Stock Selection Process
Our search begins with the formation of a Small Value Research Universe for our Small Value Portfolio.

We then engage in a disciplined and repeatable investment selection process encompassing Quantitative Selection and Qualitative Research.

Quantitative Selection
We run proprietary quantitative screens across all public companies. These screens identify US-traded, reasonably liquid, small capitalization investment candidates exhibiting Four Elements for Performance - attributes we have found in common with our most successful investments.

• Underperforming
  We purchase a company that has suffered a negative overreaction as measured by a collapsed stock price relative to the market and often its peers. The stock's cumulative total return has underperformed the Russell 2000© Value over the last three years. Others may gain emotional comfort and confirmation in their investment “insight” in a rising price. We are true Buy low-Sell high investors. An Underperforming security may be an indication of an overly pessimistic investor outlook and a company that is virtually ignored out of all proportion to its real long term outlook and value.

• Low Valuation
  We purchase a company selling at low Price/Intrinsic Value; at low Price/Normalized Earnings and often at low Price/Asset Value dampening downside price risk through a margin of safety. We gain confirmation of our investment insight from business performance and comfort from a price wholly supported by true value; a price that indicates a stock’s best returns are ahead.
  
• Financial Strength
  We purchase a company that exhibits good Financial Strength, an indication of an economically viable business model that can generate sustainable profits. Academic research and our empirical experience suggests that measuring the financial strength of a company helps to distinguish a "Value Opportunity" from a "Value Trap". We run all our investment candidates through a proprietary Financial Strength Model and direct our research efforts toward companies with above average Financial Strength.

• Strong Outlook
  We own a company executing an astute business strategy that enables it to earn its Normalized Earnings Power within the next three years. Normalized Earnings Power is the true measure of the sustainable operating profit potential of a business model giving effect to successful strategy implementation in a steady-state economy. However, current profits are usually dampened by transitory events disguising the true economic potential and earnings power of the business model. We seek to partner with solid management teams with proven execution abilities and shareholder focus to “unlock” the full earnings potential of the company’s business model and the company’s value for shareholders.

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Qualitative Research
We diligently research our prospects, one company at a time. We review each company before deciding which candidates to pursue more diligently.

We seek to validate the Four Elements of Performance, an attractive expected rate of return and business progress in executing its business strategy for value creation.

An important product of our research is the calculation of the Internal Rate of Return (IRR), the expected rate of return on the investment over the next three years. A company with a particularly attractive (high) IRR indicates a price meaningfully below our estimate of Intrinsic Value. Intrinsic Value is the valuation reflecting our outlook for a company; what we believe the price will revert to within a three-year investment horizon based on the company realizing our estimate of Normalized Earnings Power. We value companies by capitalizing our three-year forward earnings estimate (our estimate of Normalized Earnings Power) at a conservative earnings multiple:

Using a proprietary relational database system we rank-order IRR (from highest to lowest) across our investment candidates. This results in the identification of the most attractive potential investments and directs our ongoing research efforts to these companies. Our time is spent gaining insight with our potentially most rewarding investment candidates.

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