More Art Than Science

That, to me, means that management uses the cash in a smart way. The best way that management can use cash is if the company has very high return, organic growth opportunities. [One] company that can do that in a significant [way] is CVRD [Companhia Vale Do Rio Doce], (ADR on NYSE: RIO), the Brazilian mining company that is the world's largest iron ore exporter. Iron ore goes primarily into the production of steel. Not only is CVRD the low-cost producer today, it also has low-cost mines where the capacity can expand very significantly over the next three to five years. At current iron ore prices, the return is 30%, 40%, 50%, or even higher on investment from these expansions. The key reason is that it already has much of the rail and port infrastructure in place so it's simply a function, primarily, of expanding the mines and then they get some more rail cars, but it's much cheaper than greenfield expansions by any of its competitors, so [CVRD's] cost per ton is much lower and therefore its return on investment is much higher. That, to me, is very exciting because they literally can put billions of dollars to work in extremely high-return projects and as investors we'll take that any day of the week!

A second best use of cash is very accretive and strategic acquisitions. CVRD recently bought the Western world's largest nickel company, Inco, in Canada, and we believe that this is another high-return use of cash for CVRD–it might not be quite as high as some of its organic projects but even if nickel prices fall significantly from here, the return on investment from this acquisition of INCO should be very high.

The third best use of cash, if they don't have high-return organic opportunities, if they don't have inorganic acquisition opportunities, and they don't need the cash to pay down debt, then they should give it back to shareholders, either in the form of dividends or share repurchases. It's important to us that management has shareholders' interest in mind in terms of their use of cash, and a company that is hoarding its cash for a rainy day when it's not necessary, or perhaps uses the cash on a non-strategic or low-return acquisition–these are the kinds of situations that we're not favorable on.

Then the fourth criteria–valuation. I don't believe there's a single valuation criteria or methodology that you can apply to every company, every single situation, so we try to use multiple valuation approaches and hope that they triangulate towards a similar target price. We typically use a DCF [discounted cash flow] approach. In some cases we'll also look at price-to NAV, P/E, enterprise value-to-EBITDA, and sum-of-the-parts. It depends on the company.

Is there a company where your thesis just didn't work out as planned?

One example is Infineon Technologies, (ADRs on NYSE: IFX), a German semiconductor company. It's really in two businesses, memory semiconductors that go in PCs on the DRAM side, and a logic semiconductor business, semiconductors that go into automobiles, telecom, and a variety of other uses…We felt that there was a reasonable chance that Infineon could, at least, significantly narrow the gap in costs of its memory semiconductors with Samsung–not fully but partially–and by partially closing the gap, the swing in its cash flows would be dramatic. On top of that, we thought that the valuation of Infineon gave very little credit to its logic business, and in particular the chips that go into the automobile sector; it was really a pretty stable, solid business.

This is what I would call a valuation story and a turnaround situation where we thought that management would be able to make significant strides in cutting costs and they had a full roadmap for cutting the costs. Well, several quarters went by and it became apparent that the cost situation for Infineon was more dire than we had understood. Despite the fact that we thought when we bought it that the stock was inexpensive, it became even more inexpensive and we lost money. We decided that our thesis was just fundamentally wrong and therefore we sold the position.

Were would this fund fit in an equity portfolio?

The one thing I would stress with regard to the Overseas Fund is that I clearly manage the fund with a long-term time horizon and I'm willing to make high-conviction investments, if we have done the fundamental research, in the belief that our fund holders will get paid, over a long period of time. In shorter periods of time, however, there can be lots of volatility in the markets and theOverseas Fund itself can be very volatile.

What else do advisors need to know?

In line with my comments about the fund being volatile, it's because of the fund's exposure to emerging markets; over the past few years approximately 40% of the fund has been invested in the emerging markets. We've made these investments on a stock-by-stock basis and we strongly believe in the prospects of each company that we've invested in. Nevertheless, the aggregate exposure to the emerging markets makes the fund susceptible to short-term volatility and I think it's important that any investors be aware of that.