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MOI: Describe your investment process at Tocqueville Finance?

Don Fitzgerald: We focus on stock picking without consideration of benchmark, sector or country allocation and look for companies that are undervalued by the market relative to their fundamentals. Given our long term investment horizon naturally we keep our portfolio turnover relatively low and avoid overconcentration—for example, more than 5% in a single position. We avoid derivatives with the exception of very limited use of covered calls. In times of limited investment opportunities we can hold up to 25% in cash or equivalents.

MOI: What companies draw your attention? How do you generate stock ideas?

Fitzgerald: Investment ideas come from a number of sources, such as regular quantitative screenings, tracking of Tocqueville investments which have been portfolio holdings in the past, monitoring of the financial press, management meetings and conferences.

Opportunities caused by disappointments of short-term market expectations are good targets. Also spin-offs and de-mergers where existing investors often sell without doing their homework on the new company’s real value or situations where you have a forced seller pushing down the stock price are good hunting grounds for fundamental investors.

MOI: Do you have any favorite valuation methods? Are there any analytical approaches you avoid?

Fitzgerald: In the financial analysis we place strong emphasis on margins and returns stability, through-the-cycle profitability, free cash flow generation and balance sheet strength in order to generate our best estimate of intrinsic value. Valuation is judged in absolute terms, relative to the peer group, industry transaction multiples and relative to the company’s own valuation history. We often use sum-of-the-parts valuations for multi-business groups.

Regarding ratios I am wary of valuation ratios like P/Es and price to sales, which often understate the importance of creditor claims on company assets and cash flow. Likewise EV to EBITDA ratios forget that companies need to replace equipment one day and that profitable companies actually pay taxes. I think EV / NOPAT is a nice ratio that in theory corrects for a lot of these faults. However, don’t forget that ratios are just tools or marker points.

MOI: What European markets have you invested in the most and why? Do you invest in Eastern European markets? If so, are there any differences in the valuation approach you apply there compared to investments in more developed Western European stock markets?

Fitzgerald: We invest all across Western Europe and, given our bottom-up approach, there are no countries we avoid or focus on. We have limited experience investing in Eastern European markets and due to lower transparency, corporate governance concerns and issues with the protection of minority shareholders, we are not likely to change our stance in the short to medium term.

MOI: Have you favored or avoided any particular industry as a result of recent financial market dislocation and macro-economic turmoil?

Fitzgerald: For the last three years or so we have had limited exposure to financials, not necessarily because we foresaw all of the problems in the sector but merely because the profitability achieved in the sector from 2003 to 2006 did not appear sustainable and we had concerns about transparency.

MOI: What is the single biggest mistake that keeps investors from reaching their goals?

Fitzgerald: The biggest mistake investors probably make is following the herd and ignoring common sense. The herding instinct is part of the way our brains are wired and we must try to discipline our minds to avoid this default. The worst buying points in any asset occur due to bubbles caused by mass crowds pushing assets prices too far – like the Internet bubble at turn of millennium or house prices in many countries in recent years. Thankfully, value investing helps one to avoid bubbles by focusing on the difference between price and value. Other mistakes investors make is not having a proper strategy, philosophy or discipline to guide their investment decisions.

MOI: When you review your past investment successes, what key common traits do you observe?

Fitzgerald: Probably the best investments were made in companies where I had a very good understanding developed over time on the fundamentals of the company in terms of strategy, management and competitive positioning. This rigorous homework allows you to generate a fair view on the company’s intrinsic value so that you can pounce when Mr. Market offers an attractive entry price.