We believe that a sound investment philosophy should begin by making certain assumptions or postulates about the market, and then seek to derive logical conclusions that follow these assumptions.
We begin with the primary observation that the capital markets are relatively efficient over the long term, but prone to bouts of myopia and excess over shorter-term time periods. The greater the volatility of perception within a given sector, the wider the dispersion of returns, and the more opportunity for an active manager such as Cambiar to add value.
Stocks may be mispriced for a variety of reasons—low investor interest, excessive negative sentiments, or the incorrect differentiation between transitory vs. terminal headwinds facing the company. The key focal point for Cambiar is to understand why a company stock price is lagging, but more importantly…
Is there an underlying inflection point in the business that will enable the stock price to be revalued upwards?
Cambiar seeks to identify valuation disconnects in the marketplace; where companies are trading at an attractive valuation relative to their normalized earnings power. Despite an increasing trend towards passive management and inferred belief in efficient markets, Cambiar continues to believe that stocks do incur dislocations; the key is to understand the cause for the disconnect and if the issues are due to transitory events or more secular in nature.
Cambiar attempts to add value through active management—we believe that one must look different than the index in order to outperform. All portfolio decisions are based on our in-house research approach; the Cambiar investment team is focused on understanding where value is eroding and accreting within their assigned sectors, with the goal to allocate capital to the latter.
This bottom-up approach will often result in sector and individual holdings that differ from the underlying index.
“The vagaries of the market often serve to create fairly substantial compressions and expansions of business valuations.” – Brian Barish, President
Cambiar utilizes a ‘good company, good price’ discipline. Each company entering any of the Cambiar portfolios needs to satisfy the firm’s criteria on four levels.
Cambiar investment principals seek companies that are best-of-breed within their sector or industry and have some defensible characteristics—i.e. patents, established infrastructure (patents), switching costs, etc. Cambiar also looks for high quality in the way of strong financials—balance sheet strength, low debt/equity levels, and demonstrable free cash flow over a full market cycle. Finally, Cambiar companies should be led by a competent management team that has a constructive relationship with its public shareholders.
The Cambiar investment team uses conventional financial measures, such as Price/Earnings, Price/Book Value, etc to track businesses. An underlying premise of the Cambiar philosophy is that certain industries tend to follow certain valuation ranges; the market does not randomly value stocks. Our preference is for companies to be trading at the lower end of their normalized valuation range at the point of purchase. Given the underlying mean reversion element, it is critical for the analysts to be confident that the fundamentals/industry dynamics that resulted in historical valuation ranges are consistent going forward.
Another component of the investment process is to identify some type of fundamental positive development that can change the market’s current negative perception of the company. Such catalysts may come in varying forms; examples include new product introductions, managerial changes, divestiture of an underperforming division, or simply better financial performance. Valuation in and of itself is not a catalyst—there must be some identifiable event that will cause investors to reassess the business and award it a higher valuation.
The final component is the company’s upside potential: all new companies entering the portfolio must possess the potential for a 3:1 return-to-risk requirement over a forward 1-2 year timeframe. This return is generally achieved via a combination of multiple expansion and dividend yield. While Cambiar may not achieve this return target over the desired timeframe – or at all, for that matter – the return requirement is intended to channel research efforts toward those situations that offer the most compelling risk/return tradeoffs.