The investment process begins by defining the investable universe of approximately 250 companies from a starting universe of about 1,300 large and midcap companies. We utilize a broad combination of tools including quantitative analysis and focused fundamental research. The quantitative screening process utilizes a proprietary multi-factor model that identifies companies over $3 billion in market capitalization which have the following characteristics:
- Strong relative earnings stability and predictability across various economic cycles
- Sustainable and reasonable earnings growth over all time horizons
- Shareholder focus with respect to dividend growth, payout ratio, and net stock repurchases
- High quality balance sheets with low debt to capital and a high S&P rating
- Above average profitability with low capital intensiveness, large recurring revenue streams, strong ROE, and high free cash flow
- Low relative beta
The quantitative process is augmented by experience and common sense to arrive at the final list of eligible companies for consideration. The group of roughly 250 securities, which emerge from the screening process, is what we call the "Coho 250".
It is at this point where the valuation discipline begins. We build a customized dividend discount model with realistic, normalized, historic based inputs to each of these companies. This arrays the universe in order of attractiveness in terms of expected return. This, combined with our own experience and judgment, effectively culls the universe further. Much greater research effort is applied following this stage by focusing on management contacts, detailed financial analysis, conferences, qualitative analysis and more.
A stock is chosen for the portfolio when:
- A stock meets our earnings, dividend, and cash flow growth and stability criteria
- We have met/talked with relevant management, competitors, customers and suppliers
- Our proprietary dividend discount model shows at least 600 basis points of annualized expected excess return over the risk-free alternative (5-10 year Treasury)
- We have completed our "Position Paper" to objectively identify and monitor major operating and financial metrics that we expect the company to maintain or achieve at specific points in time
The Position Paper incorporates operating metrics such as: new product introduction, earnings quality, market share gains, end market expansion, and elimination of non-core business. Financial metrics include: organic revenue growth, balance sheet integrity, share reduction, cash flow generation, margin targets and trends, dividend payout ratio and policy and capital intensiveness.
A stock is eliminated from the portfolio when:
- It reaches its performance target and the expected return falls to 200 basis points versus the risk free alternative
- Position Paper metrics are violated
- A better investment idea displaces the current holding