Q:  Would you provide a brief description of your company and the fund? A : Cook & Bynum Capital Management is a Birmingham, Alabama-based investment advisory firm that manages both The Cook & Bynum Fund and private accounts. The firm was founded in 2001 by Richard P. Cook and J. Dowe Bynum to implement a pure, long-only value investing strategy. Cook & Bynum launched The Cook & Bynum Fund, a non-diversified mutual fund, in July 2009 as a result of the demand for a mutual fund product from its growing client base. The company currently manages about $140 million in assets with $40 million in this fund. Q:  What is the scope of the fund? A : The fund is an open-ended, non-diversified, value-oriented mutual fund seeking long-term growth of capital. It focuses on making long-term, concentrated equity investments in both domestic and foreign companies while minimizing risk of permanent capital loss. Cook & Bynum aligns manager incentives with those of shareholders by investing only in Cook & Bynum vehicles and by not using outside managers. Q:  Would you describe your investment process? A : We use our own fundamental, bottom-up research to uncover promising investment ideas. First, we try to identify businesses that fall into our circle of competence. If we cannot identify the factors that make a business successful, we will never be able to value it effectively. Second, we look for good businesses with durable competitive advantages. Without the presence of these “moats” we will be unable to see far enough into a company’s future to conservatively value the business. Third, the business must be run by honest and capable management. We expect management to treat us like partners, and we prefer that they have a substantial stake in the business. Additionally, we carefully scrutinize their capital allocation decisions. Management can choose to reinvest in the business, pay dividends, or buy back stock. We are indifferent as long as they are allocating in a manner that is appropriate given their opportunity costs. Fourth, we assess the price of the business. Once the other three criteria are met, we insist on receiving a substantial discount to our appraisal of intrinsic value in order to purchase shares. This discount provides the necessary margin of safety so that when we are wrong, we potentially minimize our downside. Conversely, when we are correct, we increase the likelihood of earning outsized returns. Q:  How do you generate investment ideas? A : We read a lot of public filings, reports, and articles about companies from around the world. We run screens to monitor certain criteria such as insider buying, important financial metrics, and companies that are trading at 52 week lows. We travel domestically and internationally to conduct due diligence on potential investments and sometimes come across other attractive companies in the process. We also maintain continual dialogue with many friends and colleagues in the business world. Q:  Could you give us some examples to explain this process in more detail? A : In 2001, we acquired shares of a company called Tractor Supply Co. This company supplies products to recreational farmers and ranchers in the U.S. They specifically tried to serve this niche market and avoid competition from the big Ag coops and from the big box retailers like Wal-Mart and Home Depot. At the time the company had about 300 stores east of the Rockies and thought that they could open about 300 more. Management made a mistake and implemented the first version of a new SAP inventory management system, which promptly failed. Because being out of stock is death in the retail business (no one will come back to your store if you don’t have the necessities) the company flooded their system with inventory. This caused working capital to ballon to almost the entire price of the stock, inventory turns fell from about 3.5x to less than 2x, and the company had to temporarily slow the opening of new stores because of the cash drain to fund the inventory. The CEO was the largest shareholder, and he was aggressively buying new shares with his own cash. We found the company by using a screen for insider buying (as opposed to insiders exercising options). By the time we discovered the company, they had already hired a new COO who was fixing the problem. We visited numerous stores with and without management and could see the turnaround taking place. Removing the extra working capital would almost give us our purchase price back, and the company would be once again able to open stores with an IRR of over 20% in their first year. As a side note, we discovered during our research that one of Tractor Supply’s primary competitors, Quality Stores, was no longer receiving inventory because they were not paying their bills. This state of affairs ultimately led to Quality Stores’ bankruptcy, which further strengthened Tractor Supply’s competitive position. This event allowed Tractor Supply to buy 100 of Quality Stores choice locations for far less than it would have cost to open similar locations. This event was a windfall for the company, but it was not a part of our original investment thesis. Another example of our process is our decision to invest in Embotelladoras ARCA SAB De C.V (“ARCA”). ARCA is the product of the merger of three families’ Coca-Cola bottling assets in northern Mexico. ARCA also distributes salty snacks under the Bokados brand name. Additionally ARCA controls the northern territories of Argentina and just recently bought the Ecuadorean franchise. We came across ARCA when we were investors in FEMSA, which was the major beer brewer in northern Mexico, operated convenience stores under the OXXO brand, and owned about one third of Coca-Cola Femsa. Coca-Cola Femsa controls the Mexico City territory and has an incredible business. While it does have free float, the Coke part of the business was not cheap. Consequently, we began looking at the other publicly-traded Coke bottlers in Mexico. After several trips all over Mexico, including one driving trip from Alabama down to Tampico, over to Aguascalientes and Zacatecas and back up to Monterrey, we were convinced that the franchise was truly outstanding. As we dug further into ARCA, a series of factors related to our investment framework attracted us to the business: First, the consumption of soft drinks per capita in Mexico is much higher than in most other countries. Next, the business has the leading operation and distribution platform in its markets, which it has been able to further leverage by introducing complementary offerings (including its own snack brand). Additionally, the company has been applying its best practices in logistics and operations to its newly acquired markets (Argentina as of our investment), which has stimulated growth that the previous owners of these acquired bottlers had been unable to realize due to lack of capital and to expertise. Pepsi products are also considered inferior in northern parts of Mexico (and are essentially irrelevant Argentinian markets where local “B” brands are the primary competition) and its products are sold at as much as a 30% discount to Coca-Cola. As a result, Pepsi does not have the brand, sales volume or distribution network to compete with Coke and ARCA. This point is key because over 50% of Mexican sales and a large portion of Argentinian sales are in the informal market – tens of thousands of mom & pop stores or stands that only ARCA can reach. Finally, because it does not trade on a U.S. exchange and does not have a high volume of shares trading, it is not well-known on or followed by Wall Street. Consequently, when we first established our position, the company was trading at about 7 times earnings, was growing earnings by double digits, and was paying a 9% dividend. This combination fits our investment criteria and allows a very healthy margin of safety. In total, this was a business we came across due to our travels in Mexico; one that met all of our criteria related to circle of competence, business, and people; and was also trading a big discount to our estimate of intrinsic value. This confluence of factors gave us the confidence we needed to make a concentrated investment. As a side note, we purchased and sold our stake in Tractor Supply Co. prior to the inception of our mutual fund. We do, however, currently hold ARCA in the Fund’s portfolio. Q:  What is your sell strategy? A : A sell decision is usually based on one of two criteria. We will begin to liquidate an investment when its price approaches our appraised value. An investment reaching our appraisal may have further upside potential, but it no longer offers an appropriate margin of safety for putting capital at risk. We will also sell any investment that has experienced fundamental negative changes in business, management, or return prospects since we invested that lower our appraisal or prevent us from being able to adequately predict the future of that investment. I should mention that our mandate is opportunistic, and we don’t ever feel forced to be fully invested. When we do not find good equity investments, we have no problem holding cash and cash equivalents. Q:  How do you decide on the weightings in the fund? A : We choose position size based on our estimate of risk versus reward. It is a bottom-up process that not only takes into account the expected return but also the range of business outcomes. One can commit more capital to an investment that has a narrower range of business outcomes but the same expected return as another investment. In other words, because we are trying to avoid permanent capital loss (rather than short term quotational movements), we will have smaller positions in investments that have a wider range of outcomes and larger positions in investments where the outcome is more certain assuming the same expected return. This concept is essentially a generalized and qualitative application of the Kelly Criterion where we pay just as much attention to the denominator as to the numerator. Most investors ignore the information contained in the denominator even though it is critical to sizing a position. All this being said, we do make concentrated investments, and we generally will not establish a position unless we are confident enough to make it a meaningful portion of the Fund from the outset. Q:  How many names do you generally have in the fund? A : We maintain a concentrated portfolio in which the number of holdings will generally range from 12 to 15 when we are fully invested. Q:  What is the turnover in the fund? A : It typically ranges from 20-25%. Q:  How do you view risk and how do you manage it? A : For us the only risk that matters is business risk, which we define as the possibility that a business will significantly underperform our financial performance expectations. We are only worried about negative changes in a business that cause us either to lower our valuation or to be unable to estimate its intrinsic value. Basically, we want to know how we can “die” in an investment. Many equate volatility with risk, but this is not true in an unlevered, long-only portfolio. As long-term investors volatility allows us opportunities to buy and sell at more attractive prices than would otherwise be available. Because we use no leverage, we cannot be forced to sell an attractive investment due to an adverse change in the market quote. If there is not a negative change in the intrinsic value of the business, such quotational noise may simply be an attractive opportunity to buy more of the business.