Investing in Growing Businesses with Undervalued Stock Prices

Investment Philosophy

At Naylor & Company, we believe that owning competitive companies that serve predictable and fundamental consumer needs is essential to prospering with investments.  We prefer companies that earn high returns on equity, provide goods and services superior to their competitors and operate in industries that have long-term growth trajectories.

Of course, strong companies often have high stock prices relative to their earnings. In order to invest in strong companies at attractive prices, it is necessary to buy them when their industries are out of favor or the company itself has suffered a short-term, manageable setback before resuming its long-term path to growth.

When we make an investment, we plan to hold it for several years because we view ourselves as business owners rather than stock traders. We believe that an investor can obtain better results in the stock market by focusing on the long-term fundamentals of the business itself, rather than short-term fluctuations of the overall stock market. Therefore, we do not try to time the stock market, but instead use the stock market’s volatility as an opportunity to buy good companies at attractive prices.

Investment Process

Naylor & Company uses a detailed and refined process for selecting the stocks for client portfolios.  We begin by researching industries that are in the beginning stages of recovery from a temporary economic downturn.  There are often many good attributes to the companies in these industries.

First, the stock prices can be relatively low because many investors do not have the patience to await the recovery.  Second, the strong companies have usually streamlined their operations to manage the downturn.  Third, the strong companies face reduced competition in the recovery because the weaker companies failed, resulting in less competition.  Consequently, the recovering companies can achieve both higher revenues and higher profit margins in the recovery.

We invest in these companies when the industries begin to show signs of recovery and hold them, preferably for several years, until their valuations, business conditions and performance justify selling them in favor of other investment opportunities.

In the past, we have used this process to find good investments in a variety of industries, including airlines, healthcare, online travel agencies, banking, the rental car industry, automobile manufacturing, gaming, website hosting, tow truck manufacturing, retail, cable television, transportation logistics and semiconductor manufacturing.  Having the flexibility to invest in many different industries allows us to take advantage of multiple cycles of downturn and recovery across the U.S. economy.

Investment Strategy

Naylor & Company’s Core Composite uses a deep-value strategy to create concentrated portfolios that emphasize companies with strong competitive positions, good long-term growth potential and attractive stock prices.

Investment  Approach
At Naylor & Company, we buy good companies at prices relatively low in comparison to their earnings and hold these companies for long periods of time.  This allows us to benefit from both the companies’ growth and the market’s realization of their value.

There are approximately 5,000 companies listed on the U.S. stock exchanges and Wall Street focuses on a fraction of these.  Naylor & Company seeks investment opportunities in the many overlooked and under-appreciated companies with good long-term potential.

Over the long-term, it is the company’s earnings growth that will determine its stock price.  Gaining a thorough understanding of the company’s business is essential to good investing.  We always prefer companies with businesses that we understand and that have a fairly predictable track to success.

Competitive Position
Given a choice of investments, we seek companies with strong competitive positions that will allow them to maintain good returns on equity and discourage other companies from taking their market share.

Rational Valuation
Refusing to overpay for stocks is the key to making good long-term investments.  This also mitigates some risks by avoiding over-priced stocks which can dramatically fall in value if their businesses slow for a time.

Ongoing Review
Although Naylor & Company prefers to hold investments for several years, we constantly monitor our companies to make sure that their businesses are developing as expected and that their stock prices are not getting too far ahead of their earnings.  If either of these events occur, we seek other investments that meet our objectives.

Finding Good Investments

Many investors focus on a narrow band of stocks because they are familiar with just a few names in the stock market and they feel more comfortable with large, well-known companies.  However, there is a price to be paid for investing in large, well-known companies.  These companies often have higher stock prices relative to their earnings than less well-known companies and, therefore, are more likely to generate average returns.

At Naylor & Company, we seek out good companies that are not as popular or widely-known.  Sometimes they are overlooked because they are small or medium-sized companies.  Other times, they are under appreciated because they are in boring industries or they are recovering from past problems.

First:  We always prefer to invest in companies in growing industries, or with growing market shares in their industry.  We also prefer to invest in companies that provide goods or services that meet an enduring and long-term need of the public.  Companies with growing market shares or in growing industries tend to be more stable investments than other companies.

Second:  For the majority of our investments, we demand that our companies have proven abilities to earn profits before we make an investment.  This is one of the best ways to mitigate risk in the stock market.  Many companies, regardless of the excitement around some potential new product or service, never find a way to earn a profit from those businesses.

Third:  We obtain a thorough understanding of the businesses that underlie our stock investments.  As long-term owners of businesses, we want to understand why the company is growing and whether it is likely to continue to do so.  We review the company’s financial statements and various analytical reports about the company and its industry.  We pay particular attention to revenue growth, return on equity and future market size and growth potential.

Fourth:  We then acquire a position in the company through its stock and hold this company for a relatively long period of time to benefit from the realization of the full value of the company and its growth prospects.  We typically keep our companies until the company’s growth prospects diminish or its price relative to its earnings justifies its sale.

Hour Glass

Finding Bargains Requires Patience

The best opportunities in the stock market often take years to realize their full value.  At Naylor & Company, we are constantly looking for good businesses with undervalued stocks.  We want to acquire stocks in growing businesses when their industries are out of favor.  Then, it is simply a matter of waiting patiently for the industry to recover or come back in favor.

Annualized Returns - Naylor&Co

Diversification Mitigates Risk

At Naylor & Company, we typically hold 30-50 companies in our portfolios.  This level of diversification provides a degree of risk mitigation for the portfolio, but still allows us to maintain positions sufficiently large to generate meaningful gains when those investments perform well.