Charlie Dreifus: How In-Depth Accounting Analysis Helps Find Good Investments by Royce Funds
Dave Gruber: Charlie, you’ve had the same disciplined philosophy and process since the late ’70s in running the portfolios that you manage. Can you walk us through the philosophy and process that you use?
Charlie Dreifus: It’s very much a buyer’s mentality, Dave. It’s something that, from the perspective of either a private equity or a strategic buyer, what would they earn in buying this company compared to what it would cost them to finance the purchase. So it’s seeking absolute values—companies where they’re selling in the marketplace below their economic value. And that helps during difficult times.
Another component of that approach has always been not only stressing the value—the spread between the return the buyer gets versus what it costs the buyer—but is it really a good business.
Is this something that, in Buffett’s terminology, would have a franchise, a moat? Is it something that is protected, unique? The other elements—and all of these have been in my product throughout my career, both in small-cap and large-cap—have been a free cash flow and cash conversion. How much cash does a company generate, as well as the accounting integrity. Accounting has played a very important role in the selection process.
Dave: Let’s dive a little bit deeper into that, the accounting. First talk to us about what your background is in accounting, and what you’re looking for in the financial statements through the accounting work that you do.
Charlie Dreifus: My undergraduate degree was in accounting. I did very well in it, but I didn’t really enjoy it, and I couldn’t picture myself as a practitioner. I went right from undergraduate school to a graduate program—it was a PhD program in business—and it was there that I encountered a professor who had a very profound effect on my life. That professor was Abraham Briloff.
Abe taught me in graduate school the importance of the deconstruction of financials. It’s very helpful to know how financials are constructed, so the undergraduate degree was important. But it’s the interpretation and the understanding of the alternatives that companies could have taken in portraying their results and how that affected the outcomes.