This is part two of a four-part interview with Zeke Ashton Portfolio Manager and founder of Centaur Capital Partners. The interview is part of ValueWalk’s Value Fund Interview Series.
Zeke founded the Centaur Capital Partners Centaur Value Fund back in the summer of 2002 and his conservative value style has produced some impressive returns for shareholders over the years.
From its inception on August 1, 2002, through July 31, 2016, the Centaur Value Fund produced a cumulative net return of 351.2%, versus a cumulative return of 217.0% for the S&P500.
The Centaur Capital Partners interview has been divided into several parts and will be downloadable as a PDF at the end of the series. So stay tuned for the rest of the series as well as the downloadable PDF!
Interview with Zeke Ashton of Centaur Capital Partners [Pt. 2]
Continued from part one…
How do you go about looking for investments (both long and short) at Centaur; what’s your investing process?
We have a pretty disciplined research process once we start working on an idea that we think might be a potential investment, but in terms of just gathering candidates we haven’t come up with a better way than just to read widely, cast a wide net, and then take a deeper dive when something strikes us as interesting. The most reliable source of new ideas for us has actually been ideas that we’ve researched in the past. After fifteen years of writing research reports, we have a pretty big database of internal notes, and we maintain a spreadsheet of stocks that we have researched previously that will alert us if the stock hits an interesting price. Given the work we’ve already done, we can usually determine pretty quickly how close it is to being actionable and therefore budget how much time to spend on it.
In terms of evaluating completely new ideas, we obviously see a lot of investment pitches on the web, and of course we read investor letters from other managers that we think are smart. We’ve also developed a bunch of statistical screens that occasionally produce a nugget or two. Finally, every once in a while, we do an exploratory study of an industry niche to help us understand who the players are and the competitive dynamics of that space. Sometimes we find something immediately actionable, and sometimes we end up with a stock that goes on our “wish list” to be reviewed at a lower price.
How do you approach valuation?
This is a subject that requires a whole book, because the craft of valuing businesses is effectively a career-long journey. I find that one never really becomes a master because every stock and every industry is different. I like to say that every stock has a story to tell and a lesson to teach.
In order to keep my answer to a reasonable length, I will simply offer two insights that experience continues to pound into me. One is very simply that valuing any company requires a certain familiarity with and a decent understanding of the business. The idea that an investor can just slap a multiple to earnings or stated book value is a highly superficial notion – though of course it does sometimes work. The better you understand a specific business and the industry that business competes in, the better the valuation work is likely to be. That said, some businesses are easier to understand than others, and there are many businesses that simply can’t be valued with much precision. That’s a difficult concept, I think, for sophisticated investors to accept. There is a temptation to believe that every business can be valued with enough informational input, but we’ve found that for us there is a good percentage of the investable universe that really and truly belongs in the “too hard” pile.
The other insight I will offer is that at least in our experience, the further we drift from true cash flow profitability as a starting point in our valuation work, the more difficulty we have. What does this mean? To me, it means that using EBITDA is far less trustworthy than true cash flow. GAAP or adjusted net income is far less reliable than true cash flow. And when you find yourself running DCF models where most of the cash flow is expected to materialize many years out into the future and you are discounting that back to today at some arbitrary rate, let’s just say there are lots of ways for that to go wrong. We almost always use a DCF at some point in our valuation work, especially to help us with scenario analysis, but we have to remind ourselves that a DCF model isn’t gospel. DCFs are very useful as a sanity check and thought experiment, but shouldn’t be a substitute for a more complete valuation exercise.