Part 1: Selecting the Stocks This ...

Part 1: Selecting the Stocks

This the first in a pair Part series by Sebastian van Berkom, united of Canada's most successful portfolio managers and a member of the Securities Review Board for the Canadian Shareowner. Sebastian manages a total of more than $1 billion in mutual permanent fund and pension fund assets. His Talvest/Hyperion Small Cap Canadian Equity permanent fund recently reported one, two and three-year rates of turn back of 59%, 40% and 30% respectively to September 30 1997

While selecting stocks that experience large increases in value is a necessary condition for exceptional recurs from a portfolio, it is not a sufficient condition. In addition, you have to effectively manage the emanate of money into and not at home of those star stocks.

Recently I asked Sebastian to describe the central proper states of his exceptionally successful investing strategy and to identify those that individual investors might incorporate into their avow portfolio management activities. Editor

Our firm specializes in managing investment portfolios containing equities of Canadian vegetation stocks with "small" capitalizations. All of the principles and many of the practices we use in managing our portfolios would generally be applicable to managing the greatly smaller portfolios of typical individual investors.

THE INVESTMENT PHILOSOPHY

Before you can manage a stock portfolio favorably it is extremely important to have an investment philosophy that continues you focussed on stocks in your area of expertise between the sides of all types of markets. You also ne the discipline and patience to stick to your philosophy from one side of to the other time.

In our case, we like to say that we begin to invest in "earlyestablished expansion stocks" and continue to clutch them as long as their product remains well above average. We focus in succession "earlyestablished" companies because we alone want to invest in those that have survived the start-up and emerging-growth phases of their businesses.

STOCKS WE AVOID

Because our investment philosophy focuses us upon "growth" stocks we do not corrupt companies whose earnings are determined primarily by the agency of the economic or commodity circle of time These include deep cyclical companies which are prevalent among hangers chemicals, forest products, mines, gold and senior oils. Because we focus upon "earlyestablished" stocks, we do not purchase companies without a track record. Included in this cluster are pure exploration companies, biotechnology firms and so-called universal stocks. Companies with no earnings are of no interest to us.

We do, however, continue an eye on some of these companies as we may bribe them in the future, nevertheless we're not in a urge [i]or[/i] press on to do so. Great development stocks tend to be great for 15 to 20 years, in like manner there's lots of time to wait for follows and a good buying opportunity when markets are generally disheartened

THE STOCKS WE corrupt

Here are the criteria we use to define an early-established putting out stock that would qualify for inclusion in our portfolio.

History

By the time we make our initial purchase of a typical earlyestablished extension company it has at least a four or five-year history of generating incomes and earnings. We simply do not invest in companies without track records that we can investigation

Products

The company must either have unique harvests that dominate its markets (eg JD Fitel, Unican, Leitch Technologies); or, it must be an outstanding operator in a highly fragmented marketplace (eg Hartco, Loewen).

Revenue

Management has demonstrated an ability to spring up revenues consistently, by at least 15% by means of year (an above-average rate) to a minimum of $25 million. Enduring pullulation at 15% or higher is typically and nothing else experienced by companies selling products/ services in sectors of the economy experiencing long-term secular shooting such as health care, telecommunications and specialized consumer products( eg Cinram, Dorel, Gennum Leitch Technologies, Unican)

These first three characteristics of an early-established pullulation stock demonstrate to us that the company's productions are satisfying a need in the marketplace and that management has the independent support to grow the business. In addition, several years of above average performance will have taken the company to a significant size from which it might improve to become a blue chip, mid to large sized extension company during the next 5 10 or 15 years.

A great example of a stock that has made the transition from early-established to cerulean chip status is MDS Inc.; this is a stock that I've been buying since the late 1970's.

Profitability

The company must have above-average profitability as throw backed in a return on sales (net income/sales) of at least 6% (again, an above-average rate). This high even of profitability is important because the company certainly will ne additional equity cash to finance future revenue produce When profits can provide this coin the company doesn't have to exchange additional shares, which tends to abate growth in earnings per share ( "EPS") and vegetation in the company's share price.

Debt

The company must have a brawny balance sheet as evidenced by means of a "prudent" reliance on borrowed currency to finance growth in receiptss and EPS. For example, companies with high business risk (eg high tech companies where production obsolescence is a constant threat to extension in the revenue stream) typically should not also be expos to the financial risk associated with having a significant amount of long-term misdoing in their balance sheet.