Focusing on Companies Trading at Discount to Intrinsic Value with Growth Prospects: Wall Street Transcript Interview with Paul Hogan, Co-Manager of the FAM Equity-Income Fund at Fenimore Asset Management

Wall Street Transcript

67 WALL STREET, New York - September 4, 2012 - The Wall Street Transcript has just published its Large-Cap Value and Other Investing Strategies Report offering a timely review to serious investors and industry executives. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

Topics covered: Large Cap Investing - Downside Protection - Value Investing - Risk Mitigation

Companies include: Mattel Inc. (MAT), McCormick & Co. Inc. (MKC), Aqua America Inc. (WTR), Meredith Corp. (MDP) and many others.

In the following excerpt from the Large-Cap Value Investing Strategies Report, an highly experienced portfolio manager discusses his investment criteria:

TWST: How would you describe the firm's investment philosophy, and what do you believe makes this approach unique?

Mr. Hogan: We are certainly value investors, but we are looking for enterprises that are growing. For us, it's not enough for a company to be trading at a cheap valuation - they have to be able to grow over time and meet our stringent investment guidelines. When we make an investment, we have a long-term growth horizon, so we've held a number of the investments in the funds for a decade or more and our shareholders have benefited.

I manage the FAM Equity-Income Fund. The fund started in 1996, and we concentrate on small- and midcap companies, which is quite different from most equity income funds. Most equity income funds are in the large-cap value space. When investors are trying to distinguish between a large-cap value fund and an equity income fund, there is very little difference. They all own the same names.

In contrast, the FAM Equity-Income Fund is firmly in the midcap space, and it looks very different from the typical equity income fund. In fact, 60% of the businesses that we invest in are outside the S&P 500 Index. We want excess cash flow of the business to be paid out to shareholders in the form of dividends. Dividends have typically been a very meaningful part of equity returns over time. The S&P 500 Index states that dividends have made up roughly 40% of investor returns for the greater part of the last century.

TWST: Would you walk us through the nuts and bolts of Fenimore's stock-selection process?

Mr. Hogan: We have four main investment criteria. First, we are looking for businesses that are understandable to us and have a long competitive runway. These businesses typically generate more cash than they need to reinvest in their operations. That excess free cash flow can be used to pay dividends to shareholders, buy back stock or make acquisitions that grow the business. We look at how well management uses that excess cash since we're equity investors and provide them with capital.

Second, we seek businesses that are financially strong, have manageable debt and have high returns on invested capital. It's great to have cash flow when times are good, but we saw a lot of companies during the 2008 meltdown that had to cut their dividends because they were overleveraged. We try to avoid those situations. We're debt averse.

Third, the management teams are crucial to us. We spend a lot of time getting to know the leaders and try to have face-to-face visits with every company that we hold in the fund at least once a year. The benefit is that we can see the enthusiasm these managers have for their companies, new products or markets that they are pursuing. It's the leadership that sets the tone for the business and the employees in terms of the culture and vision, so that's very important.

Finally, we want to make sure that we are not overpaying for the stock. We like to invest in a corporation below its intrinsic value and that gives us a margin of safety - in other words, protection on the downside. Those are our four criteria.

TWST: What kinds of companies are you looking for?

For more from this interview and many others visit the Wall Street Transcript - a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs, portfolio managers, and research analysts. This special issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

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