Our equity philosophy is based upon the belief that companies which generate a consistently high return on shareholders' equity will provide above average rates of return to their shareholders over a long period of time. In addition, we favor companies whose use of leverage is prudent within the industry in which they operate.
The compounding effect of a high return on equity coupled with a high reinvestment rate should result in one or more of the following:
- Above average earnings growth
- Growing cash balances
- Above average dividend growth
- Wherewithal to repurchase stock at advantageous prices
Generally speaking, return on equity is an indicator of the company's competitive position in the industry. We favor dominant companies with relatively high market shares in their respective business. Financial strength, high profitability and strong market position are three variables which result in these companies gaining market share over the long run, leading to enhanced profitability.
The above characteristics can be found in both "growth" companies and relatively "mature" companies. Often, a mature business can generate high returns because of market dominance. In addition, those mature but high return businesses generate substantial free cash flow. Growth companies possessing the above mentioned characteristics have the ability to compound earnings, cash flow and equity at high rates.
Market capitalizations of these companies vary greatly, and our investment universe is not restricted to large capitalization issues. Practically speaking, market capitalizations above $200 million are our primary focus.
The vast majority of our investments are encompassed by this basic approach. However, we also invest in companies where the underlying assets are undervalued in the marketplace. These types of investments include companies with hard assets such as real estate, oil and gas or timber. They also include licenses or other intangible assets that are the means by which a company generates its cash flow. As is true with the approach described earlier, cash flow, return on equity and financial leverage are important variables in the analysis. Purchased at a significant discount to underlying value, these investments are rewarding over the long run as significant asset valuation discounts are eventually discovered by the market.
Overlaying both approaches is the final element in the philosophy: valuation. As fundamentalists, price/earnings, price/cash flow and relative price to earnings ratios are important variables in our analysis. We are cognizant of the price we pay for growth or earnings momentum. Valuation is a function of the long run characteristics of the business, not just near term prospects. In addition, we make judgments about the economic cycle, industry leadership and other macroeconomic variables. Our philosophy requires us to stress the fundamentals underlying each stock investment.
A typical Luther King Capital Management portfolio, if aggregated and considered as a single equity investment, would have an above average return on equity, less financial leverage, greater historical rate of growth in earnings and dividends and a price earnings multiple approximately equal to the general market.
We are investors in businesses for the long term and therefore portfolio turnover is relatively low, averaging 35% on an annual basis during a market cycle. Long holding periods allow fundamentals to develop which should be reflected in higher stock prices.
Our philosophy is not one for all seasons, since investing styles change periodically.
Nevertheless, we believe shares of companies with the characteristics described earlier provide superior investment returns to investors over time.
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