Aronson+Johnson+Ortiz

Our philosophy encompasses our view of the equity markets, how best to profit from them, how to hold onto profits, and the way we run our business.

STOCK MARKET

We believe the stock market is reasonably efficient but emotional enough to provide opportunities for the disciplined investor. Because the market is complex, opportunities are best exploited with a systematic, quantitative approach. We use modern investment technology and academic research to complement the wisdom of classical investment thinking and analysis.

INVESTMENT STYLE

We are value-oriented but believe superior results are best achieved by combining value, management (growth), and momentum. Our work holds security analysis to be most productive when relative value is gauged on an industry or peer-group basis. Indeed, peer-group valuation and diversification constitute important aspects of our process. We focus on well-managed companies with quality cash profits, relatively low market valuations, and positive price and earnings momentum. We optimize portfolios to diversify multi-faceted risks.

IMPLEMENTATION AND TRADING

We believe transaction-cost management is a vital component of the portfolio management process. Transaction costs — the ultimate cost of implementing any investment strategy — are higher and more complicated than is generally perceived. Controlling transaction costs is key to exploiting stock market opportunities.

BUSINESS MANAGEMENT

Investing is our only business. We’re independent and owner-operated. We practice investment management in an atmosphere of candor and mutual respect, where patience and humor are the norm. We believe it is essential to forge a partnership with clients (and vendors). Detailed, frequent, and complete communication is highly valued. We aim to create goodwill that will help us endure unavoidable periods of subpar investment results.

VALUE, MANAGEMENT, AND MOMENTUM

We employ a multifactor valuation model that emphasizes three categories of variables: value, management, and momentum.

VALUE — We examine price-driven measures at various points on the balance sheet and income statement. We begin with the balance sheet, because asset-rich companies resist market declines and are prime takeover targets. It is argued that book-to-price is among the more predictive characteristics of future returns: the higher the book-to-price ratio the better. On the income statement, earnings yield (the reciprocal of P/E) is among the more robust measures of a stock’s fundamental valuation. As with book-to-price, the more earnings for every dollar invested, the more attractive the security. Multiples of earnings and assets are discriminating, profitable measures of relative value. The same holds true for multiples of sales.

Neither low price-to-book ratios nor low multiples of income and sales by themselves are sufficient. For instance, a company may deserve a low multiple if there is no prospect for growth, indicating no evidence of successful management. Our valuation model considers the relative success of management — and their signals about prospects for future success — to be as important as assets, earnings, and sales.

MANAGEMENT — Our so-called management factor quantifies the relative success and outlook of management by measuring the basic underlying performance of a going concern. In addition to considering past corporate performance, we gauge management and insider “predictions” of future performance. We use a composite measure of variables that our research shows provides an accurate profile of management savvy:

	•	Return on assets (ROA) is the best measure of overall corporate performance, reflecting the extent to which all tangible corporate resources are utilized.
	•	Earnings quality distinguishes among companies whose earnings, while similar in quantity, may be quite different in terms of quality. R&D expenditures, cash versus accruals, and level of debt are key.
	•	Change in sales-to-assets is a measure of activity that indicates how efficiently the firm uses assets to generate sales and relates to both ROA and earnings growth.
	•	Long-term forecasted (consensus) earnings growth complements historic ROA by indicating future corporate performance.
	•	Insider trading is a tangible reflection of expected future company prospects. Purchases, in particular, reflect where insiders think their company is headed.
	•	Share repurchases, much like insider trading, indicate the faith corporate insiders have in their company's future.

In line with the goal of all security analysis, the integration of these measures and financial ratios has been successful in discriminating future corporate performance.

Finally, we use momentum to distinguish attractive stocks from unattractive ones.

MOMENTUM — We rely on momentum to gauge Wall Street's appraisal of a company's future prospects. Momentum is defined and measured in five dimensions:

	•	Earnings-estimate revision measures the trend of analysts' opinions.
	•	Relative price strength reflects the market's up-to-the-minute take on a company's performance. It is our quantitative equivalent of the maxim, "don't fight the tape."
	•	Price stability is prized. We aim to buy names with strong and steady price paths and steer clear of (or short) those names that are violently declining.
	•	Earnings surprise assesses the extent to which actual earnings differ from expectations.
	•	Short interest is inversely correlated with future returns.

Momentum helps distinguish between future leaders and laggards.