Stock Collecting ... An interview with the Portfolio Managers of Investment Advisors of Indianapolis, Inc.

How would you characterize your style of investment?

It's more a hybrid of the growth and value styles than anything else. We first look at companies and their business prospects for the next decade or so, which means there is a heavy slant toward growth. We then ask ourselves, "if we could buy the whole company (fantasizing) would we and at what price." This leads to our value analysis, which is mainly an effort to really understand the cash-flow of the company. With significant free cash-flow comes debt-repayment, share repurchases, capital expenditures to grow the business, and/or dividend growth for the benefit of all shareholders. This long-term look at the company from an ownership position leads to rather long holding periods and steady annual portfolio progress.

You'd call yourselves stock pickers, then?

Well, more like stock collectors. We want to own a percentage of a very good company, and share in the long-term growth in shareholder equity. If you are going to own equities for the future, and most people should, you almost have to focus on company selection. Let's face it, who are some of the wealthiest families in America? The DuPont’s, Rockefellers (Standard Oil), Hershey's, Busch's, etc. Why not become a DuPont or a Busch (once removed) and own what they own.

The only other approach is to be a market timer, and we don't believe anyone can effectively time the market.

What kind of growth are your looking for?

Revenue growth is the most important indicator for us, and we like to see from 8-15% as an objective range. Anything higher is fine, but you have to realize you are going to pay a premium for it, and as is often the case, one quarterly disappointment and that company couldn't find a friend. It's rather mercilous that way.

And how long do you usually own a stock?

We have some positions which exceed ten years, and this list will probably continue to expand. If the company is marching forward on a steady pace, we would be much more inclined to stay in the position, rather than trying to trade in and out. Trading adds frictional costs, tax consequences (in taxable accounts), and overall portfolio confusion.

So turnover is low?

Very.  Purchasing quality securities leads to long holding periods.  In addition, many of our clients have taxable accounts in which tax-issues are a factor.

How many stocks do you usually own at any one time?

It varies by the size of the portfolio, but it wouldn't be unusual for there to be 25 to 40 names. When we take a position in a particular stock, most often we make an initial purchase of 2% of an accounts market value. Subsequently, most accounts have position sizes ranging anywhere from 2-4%, depending on the movement of each individual holding. This allows us to diversify not only by security, but also by industry sector.

How many companies do you watch to decide on the 25-40 you like?

We get hundreds upon hundreds of annuals and quarterly reports, and are adding to this list constantly. We grind up the numbers as they come in either via reports, corporate newswires, data services, etc., ... then determine if we want to become owners, and if so, what is a fair price to pay.

What other names are we talking about? What are some of the stocks you own or have owned?

One of our largest holdings year-in and year-out has been Sprint, one of the premier telecommunications companies in the world. They are invested in a variety of businesses, have tremendous strategic alliances, and are cash-flow heavy to the extent that their major problem is figuring out what to do with all the money. What a problem. Another is Hershey Foods, one of the two leading contenders in the chocolate business (and the only one publicly traded). Their product list is enviable, is professionally promoted, and is growing every year.

Are they all large-cap stocks?

No, they vary in market-cap from smaller local companies to the large-cap companies such as Hewlett-Packard and Sprint. Because we are not pre-empted from owning smaller companies like many institutions, which can't get the amount of shares they require, we can easily participate in all markets. At the present we own a balanced cross section of medium and large-cap companies.

What about the new technologies?

Ask yourself "do I really understand this techno-babble and the investment ramifications therein." There are significant players in these groups with dominant market niches, but when you can be leapfrogged out of business by a technological innovation ... well, we're not often interested in assessing risk-return on that basis. On the other hand, if we do feel we have a good understanding of the markets and the business in particular ... well, then we’re interested.

Do you use any kind of computer screens or models?

Several models. This really leads to risk assessment. (or...what is my downside in this stock?) The advent of computers makes it easier to digest more financial information and develop a base price at which you feel any company should reasonably trade. Bottom line to us is to assume we were management and wanted to buy the entire business -- what level of debt could we assume with the current and anticipated cash-flow from the business (leaving additional room to pay off the debt). This number translates into a per-share figure.

One of the great quotes in this industry is to "never forget the two most important rules of investing:

Rule #l - Don't lose money, and

Rule #2 - Don't forget Rule #1."

Where do you get your ideas?

Anywhere and everywhere. Stores, advertising, news items, journals, friends, etc.... that's what makes the business so much fun. You never know when you're going to get a chance to get in front of a trend.

Is Street Research important to you?

Seldom. Corporate numbers are very easy to come by. Additionally, most companies in the research circles are a "buy" or "strong hold," or some other such techno-jargon (B.S.). We recently witnessed a local company get downgraded from an "Above Average" to a "Buy " by a national brokerage firm after falling some 28 points. Makes you scratch your head and wonder.

What other criteria do you look for? Book Value?

Other than growth in revenues and cash flow, consistency in operating margins and return on equity is fundamental. On gross margins, consistency means that there is value perceived in the product or service offered and competition is not causing excessive pressure on pricing. It also indicates that costs (overhead) is at least not expanding as a percentage of sales. Return on equity tells us how well a company is reallocating their free cash. A consistently high ROE generally translates into either competent management, or a product or service so good that management can't hurt it.

Book Value is used when it contains other corporate stock holdings (ie. Seagram owned 34% of Dupont), large amounts of cash, or asset holdings which can be fairly easily quantified. Stated Book is easy to calculate, but seldom reflects the real asset value of a company.

With your buy-sell disciplines, do you tend to be either in or out of a stock?

Not always. On the sell side, unless we believe some event either corporate-wide or industry-wide could seriously damage a company holding, we usually only sell in partial positions to reallocate into other stocks or to build up a reserve. Also, it's not uncommon for us to add a little to existing positions from time to time if the price is right.

So you don't make a decision about the market as a whole?

We have yet to meet the soothsayer who can provide this type of prognostication with any level of accuracy or consistency. There are far too many market influences to predict overall market gyrations. Our portfolios are generally invested when we can find good bargains, and lightened somewhat when either the pickings are slim, or we sell partial positions which seem to be excessively extended.

And your cash position now?

For accounts that have been in the process for at least a year, the average cash position is generally less than 10%. Barring a meteoric rise in the market in the near-term, we would probably remain in a nearly fully-invested position. On newer accounts, we build the accounts up over a period of a year or so as stocks we are interested in fall into our purchase parameters.

What have been some of your biggest winners?

Generally they are purchases made when fear and skepticism is high, and short-term earnings reports become cloudy. Names include Nike, Hewlett-Packard, Pepsi, Sprint, and Philip Morris.

And the big losers?

Probably our poorest holding was a position in Chiquita Brands, a consumer brand with a dominant position in their market. Unfortunately, bananas are often treated like any other commodity, and when supply is plentiful, competition becomes heated and prices (and margins) fall. We consequently take a jaundiced look at companies which are unduly exposed to commodity pricing.

You make it sound simple.

It certainly isn't as tough as most financial pundits seem to make it. Old fashioned portfolio management like we rely on involves purchasing individual securities for which there is abundant information. We don't do special products, sizzle items, or participate in any of the new investment schemes or themes offered daily by many institutions.

What's the biggest drawback in your approach to investing?

Although we are committed to the stock market, and all that it entails, our approach is occasionally dull. Turnover is low, volatility is generally low ... just not all that much excitement.