some extra powder in the keg is a valuable and important option in times of market volatility.
Sell Discipline
For high quality, well-run, cash generating businesses, per share growth occurs through time through the basic accumulation of cash flows and investment. For this very reason, we are happy to own great businesses for as long as possible. Aside from benefiting from compounding capital appreciation, long holding periods serve to minimize friction costs such as transaction costs and tax liability. That said, sales transactions can result when:
:: Through appreciation, the investment becomes either grossly overvalued or overweight within the portfolio.
:: Another investment offers better risk-adjusted return potential.
:: We determine our initial fair value estimate was too high and the shares trade at unacceptable price to revised value ratio.
Investing Principles
We define risk as potential of losing capital, not volatility.
We think it is far more important and productive to worry beforehand about whether a business has staying power and value durability as opposed to worrying about its stock price volatility afterwards. By maintaining an independent, confident and unemotional view of a stock’s intrinsic value and being diligent about price paid, we believe we can best control the risk that matters most: permanent loss of capital.
Keeping it simple keeps us within our realm of confidence.
There are no points awarded for investment difficulty. An easy-to-understand business that has transparent and lasting value drivers can enable an investor to compound wealth over long periods of time as much or more than that of a complex investment with a myriad of ever-changing, hard-to-predict variables. New issues or businesses going through rapid transition and venturing into unproven territories are generally not considered.
It pays to be contrarian.
Opportunities often arise when the herd is running in one direction and we are willing to run in another. We are happy and willing to own a stock that’s currently unpopular if problems are temporary and solvable.
Cash flow is king.
We prefer companies that are established and are likely to generate cash long into the future. To this end, we dig deep into financial statements to uncover the cash reality that can be concealed beneath accounting artistry. In our world, dividends, share repurchases and business re-investment don’t happen unless there’s cash available.
Benchmark risk takes a backseat to absolute returns.
Our goal is to grow capital on an absolute basis through an investment lifetime, while not exposing our clients to undue risk. We do not focus on one particular index when investing in individual stocks. Additionally, we will hold cash if there is a lack of attractive investment opportunities.
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