Q: Can you explain to our readership of financial professionals why you invested in Marvel Enterprises? A: We combine value and momentum characteristics. That is what sets us apart from a lot of value managers. We want to buy undervalued companies that have positive momentum in their earnings and sales. Q: Do you determine this from researching the company's data? A: We measure momentum four different ways to derive momentum scores for each company. It could be as low as minus four and as high as plus four. The factors we look at are earnings surprises and revisions. The third is relative strength. Then we look for some concrete, positive momentum within the company: a positive development like a new CEO, a new product or an old product that is selling well. Some positive, concrete factor that would explain the rise in earnings, stock price and relative strength. Q: That partially explains the investment into Marvel Enterprises. Some call them investment themes. A: We call them strategic focus areas. Everything we buy has to fit into one of these focus areas. Marvel fits into the entertainment and leisure area that we like and where a lot of money has been made over the years. It was undervalued. We bought it around two dollars a share. A year or two later, they came out with the Spiderman movie and made almost that much in earnings. It was a fit into an area we like. And it was what we call seasoned, because it had been down for at least a year and a half to two years. It had a chance to fix its problems. Our research indicates that a year and a half to two years is a minimum seasoning period. So, that company met all the criteria. Q: You've named one strategic focus area. How about the other six? A: Technology, communications, healthcare, financial services, consolidating industries, defensive industries and consumer staples. Entertainment and leisure falls into consumer staples, the types of entertainment companies we buy anyway, that produce television programming, movies, and cable TV. Those basic forms of entertainment are non-cyclical. Basic entertainment tends to hold up well in a down market or a soft economy. As we saw, when the economy got soft, movie ticket sales increased. So did movie rentals. People stayed home or went to the local movie theater. Entertainment never goes away, even when the economy is soft. Q: What does the scoring model entail? A: The first 10 or 12 are financial and value ratios, like price-to-sales, price-to-cash flow, and price-to-earnings. We look at each one two or three ways. Take price to sales for example. We want to see a company have a low price-to-sales ratio for the industry that it's in and also low price-to-sales for the company historically. We ask what has the market typically been willing to value a dollar of this company's sales? All we're really asking these companies to do is return to historical levels. We believe that under normal circumstances, given time and a reasonable basis to do so, the market will probably value that company again at that same multiple at some point. So, we're looking at things that are low on a relative or historical basis: Low debt to equity, a PE that is lower than its growth rate, decreasing debt to asset levels, and improvements in the current ratio and margin improvements on sales. Also, asset turnover improvement to show that they're turning their inventory quicker. These are examples of some of the characteristics we're looking for on the financial ratio side. On the business side, we're looking for companies that have a long product cycle and a short consumer repurchase cycle. A good example would be the cornflake. We like companies that have decreasing capital expenditures, meaning that they don't have to keep investing more every year on new equipment, new factories. We want a business with immunity to product obsolescence. We’re afraid of companies that can go away pretty quickly because of a new technological innovation. A recent example I can give you is PageNet. Pagers kind of became extinct. Q: What other business factors affect your decision making? A: We like to see businesses that have organic growth, high barriers to entry, and a history of rising earnings over the long term. On the price side, we like to see them at least 30% off the five year high, negative analyst sentiment and the momentum characteristics I explained. Q: You don't sell very often, either. The annual turnover for the past 12 months was 33%. A: I think we research maybe a couple dozen companies and we end up buying a dozen as new investments We think looking at a couple dozen companies is a lot during the year because we do a lot of work on them. But we invest in very few. It's been a successful process for us. Q: That's the value approach? A: If you think about it, the perfect investment is an undervalued company that has positive momentum. There's nothing better than that. Q: Momentum has been described as the 'ah ha' effect in which people respond only to a rising stock price. Obviously you prefer to say this as early as possible. A: We're looking at companies that are fundamentally undervalued by any traditional value manager's criteria. We insist that it not only be fundamentally undervalued, but that it also be seasoned, meaning that it's been down for quite some time and had a chance to fix its problems, fits into one of our strategic focus areas that we know is an area where most of the money has been made in the market, and at the same time that it be demonstrating at least some of the initial signs of momentum. Q: Do you use computer software for your scoring system? A: It may sound like a screening system, but a computer is not really involved. The scoring model is a way to take all the research that we do, quantify it, and put it on one sheet of paper. We add up each of our decisions and come up with one final number, so we can score different companies against each other on an equal footing. We've basically identified these 28 things that a perfect company would possess and no company has ever scored 100%. If a company scores 50 or 60%, that's excellent. If they fit 14 of the 28 criteria, they get a yes. The highest score I think we've ever had is maybe 70%. We compile it and put it into a spreadsheet. It's not really a computerized score at all. Q: From the process, you're also indirectly implying sell criteria by defining the upper limits of a company's historical performance. A: Our sell discipline is a lot different from a lot of value managers. We set a target price like many do, but once it hits it, most would sell because they would say it's no longer a value stock. We also bring momentum factors in on the sell side. Let’s use Marvel as an example. We bought in at two, three dollars a share. We bought some more at five and seven dollars a share. The price target was somewhere in the $12 to $15 range. Q: It's currently higher than that. A: When it exceeded our price target, we looked at the momentum factors. Price is a factor; valuation is a factor, but momentum is the other. Everything we want to see in a company was true in Marvel. It had continued a pattern of reporting earnings that exceeded expectations. It had momentum in the stock price in terms of relative strength compared to the market. It had positive momentum in terms of earnings revisions. Then, we looked at the fourth momentum criteria that I mentioned, which was a concrete development within their business that you could see or touch or feel. They produced the number one box office gross movie of all time, Spiderman. Prior to that, they produced the original X-Men. It was a huge hit but they didn't make any money because they didn't have a beneficial licensing arrangement. Spiderman was a different story. They had new management in place that cut the right kind of deal with Sony. Next, they came out with Daredevil, which was a big hit. Then they came out with X-Men II, which was another blockbuster. Last month they came out with the Incredible Hulk. This is a company we won't sell until two things happen. It's exceeded our price target and the company has lost its momentum. Until Marvel comes out with disappointing earnings, bad earnings, and the stock price starts underperforming the market, those are the kinds of things that we're looking at for our sell indictors. Q: Most managers, like retail investors, tend to sell their winners too early. A: Remember, we're students of momentum. Once we see it change, we sell. Most value managers don't believe in momentum and they sell because it exceeded their arbitrary target price. The stock doesn't know your target price. The stock is going to do what it's going to do independent of your target price. If there are good things happening in the company, it's not going to stop because that is where your price target is. We're in this to make money. We want to make as much money on the research that we do because, as you know, we don't research that many companies. When we finally do invest in something, we want to get the most out of it that we can. Q: How many people do you have on the research staff? A: There are four of us that participate in the process. I drive it. A couple of analysts do the work. I review that work and then we discuss it in our investment committee meetings. I make the final decisions. I started the firm 15 years ago when I was 25 years old. I had five or six clients that were family, friends and co-workers and had been managing their money for a little while, but they weren't paying me. I decided that since I was doing pretty well and I enjoyed this business, that I wanted to make a go of it. My wife had a good career. We didn't have any kids. I saIdent, 'I want to go out and start a business,' so I did. Q: What kind of acumen have you acquired that has kept you successful? A: I think we've learned from our mistakes and evolved our process over the last 15 years. Five to seven years ago we were a lot more traditional in our value approach. We have evolved as money managers. We used to be considered contrarians; deep value managers. Now, I would say we're considered relative value managers. Occasionally, like I saIdent, we drift into blend, because we're holding some of our companies a little bit longer. We're letting our winners run a little longer. The reason why most value managers don't do that is they're afraid of style drift and moving from one style box to another. You aren't paid by how long you stay in your style box. And it doesn't reward your clients to stay in your style box. Your shareholders are paying you to make them as much money as possible. We try to stick to that objective first. Seasoning is the biggest part of not being early. The biggest part is just being patient and waiting 18 to 24 months to enter a stock, no matter how cheap it looks. It's a hard thing to do. You see something that looks cheap. You think you're right and everybody else is wrong and eventually everybody else will figure it out. It's hard to wait. It's not human nature. But, we wait.