For the last 20 years ending March 31, 2010, the FPA Capital Fund has generated an average annual return of 13.94% compared with a return of 8.66% for the S&P 500 stock index. That’s a margin of 5.28% per year.
To put that in perspective, if you had invested $100,000 in the FPA Capital Fund on September 30, 1990, over the next 20 years it would have grown to $1,359,954 compared to $526,495 if the money was invested in the S&P 500 stock index.
The fund’s manager, Bob Rodriquez, although perhaps not as well known as other prominent investors, is in my judgment one of the best investors you’ll find anywhere. He is worth studying, and I intend to cover the fund on this blog. Bob Rodriguez is currently on a one-year sabbatical and the fund is now managed by Dennis Bryan and Rikard Ekstrand who have been with fund for nearly two decades.
Readers of this blog know that I have published my investing blueprint which puts forth my investing process and which is based largely on the teaching of Warren Buffett. I am a big believer that, in order to be successful over the long-term, an investor should spend a lot of time thinking about and defining his or her own investing process. There are numerous similarities between the investing blueprint and the approach taken at FPA.
In their semi-annual letter dated September 30, 2009, Bryan and Ekstrand lays out the investment process that Rodriguez developed and which has driven the funds superlative inception since its inception.
Namely, our investment strategy is to own a concentrated group of businesses with leadership positions that are trading substantially below their intrinsic value and hold those investments for the long term. The strategy also includes owning companies that have a strong management team with a proven track record of success and that have a history of good profitability. That is, we do not want to speculate that a company might one day become profitable, rather we want to see a history of good returns on capital and profits.
The investment strategy further endeavors to invest in companies with strong balance sheets, exhibited by limited private or public debt. Lastly, our strategy embraces an “ownership” mentality rather than Wall Street’s commonly held view today that stocks only should be “rented.”
Our long-term view allows to us to increase the odds of compounding our clients’ assets at attractive returns, and not be seduced into selling a holding because of short-term perception changes by other investors or traders.
Our investment process boils down to searching for and understanding why industry leading companies are selling at bargain prices, and then determining whether they ought to be included in our clients’ portfolios. The process starts with identifying the companies that meet certain quantifiable metrics. For example, we want to buy small- to midcapitalization companies so we screen for companies within a range of market capitalizations between $1 billion and $4 billion.
We have several other key metrics for which we screen and additional ways to identify our initial list of potential stocks for the portfolios, including identifying companies whose stock prices are trading at their 52-week low.
After we identify potential investments, we then start a thorough fundamental analysis that often quickly weeds out many companies that passed the initial identification stage. The analysis includes a rigorous review of a company’s financial statements, often extending back a decade or longer. This step also includes assessing the company’s operations and its competitive position; our goal here is to avoid value traps.
The fundamental analysis can take many months to complete, and sometimes ends because we cannot sufficiently understand the risks posed by owning equity in a complex or challenging business.
The third step is to put all the companies which have passed the first two steps through a valuation analysis. This step includes analyzing a company’s valuation based on its sales, earnings, cash flow, and book value.
Finally, the companies that pass all three steps are then candidates for inclusion in our clients’ portfolios. At this point we may end up with between 20-40 companies for the portfolios that we manage, and three industry sectors often represent more than 50% of the portfolio’s assets.
The important factor to remember is that we have been executing this strategy everyday for nearly the past two decades at FPA, and Bob has been doing it for the last twenty-five years at our firm. We do not expect any changes to this fairly simple investment strategy, but the key is to execute the strategy when the valuations warrant either a buy or sell of a security.
One of Bob’s favorite terms is that we like to invest in the “land of tall trees.” That is, we don’t want a bunch of small positions, but rather a few great saplings that will grow as their dominance in the market earn larger profits for shareholders.