Our Investment Philosophy & Strategies
We Believe in the Risk-Adjusted Superiority of Long-Term Value Investing
At Kennon-Green & Co., we are passionate value investors. In simple terms, this means we look at stocks as a piece of ownership in a real operating business. We aren’t interested in the day-to-day, or even year-to-year, market fluctuations in the companies our clients own except to the extent we can take advantage of the situation for them by accumulating more equity when shares are cheap and, in some cases, selling when shares are dear. That is, the stock market is merely a means to an end: Getting our clients’ hands on productive assets that generate what we hope turn out to be ever-increasing gushers of cash (whether that cash is paid out in the form of dividends, used for share repurchases, retained for further growth, or some combination thereof) for them to secure financial independence and enjoy the time they have been given.
Going further, absent client-specific considerations when it makes sense to liquidate a holding (such as to rebalance within risk tolerances or to fund a child’s education), our general preference is to rarely, if ever, sell ownership in truly wonderful businesses. This is because the exceptional enterprises of the world are rare; companies that have sustainable competitive advantages, enjoy higher returns on net tangible capital, and have shareholder-friendly managements. In some cases, you may only get a chance to buy holdings at a reasonable price once or twice a decade. We communicate with our clients regularly about these gems, spelling out what is special and why we think they are essential components in the “compounding machines” we seek to design, construct, monitor, and maintain for them. One added advantage of this orientation is that, for many of our clients who enjoy high incomes but suffer significant tax burdens, it reduces the frequency and severity of capital gains taxes, allowing for longer, non-interrupted stretches during which the money can work its magic.
“All the real money in investing will have to be made – as most of it has been in the past – not out of buying and selling but out of owning and holding securities, receiving interests and dividends therein, and benefiting from their long-term increase in value.”Benjamin Graham
Given that we live in an uncertain world – losses are always possible as companies can and do go bankrupt, operating profits can suffer losses due to competition or changes in industry conditions, inflation can reduce the purchasing power of fixed-income securities, or a host of other problems including known unknowns – a foundational key to success in value investing arises from the concept of a “margin of safety”. In basic terms, the margin of safety is the discount a person pays relative to conservatively estimated intrinsic value. (Intrinsic value, in turn, is most often calculated as the net present value of discounted cash flows and represents what a reasonable, prudent, and relatively conservative businessperson should pay to acquire 100% of a corporation or holding.) Essentially, the greater the margin of safety, the better the chance that things will work out satisfactorily even if the world throws a few curveballs along the way. In other words, the old adage, “well bought is well sold” holds true even today, centuries later.
Good long-term value investments tend to have certain characteristics. As a result, typically, but not always, when we search for opportunities around the world, the investments we make for our clients may have one or more of the following traits:
- High returns on tangible capital both absolutely and/or relatively to peers;
- High “owner earnings” relative to market price, which is a modified free cash flow measure the Firm may use in its analysis that seeks to adjust for things like maintenance capital expenditures and unit volume;
- A low price-to-earnings ratio;
- A low price-to-earnings-to-growth ratio;
- A low dividend-adjusted price-to-earnings-to-growth ratio;
- A low price-to-book ratio;
- An above-average dividend yield;
- A history of above-average dividend growth;
- A low price-to-sales ratio in comparison to companies within the same industry;
- Significant share repurchases;
- Significant purchases of shares by corporate executives and/or directors;
- Moderate to no leverage;
- A stock price that has declined meaningfully from a previously higher price;
- A low share price;
- Cash flow sufficiently ample to comfortably exceed fixed charges;
- An asset or assets that the Firm does not believe is fully reflected in the market price of a security;
- A small market capitalization; and/or
- A characteristic, trait, advantage, or asset that makes possible the maintenance of what the Firm perceives to be a major competitive advantage that allows the issuer of a security to remain dominant in a particular sector, sub-sector, industry, or market.
Our Investment Strategies
Kennon-Green & Co. offers numerous investment strategies all based upon a foundation of value investing. With the exception of Bespoke mandates (e.g., those designed for clients with particularly unique needs, such as executives or managers of publicly-traded companies who wish to avoid stocks in their primary industry in order to reduce correlated risk with their employer to provide one illustration), nearly all assets under management are invested using one of the following three strategies:
Value Investing Strategy
The firm’s Value Strategy is an opportunistic portfolio that seeks to acquire assets Kennon-Green & Co. believes are undervalued relative to the Firm’s estimate of intrinsic value or that the firm believes represents a fair value for assets that appear to be above-average in quality as demonstrated by a number of quantitative and qualitative characteristics.
A value portfolio can be managed under a domestic, global, or international geographic mandate.
Although the primary emphasis at most times is likely to be on cash and common stocks across a spectrum of market capitalizations, depending upon market and other factors, an account may also invest in preferred stocks, fixed-income securities such as those issued by the U.S. government, agencies, foreign governments, corporations, and municipalities, warrants, certain derivatives (e.g., writing cash-secured equity puts or writing covered calls), real estate investment trusts, master limited partnerships, royalty unit trusts, mutual fund shares, exchange traded fund shares, commercial paper, certificates of deposit, money market funds, and other securities and cash equivalents.
These accounts are most appropriate for long-term orientated clients who are able to think like private business owners, who can handle significant volatility even if it means sitting on unrealized losses for several years, and who can focus on the underlying economics of an enterprise or security rather than current market price.
High Dividend Strategy
The firm’s High Dividend Strategy is employed when the client desires a portfolio made up of a collection of carefully-selected common stocks, and in some cases and under some market conditions, other securities that offer high dividend or distribution yields particularly at the time of acquisition including, but not necessarily limited to, preferred stocks, real estate investment trusts, master limited partnerships, and royalty unit trusts.
High dividend portfolios can be managed under a domestic, global, or international geographic mandate.
Dividends can be reinvested or, when made available by the client’s selected custodian, distributed by the custodian to the client’s linked checking or savings account, usually either one business day following receipt of the dividend in the client’s custody account or, if the client prefers for the sake of simplicity, aggregated once a month.
The firm may employ certain conservative derivative strategies in an attempt to enhance income or lower risk, such as writing covered calls on positions that Kennon-Green & Co. would be open to selling at higher valuations or writing cash-secured equity puts on positions Kennon-Green & Co. would like to acquire for the client that, if exercised, will result in the client paying a lower price than he, she, or it otherwise would have paid based upon the then-market price at the time the option is originally written or, if not exercised, generating premium income.
Defensive Balanced Strategy
The firm’s Defensive Balanced Strategy is for clients who desire a traditional mix of equity and fixed-income holdings in a diversified portfolio meant to help weather a myriad of economic conditions while still accepting the sometimes-significant volatility that is part and parcel of holding stocks and bonds.
Generally, defensive balanced portfolios will have a combined cash and fixed-income target allocation of no less than 25% and no more than 75% depending upon client-specific factors as well as economic and capital market conditions.
The cash and fixed-income component will be tailored to the client’s particular situation and needs but usually consists of investment-grade securities such as, but not necessarily including or limited to, Treasury bills, Treasury notes, Treasury bonds, STRIPs, agency bonds, commercial paper, certificates of deposit, money market funds, municipal bonds, funds including fixed-income mutual funds, fixed-income index funds, and fixed-income exchange traded funds, corporate bonds, and sovereign bonds.
The equity component of the portfolio is also tailored to the specific needs and circumstances of the client but at most times, under most conditions, is likely to be primarily constructed from a diversified selection of blue chip stocks that offer a history of stable and growing dividends.
The firm may have the client hold any number of securities aside from, or in lieu of, those mentioned depending upon Kennon-Green & Co.’s assessment of what is in the best interest of the client and market conditions. For example, the firm may have a client invest in non-blue chip stocks, preferred stocks, real estate investment trusts, master limited partnerships, royalty unit trusts, mutual fund shares, exchange traded fund shares, or any number of other securities.
As with the value and high dividend strategies, the firm may employ certain conservative derivative strategies in an attempt to enhance income or lower risk, such as writing covered calls on positions that Kennon-Green & Co. would be open to selling at higher valuations or writing cash-secured equity puts on positions Kennon-Green & Co. would like to acquire for the client that, if exercised, will result in the client paying a lower price than he, she, or it otherwise would have paid based upon the then-market price at the time the option is originally written or, if not exercised, generating premium income.