Q:  What are the core beliefs that guide your investment philosophy? A : Our investment philosophy is to buy high quality companies with good growth potential at bargain prices. We buy them at a discounted price knowing that over time they should provide superior returns for investors. This creates a margin of safety to minimize downside risk. Our belief is that preservation of capital is as important as growth of capital. We focus on personal relationships and gain the trust of our investors. The overriding investment philosophy of the firm is a value based approach in which a stock represents ownership in a business, and therefore the business is ultimately going to drive the value of the stock. We believe in looking at companies as businesses and us as investors in these businesses. One of the key measures of the worth of a business is its ability to generate free cash flow. We are looking for businesses that have predictable cash flows in excess of their capital needs. We also evaluate the effectiveness of the businesses in managing their capital so the returns on capital over a long period of time are also important to us. Q:  How does your investment philosophy translate into an investment strategy? A : Our goal is to maximize long-term total return on capital by seeking investments that demonstrate promising long-term growth potential. Therefore, we employ a patient, long-term value approach to investing based on a consistent process. What this means is that we adhere to specific investment criteria. When we invest we don’t just review stocks, we evaluate businesses. The fund seeks both appreciation and, to a lesser degree, dividend income, which constitute the two principal components of a total investment return. Q:  Would you provide a historical overview of the fund? A : Fenimore Asset Management, Inc is an independent investment advisory firm located in the Schoharie Valley town of Cobleskill, New York. Thomas O. Putnam founded Fenimore in 1974 as a means to manage family money after they sold Fenimore Fabrics, a textile company. During that time, the Dow Jones Industrial Average declined more than 50%; however, the Putnam family assets actually posted modest gains. Eventually, Tom established two mutual funds – the Fam Value Fund launched in 1987 and Fam Equity- Income fund launched in 1996. Fenimore is the investment advisor to both of the Fam Funds. Each fund employs a long-term, value oriented investment philosophy. The average return of the Fam Value Fund over 22 years is 9.4% net of fees with a low turnover of about 15%. Q:  What are the components of your research process? A : Our research process is very company specific. We conduct exhaustive, original research. We build our own models for individual companies that we follow and do not rely on broker research. This includes creating detailed, five-year models for each stock holding and analyzing balance sheets, cash flow statements, and income statements. We also speak with competitors and customers and attend industry conferences. Each analyst in our team covers twelve to fifteen companies on a dayto- day basis. In terms of getting new ideas into the portfolio, analysts come up with ideas and write-up a report and present it in the research meeting and suggestions are made by the team. And if it‘s an idea we like we value the business and establish an entry price and then we wait for the price to come in and follow it as if we own it. We follow consistently a repeatable pattern that guides us as we invest for lasting value. We invest for lasting value using four criteria to guide our investment decisions and they are quality of businesses, strength of balance sheets, superior management and price. We certainly have a quality bias. Our strategy is to invest in the best businesses that we can find by sector or industry. The first criterion is that the business has some type of franchise value or competitive advantage. When we seek consistent high quality company stocks we look for good businesses that we understand, have a competitive advantage and possess high profit margins. Number two is that we look at the finances of the company and are looking for companies that grow over time, have balance sheets with little or no debt, generate free cash flow, and deploy capital wisely. Number three is management, and we spend a lot of time talking to management. We visit every company we own at least annually. We are looking for enterprises with superior management teams; leaders who are honest, ethical, energetic, and have a strong track record of building the economic value of their organizations. The fourth factor is looking at businesses we can buy at a discount to our estimate of economic value – this is our margin of safety. We focus on the macro environment too. Our belief is that we can‘t predict the macro environment but we obviously cannot ignore it. So, we read all the government releases and hundreds of company earnings reports and listen to conference calls for stocks that we own. For instance, we do not own any home builders. But, we own companies that sell to the home builders and it‘s also a window to the economy. Consequently, we read every release and track the new orders and the closings and the backlog and cancellation rate at twelve of the largest home builders. Also, we track all the government data, transportation data, the trucks and the rail shipments, the shipping containers leaving California and home constructions and other data. We do not try to predict the economic direction so that we can position the portfolio based on such an estimate. But we do try to understand the factors that influence companies and where we are in the economic cycle. Q:  Would you provide an example that illustrates this process? A : One of our larger holdings is a company called Brown & Brown, Inc., which is a diversified insurance agency and a wholesale broker. They do not underwrite insurance. In terms of growth, they have a good long-term track record of building their earnings. A decade ago they earned about $0.25 per share but this year it is about $1.15 per share. So, it definitely has grown over time. Their operating margins are significantly higher compared to their peers. We estimate the company to earn this year $225 million in operating cash flow. This company has traditionally reinvested their cash flow back in the industry by making acquisitions. Their return on equity is in the midto- high teens, which is very satisfactory and it generates lots of free cash. This company earns owners equivalent of $1.50 a share and the stock trades around $19, which is less than thirteen times cash flow or an 8% free cash yield. We have known this company for more than a decade. We met with them fifteen to twenty times over that period of time. The management has significant ownership, meaning they own 13% of stock personally. So we take all of these things into consideration before investing in that company. Another example of a company that has been terrific even in this downturn is Ross Stores, Inc., the discount apparel outlet. They had their troubles with their internal systems in 2003 and 2004 but since that time it has been a terrific stock. Earnings have grown. Five years ago, the company earned $1.22 a share and this year the company is expected to earn well over $3 a share. In 2008 they generated over $500 million of operating cash. Of this cash they spend about $200 million on opening stores and the rest is used to pay a small dividend and the remaining cash they put back in the stock buyback. So, the share count is shrinking 2% to 3% a year over time, which definitely helps earnings per share. For example, in the last ten years the number of outstanding shares has shrunk from 191 million shares to 131 million shares at the beginning of 2009. The company’s return-on-equity and return-on-capital were in the mid-teens area. The reason why we own the company’s stock is because we like the financial characteristics of the company. We like the treasure hunt aspect of the store experience. People love to get a deal and love brand name items and if they can buy at 40% off, that‘s even better. And the inventory in the stores is always changing. The curiosity of what is new in the store goads the customer again and again to shop in that store. And the company talks about the treasure hunt mentality. We like the fact that it is repeatable. In the new age of thrift, we like the fact that it‘s a discounter and it has terrific financial metrics. Q:  What is your definition of “value”? A : First of all, we are not a deep value investor. That is probably because we are low risk investors and we do not like to lose the capital. For instance, some companies may have an issue with debt or refinancing their debt or they may be in industries that are in upheaval like newspapers. We are not averse to buying companies that do not have an immediate catalyst. For us value is its own catalyst and we are quite patient. For example, we will buy an insurance company when the reserves and management is good and is trading at 65% of book value. We are willing to be patient and wait as long as the business generates free cash flows. Q:  Why do you think that newspapers are not good value? A : Our belief is that the Internet is a much better technology for automobile, real estate and job listings than newspapers. Firstly, we can search and sort and look sfor a job that‘s not in the today’s paper which could be found on the Internet. So, the technology is much better suited for these commercial listings. Secondly, the returns on capital are weak as the revenues sources have declined and newspaper companies do not generate adequate free cash flows. In addition, the balance sheets are weak or deteriorating. Q:  How do you do your portfolio construction? A : The funds are managed as diverse, yet relatively concentrated portfolios. We only own about 45 stocks and our average stock holding period of more than five years reduces annual capital gains distributions and promotes tax efficiency. We focus on absolute returns and not on relative returns to a benchmark. In terms of the weightings in the portfolio and portfolio construction we look at the sector weightings. We can overweight up to two times market weighting if we want to be in a sector but we may not exceed our weightings three or four times in a sector. We initiate a position with 2% size and as we get more confidence over time we build it up and pause near 5%. We are trying to buy stocks when they trade at 20% to 30% discount to intrinsic value and sell when they trade at fair value. We also look at where it is traded in the past and historical multiples. That encompasses our discipline on the sell side. If the company, in our estimate, can deliver 12% to 15% annualized return rate over the next five to six years, it will be on our buy list. We also calculate the discounted cash flows to create a worst case base-line scenario based on no cash flow growth that is discounted at 10% rate and then check against historical average multiples to earnings, to cash flow and to sales. We sell a company’s stock when the valuation is so high that the expected return falls below the rate of return on the U.S. Treasuries and trades well above historic long-term average multiples. The other consideration for selling a stock is if the economics of the business are deteriorating or the investment is construed as a mistake. Q:  What kind of risks do you perceive in the portfolio and how do you manage these risks? A : We define risk as losing money, meaning permanent loss of capital. The way we protect against risk is by buying high-quality companies, the strength of their balance sheets and the price that we pay for them. Q:  How do you evaluate the earnings of a company? A : That will depend from one company to another. Some companies are very cyclical and we have to think about the business cycle. For instance, industrial companies’ earnings currently are very low and the price-to-earnings are high. But they are generating below average earnings compared to what they would have in normal period of time. For other companies in the healthcare or insurance sector we look at current year earnings and would capitalize on their current year cash flows. That is why it depends on the business and we have to understand how cyclical the business and the industry are. Q:  What are the fund’s key advantages to investors? A : Because of our low portfolio turnover we tend to hold things for a long time, which is extremely good for shareholders in that capital gains are unrealized. Additionally, we do not pay out very large capital gain tax over time and thus we improve after-tax returns.