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Acknowledging that interest rates, emotions, and perceptions about the future play a role in market movements, we believe that stock prices reflect the earnings characteristics of companies over longer periods of time. Stock prices reflect not only the growth rate of those earnings, but also their pattern of volatility. Having an objective of outperforming our benchmark over a full market cycle with less risk (volatility), Red Granite builds portfolios of high- quality companies with above average, and more persistent, earnings growth relative to their industry counterparts. High-growth companies have proven their ability to generate high rates of return on new investments; the result is accelerated if operations are tightly managed. Consequently, high profitability is important with earnings consistency harder to achieve in an intensely competitive world with more transparent accounting standards.
As corollaries to our approach, we must be long-term investors in companies for the earnings/stock price relationship to be valid, and we must invest in established, high-quality companies where managements have demonstrated their abilities to grow businesses under good and less-than-good economic settings. The more propietary a company’s competitive advantage, the longer the company’s potential to generate above average returns exists. Ongoing success demands the ability to identify and create new opportunities for putting today’s profits to work at a premium rate of return. To mitigate the risk of overpaying and the influence of emotion, we emphasize relative price-to-earnings valuation in securities selection.
History has shown that preserving client capital in difficult markets is an important component of building long-term wealth. As our “shadowing bear” logo suggests, successful investing is not a one-way street; risks are ever present. The value lost from a large negative return can take years to restore.
As an example, the table above compares two 10-year sets of performance returns and the value of $1,000 invested with hypothetical managers. Manager A has the more volatile track record, yet Manager B’s lower risk levels do not result in sub-par performance. Of course, this example serves merely to demonstrate the potential advantage of a chosen investment philosophy and is not intended as model or actual performance. Still, several observations can be made: Manager A’s volatile track re c o rd produces better returns in each of the positive years; Manager B only outperforms Manager A in three negative - return years; yet, Manager B’s lower risk approach earns a higher value with lower volatility. Reduced volatility can be appealing psychologically and prove very useful for planning purposes.
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