Objective

 

Granite's objective in managing equity portfolios is to provide superior risk-adjusted returns and to outperform relative benchmarks over a full market cycle.

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Investment Philosophy

 

Granite's investment philosophy is a fundamental and research driven approach to investing in a concentrated portfolio of high quality companies between the appropriate market cap ranges for the given strategy. Granite is devoted to finding companies with strong management teams and superior business models that can also benefit from catalysts expected to drive gains in discretionary free cash flow, revenue, earnings and returns on invested capital.

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Decision Process

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Independent Research

 

Original research is the core of our investment process and all portfolio managers are also analysts. Each member of the investment team is responsible for researching and recommending investment ideas.

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The generation of new ideas starts with an eclectic group of sources, including company managements, industry contacts, trade shows, industry conferences, trade and general media, proprietary quantitative screens and, on a limited basis, Wall Street research.

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Independent sources such as customers, suppliers, and competitors are often used to cross-reference facts and information derived from company management interviews. These meetings and discussions can also add a different perspective to the merits of an investment idea.

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Granite company research may also include a “Porter’s 5 Forces” analysis which reviews entry barriers and the threat of new entrants, threat of substitutes, bargaining power of buyers and suppliers and rivalry among competitors, as well as a business discussion and an earnings model which reflects historical and expected financial performance.

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After the initial review, the most compelling ideas are presented to the entire investment team in order determine which companies merit further due diligence and research.

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Analysis

 

Qualitative Analysis

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Proven Company Management

In meeting with management teams, the evaluation may include a determination of their vision, culture, incentive plans, strengths and weaknesses. Our goal is to invest in companies with management teams that are experienced, prudent, visionary, have a history of success and act in the long-term best interest of shareholders, particularly through effective allocation of capital.

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Superior Business Models

We search for companies which have the organizational processes and a structure in place to meet today’s evolving challenges. Many of these companies maintain dominant market share yet have transparency of their operations. We also prefer to invest in companies that demonstrate organic growth, recurring revenue models and an operating business that benefits from incremental unit volume increases that fall directly to the bottom line. This evaluation often includes reviewing the company’s product lines, distribution capabilities and product pricing.

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Fundamental Catalysts for Positive Change

We believe that value can be added when we identify, at an early stage, positive changes affecting a company that the market has yet to discern. These catalysts are often a mixture of secular trends, such as technological advances or structural changes in an industry, combined with positive fundamental changes occurring within a company. Fundamental catalysts are often the greatest driver of the growth of revenue and earnings for a company. Examples of fundamental catalysts include; a new product introduction, application of an emerging technology, a positive change in management, advances in operational efficiencies or a strategic acquisition.

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Quantitative Analysis

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Operating Metrics

After reviewing the qualitative aspects of a company we then focus on the quantitative side, including operating metrics. We tend to focus more on positive changes in cash flow and not on accounting earnings and those companies with increasing returns on invested capital versus the cost of their capital, reasonable debt levels and strong balance sheets. We also prefer that these companies have expense and operating leverage, improving margins and earnings per share growth.

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Superior Business Models

We search for companies which have the organizational processes and a structure in place to meet today’s evolving challenges. Many of these companies maintain dominant market share yet have transparency of their operations. We also prefer to invest in companies that demonstrate organic growth, recurring revenue models and an operating business that benefits from incremental unit volume increases that fall directly to the bottom line. This evaluation often includes reviewing the company’s product lines, distribution capabilities and product pricing.

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Cash Flow Modeling

The Granite research team often conducts proprietary cash flow modeling to determine the sustainability of a company’s cash flow which is then reconciled back to its earnings. The research group utilizes an extensive proprietary investment model which dissects key operational aspects of a company’s performance. We evaluate a company’s ability to generate cash from earnings utilizing these proprietary ratios. An example of this would include assessing the earnings quality of a company by comparing cash EBITDA relative to income EBITDA. We believe this metric gives us a good indication of the cash conversion quality of companies we consider. We also review free cash flow yield, compare free cash flow relative to net income and working capital management.

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Valuation Criteria

 

Critical to the investment process is the identification of companies exhibiting the highest growth potential at the most attractive prices or valuations. We prefer companies that are selling at a price level below their intrinsic business value and their projected growth rate or relative to alternative investments within an industry. In reviewing intrinsic value of a company we often generate discounted cash flow models over a five to seven year time horizon. Often these companies may have missed recent earnings estimates but have improving fundamentals and lower valuations. Other proprietary valuation models may be built for companies considered for investment and form the basis for our valuation judgments.

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Security Selection

 

Companies that pass the rigorous qualitative and quantitative assessments from fundamental research are presented to the equity team for review. These group evaluations ensure that the reasoning and analysis behind each recommendation is solid and defensible and that the criteria of superior business models, proven managements and a fundamental catalyst which will increase discretionary free cash flow are considered. Final security selection is a result of the compilation of all analysis and is at the discretion of the Portfolio Manager.

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Sell Discipline

 

The sell discipline we use incorporates several factors, including: individual securities reaching the maximum market cap, identification of a better idea, overvaluation relative to the research team’s determined fair value compared to other like securities, a deterioration in company fundamentals, a questionable change in strategy or failure to meet operating objectives.

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Risk Control

 

At the security level, the primary portfolio risk control mechanism is our fundamental evaluation of a company’s business model, management team and financials. We also control risk through the portfolio construction process limiting individual position size and broad sector exposure previously described. In addition to security level and portfolio construction risk controls we overlay the secular catalysts identified to insure diversification across many industries and sectors.

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Decision Process Flow

 

Our internal research is presented at our daily research meetings as well as monthly at our equity strategy meetings. Daily meetings focus on updates of news items affecting our holdings such as events leading to change in the financial markets and developments in global markets. Monthly meetings cover more comprehensive company analysis in which new ideas are presented by team members to the entire group. These presentations are a focal part of our discussion and debate and an integral part of any stock recommendation.

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