Mr. Coats: In January 1993, we launched the Oak Value Fund (the Fund). Our philosophy is grounded in the teachings of Benjamin Graham as further developed by Warren Buffett, but also with the influence of people such as Michael Porter, a professor at Harvard who has developed the notion of a "competitive framework." We are also influenced by Charlie Munger and one of his mentors, Phil Fisher, who had a focus on buying higher quality great businesses when there is opportunity to buy them at attractive prices. In a nutshell, our focus is on identifying and investing in a select few advantaged businesses that are run by able management when we can buy those businesses at very attractive valuations. Now, if you think about those three criteria - advantaged businesses, able management and attractive valuations - essentially what we have done is we have taken the traditional view of value investors and we have inverted the priorities of that view, if you will. Traditionally, value investors begin with what is cheap, what is the most attractive from a valuation standpoint and then they go through the process of analyzing those opportunities to identify their potential investment universe. Realizing that there were some unintended consequences of taking that approach and based on a long period of experience, several years ago we made the decision that we should invert that process and actually begin with what are the best businesses - what are the types of businesses we would like to own - and confine our efforts to those businesses. Buffett and Munger have many times said that it's important that you recognize that you have a stack or a pile, if you will, that is called the "too hard to call pile." What we realized several years ago is that you should also have another pile that you put potential ideas into, and that is the "don't care pile." In the process of reviewing all of the companies in the Russell 1000 and the Russell 2000 on a company by company basis, we basically separated the world of potential opportunities into various categories based on an internal process that allows us to focus only on those businesses that produce advantaged economics and have the ability to sustain those economics over time. Then the key becomes understanding what it takes to qualify as an advantaged business and what are the characteristics that we are looking for. As we go through that broad universe of some 3,000 companies in order to narrow down our investable universe, we're focused on businesses that have high operating margins, high returns on equity and high returns on invested capital. We're focused on businesses that have a competitive advantage; Buffett calls it a moat and castle. Once I was with Buffett and I said to him, "There is this professor at Harvard who wrote a book about competitive framework and he maintains that a company's ability to control the future is to a large extent determined by its position relative to customers, suppliers, competitors and substitute products. It seems to me that this is essentially the same thing that you, Mr. Buffett, talk about when you use the analogy of a moat and castle." He chuckled and said, "Well, Professor Porter writes books about it, and I make billions, but they are the same concepts." That is a very important realization and complements the lens through which we view companies. We have focused on businesses that tend to generate advantaged economics and have an advantaged competitive position primarily as a result of one or more of the following positions: they have either a brand or a niche, they have some advantage from a franchise standpoint, they have a cost advantage or a scale advantage or they have a distribution advantage. They have the ability to essentially control their future, and in doing so, drive above average economics more so than might be the case with companies that don't possess these characteristics. The Fund has a focused portfolio, typically 20 to 25 names. Average operating profit margins are currently around 25%. Average return on equity is approaching 30%. Debt to total enterprise value is just above 20%, and if you take out the financials, the debt to total enterprise value is in the low teens, almost single digit. The Fund has a portfolio of highly profitable businesses generating high returns on equity and capital, doing so without employing significant leverage from a balance sheet standpoint, driving more than half of their revenues on average from business outside of the US. Moreover, this collection of businesses is trading at a discount to the overall market in terms of their current p/e. I think that covers philosophically who we are and what we do. We believe this is really important. So much has been written and talked about, in terms of the principles that Benjamin Graham gave us from his early writings as value investors. Those principles that are the most commonly referenced are as follows. One, if you are going to own equities, view them as businesses and pursue them accordingly with the same diligence, thought process and analysis that you would if you were going to buy the entire business. Two, always require a margin of safety in every allocation of capital. Three, maintain the appropriate perspective on the market, recognizing that the market is a mechanism - it's a vehicle to facilitate what you may wish to do, but it doesn't require that you do anything. Most value investors tend to focus on the second and third of those principles - the margin of safety/valuation component - and the appropriate perspective often translated: be contrarian in terms of the way you view the investing world. We believe that the first principle, which addresses what you are going to own and how you should view it is supported by one of the other statements that Benjamin Graham wrote in The Intelligent Investor, and that is that "investing is most intelligent when it is business-like." If you are going to buy a business, you wouldn't begin necessarily with what is cheap today. You would begin by asking yourself, "What are the types of businesses that I would like to own and what are the characteristics that I would require, and where am I most likely to find those characteristics." Thus we spend what we believe to be an appropriate amount of time focused first on what are the advantaged businesses that we should have in our investable universe and then we work from there.
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