Mastering Value Investing: Insights from Lowell Capital's Approach

Value investing has evolved significantly since the days of Benjamin Graham, with modern practitioners blending traditional value principles with a focus on quality businesses. Lowell Capital, a small investment firm, offers valuable insights into how they've adapted value investing for today's markets.

Balancing Value and Growth

Lowell Capital aims to buy "growth companies at value prices." Rather than just looking for statistically cheap stocks, they seek quality businesses trading at reasonable valuations that can compound over time. This approach aligns with Warren Buffett's evolution from cigar butt investing to buying great businesses at fair prices.

The firm looks for companies that are:

• Already generating strong free cash flow
• Have high returns on invested capital
• Trade at valuations reflecting low expectations

They aim to find misperceptions in the market, such as companies in misunderstood industries or those flying under the radar due to size. Many of their investments have little to no analyst coverage.

Focus on Free Cash Flow

Free cash flow yield is central to Lowell Capital's investment process. They want businesses that can consistently convert profits into actual cash, not just show profitability on paper. When evaluating free cash flow, they look for:

• Repeatable, resilient, and relatively predictable cash flows
• Capital-light business models that don't require massive reinvestment
• Low capital intensity relative to revenues
• Recurring revenue and sticky customer bases

They view sustainable free cash flow as a key indicator of a quality business with a durable competitive advantage.

Simplicity and Circle of Competence

Lowell Capital places a strong emphasis on simplicity and staying within their circle of competence. They ask themselves:

• Can we easily explain how the business makes money in a few sentences?
• Is it generating strong, sustainable free cash flow today (not based on future projections)?
• Do we quickly understand the competitive moat?

If they can't quickly grasp these elements, they put the investment in the "too hard" pile and move on. They believe true simplicity often shows up in how resilient a business performs across multiple environments.

Short-Term Forecasting

Unlike many investors who use 5-10 year discounted cash flow models, Lowell Capital typically looks no more than 2-3 years out when underwriting an investment. They believe uncertainty compounds over time, making long-term forecasts unreliable.

By focusing on a shorter time horizon, they aim to:

• Avoid overconfidence in long-term projections
• Focus on businesses already working today at undemanding valuations
• Load more of the investment thesis into current performance and near-term outlook

Risk Management

Lowell Capital takes a conservative approach to risk management:

Cash Position

They maintain a significant cash position, often exceeding 40% of assets when they feel a more defensive approach is needed. This gives them optionality when opportunities arise and helps them navigate difficult market periods.

Fort Knox Balance Sheets

They prefer companies with very strong balance sheets, which they believe reduces risk tremendously during economic shocks or unexpected events.

Avoiding Leverage

They generally avoid companies with high debt levels, focusing on businesses that can generate strong returns without relying on leverage.

Quick to Cut Losses

If an investment isn't working out as expected, they aim to exit quickly and preserve capital rather than averaging down.

Learning from Mistakes

Lowell Capital is candid about past mistakes and uses them as learning opportunities. For example, they've become more cautious with retail investments after disappointing results with companies like Barnes & Noble and Tilly's. They now focus more on:

• Understanding a retailer's true differentiation and competitive moat
• Ensuring cash flows are sustainable and not driven by temporary factors
• Favoring non-discretionary products and services

Key Takeaways for Investors

1. Look for quality businesses trading at reasonable valuations, not just statistically cheap stocks.
2. Focus on sustainable free cash flow as a key indicator of business quality.
3. Stay within your circle of competence and favor simple, understandable business models.
4. Be cautious of long-term projections and focus more on current performance and near-term outlook.
5. Maintain a defensive approach to risk management, including holding cash and favoring strong balance sheets.
6. Learn from mistakes and continually refine your investment process.

By adopting some of these principles, individual investors can potentially improve their own value investing approach for today's market environment.

Article created from: https://www.youtube.com/watch?v=m1u7xzygf4k