25.01.2005

It’s been difficult to ignore the success of Brandes Investment Partnersin 2004. The US investment firm has made serious money last year on the UKstock market after taking big stakes in Marks & Spencer (LSE: MKS) and AbbeyNational (LSE: ANL) prior to some high-profile takeover developments.

Though its selections are not Qualiport candidates, what’s really strikingabout Brandes is its dedication to the stock-picking approach pioneered by the‘Father of Value Investing’, Benjamin Graham, during the 1930s. A moneymanager must be worth following when it continually refers to The IntelligentInvestor and ‘margin of safety’ within its promotional literature, and has aManaging Director of Investment that remarks: “We don’t ask our analysts torecommend stocks – we ask them to value businesses”! Not surprisingly,Graham's value philosophy has served Brandes well over time. Indeed, it hasbecome one of the fastest-growing fund managers in the world. After itsformation in 1974, total assets had reached $11m by 1984. However, by 1994,those assets had swelled to $3.9b and by 2004, they topped $87b.

Strategy

So what’s the Brandes strategy in practical terms? The following has beenextracted from The Search for Value, a document from the group’s website thatoutlines its stock-picking philosophy:

How do you determine whether a stock is good value?

We analyse long-term rates of return, cash flows, balance sheet strength,management, asset values, and liquidation values. We also often look at privatemarket transactions to determine intrinsic, or fair, value. We look for abusiness with a potential margin of safety – one selling at a price below ourestimate of its intrinsic value. A margin of safety provides some protectionfrom error and uncertainties. This is a conservative approach that aids inpreserving capital and gives us the opportunity for profit.

How important are book values in your methodology?

Book values can be very misleading as a measure of value… For example, anobsolete steel plant may be worth far less than the stated value on the balancesheet. Conversely, a well known, dominant brand name may have accumulatedtremendous value that is not reflected on the balance sheet.

Do you own stocks with low price to earnings (P/E) ratios?

Most of our stocks carry low P/Es. This is fundamental to our approach. Butas in the case of asset values, earnings may need adjustment – and we focuson “normalised” earnings, not the most recently reported results. Ingeneral, we tend to pay as little as possible for the earnings stream of abusiness.

How important are dividends?

Typically, dividends are not considered in our process of screening for valuestocks. However, businesses priced at bargain levels in many cases payhigher-than-average dividends.

Is it really possible to acquire companies at bargain prices?

Yes. Many companies are overlooked, misunderstood victims of investors’overreactions, misplaced fear, and exaggerated focus on short-term performance.We are often able to acquire companies inexpensively when they experiencetemporary difficulties or when market conditions are generally weak. We thinkindependently and make investment decisions based on quantifiable evidence. Weseek to shield ourselves from the influence of short-term public sentiment, andour actions tend to counter current opinion. We are patient, conservativeinvestors who are willing to wait for values to surface. We also seek tocapitalise on changes in corporate direction and strategy that increase acompany’s intrinsic value. Often, the market is slow to respond to positivechanges, creating an opportunity for the patient value investor.

What is the role of economic and industry analysis on your investmentprocess?

Analysing or attempting to predict future macroeconomic trends playsvirtually no part in our investment process. For example, we do not baseinvestment decisions on our opinion of future changes in interest rates oreconomic growth.

How important is company management in arriving at an investmentdecision?

We prefer companies with management teams dedicated to the interest ofshareholders, not to building empires and their own net worth, independent ofthe shareholders. We look at a variety of factors such as compensationarrangements, stock holdings, management goals and statements, and actions thatindicate attitude toward owners.

How diversified are your portfolios?

We concentrate our portfolios in 45 to 75 stocks…We believe our valuediscipline enables us to confidently take positions that can be significantlydifferent from the composition of popular indices.

How long do you hold positions and what is your sell discipline?

We have no fixed holding period. We may hold an investment as long as theintrinsic value exceeds the stock’s market price. When a company’s stockprice reaches our estimation of its intrinsic value, or if we are able toidentify a superior alternative, it is sold. Our holding periods typicallyaverage three to five years.

Sources;

  1. Motley Fool’s Value Investor newsletter, produced in the UK to help inform and guide UK investors. (26/10/04)
  2. Brandes Investment Partners LLC.