Peter Smith, managing partner and CIO of the newly-created value investment house Palm Harbour Capital, outlines the firm's key pillars based on the hunt of undervalued stocks globally.
Palm Harbour Capital was co-founded by Spanish world-renowned investor Francisco García Paramés and Peter Smith in 2018 in London.
Cobas Asset Management, which is the Spanish value investment boutique owned by Paramés, took a majority stake in Palm Harbour last year through its parent company, Santa Comba. The move was considered by many as an attempt by Paramés to promote and spread the investment principles of the US-born investment style.
While the majority of the market buys securities hoping someone else will buy them at a higher price, value investors like us do it by buying at a significant discount to intrinsic value."
Smith says: "Paco clearly believes in value investing philosophy and he set up the value school to teach value in Spain, and to give options to Spanish investors and to educate them.
"Spain has a very low holding of equities compared to the US or the UK. And Paco has a very strong feeling that holding companies is the best way to protect your money against inflation and against other things that happen in the world."
Paramés, who is behind the rise of value investing in Spain, began his career at Bestinver in the 1990s and, following the investment philosophy of the great US value investors, such as Warren Buffet and Peter Lynch, achieved extraordinary returns of around 15% annualised over 25 years.
After serving a two-year non-compete clause following his departure from Bestinver in 2014, he launched Cobas Asset Management in 2017.
To further understand the partnership that led to set up the UK boutique, it is necessary to go back to the beginning of the relationship between its two co-founders.
Peter Smith, from Texas in the US, was always interested in Europe. His passion for the old continent as well as for the financial world dates back to high school, when the value investor was taking his classes of European History and Economics.
That first academic approach led him to choose the International Business Bachelor Degree and minor in German at the Tech University in Texas, which also explains his later entry in Commerzbank in Frankfurt, where he worked focusing on equities. During that time, he started reading about value investing and felt it made sense.
"While in Commerzbank, I wanted to move to the "buy side" but after the financial crisis, this move was difficult. So I went to the London Business School and its Value Investing Class looking to make that shift.
"It was on that time when I started reading about Paramés. I felt I wanted to have my own creation but at the same time I was looking for a job in value investing. I could not find a value investor in London that I really connected with from a philosophical and process point of view. I was lucky when so a colleague from university introduced me to Paramés and I was able to pitch him stock ideas as well as my idea for a UK boutique manager."
After some two years of sharing ideas, Smith started working as an external analyst at Cobas AM in 2016 but was not until last year that the two value investors teamed up for the manager's creation.
Palm Harbour Capital is led by Smith, who holds the positions of managing partner and chief investment officer at the firm. The firm counts with the support of Paramés as the firm's non-executive partner and also with Thomas Livesey as a research analyst, who has been working alongside Smith pitching ideas to Paramés and its boutique Cobas since March 2017.
Palm Harbour is a research-driven, fundamental, long-term value investment house that aims to provide superior long-term investment returns.
This research-driven process means that the firm will normally challenge the conventional wisdom and status quo while confronting assumptions and finding the facts through intense due diligence. Smith and his team spend significant time speaking to industry insiders, attending trade fairs and understanding industry dynamics.
For the time being, it has launched just one investment strategy, the Cobas Lux Sicav - Palm Harbour Global Value Fund, managed by Smith and unveiled on the 4th of April.
Palm Harbour Global Value Fund invests primarily in global equities with an emphasis on small and mid-sized European companies, with a typical market capitalisation between €100m to €5bn.
The strategy, which focuses on equities but may also invest in credit and derivatives, is built on two complementary pillars: long-term core investments, which they label at the firm as compounders, and investments in special situations.
Smith follows: "We look for situations in which sellers may be motivated by reasons unconnected to the underlying economics, allowing us to purchase the security at a discount.
"We look for companies that are undergoing change and may be overlooked or misunderstood by the market."
Some examples of this special situations might be the spin-off of a business unit that is too small for most institutional investors, some overlooked companies emerging from bankruptcy, or hybrid securities issued from corporate actions.
The fund, which currently holds 20 stocks, presents a relatively concentrated portfolio with the aim of investing in companies the firm knows well. It won't normally hold more than 30 positions,accounting each of them for 0.5% to 10% of the total exposure, with average around 4%.
Although the fund invests in undervalued stocks globally, it focuses on European companies. According to Smith, around 80% of the fund's portfolio is invested in Europe while the remaining stake is invested in the US. Despite being an unconstrained strategy with regards to sectors, it will rarely invest in finance, technology or bio-tech industries.
Westinghouse Air Brakes Technologies Corp is one position of the fund. Smith and his team feel there is an opportunity to buy a niche rail brake manufacturer trading at a low multiple to future cash flows despite its high-quality business.
"The opportunity to invest arrived due to General Electrics' divestment of its train locomotive division to the company through unusual spin-merger. This has led to a share overhang due to a set time line of GE selling and likely, GE shareholders selling," says Smith.
VALUE INVESTING VERSUS SPECULATION
When explaining the firm's investment approach, Smith emphasises on the difference between investing and speculation. He says: "While the majority of the market buys securities hoping someone else will buy them at a higher price, value investors like us do it by buying at a significant discount to intrinsic value, in other words with a margin of safety, an intrinsic characteristic of the value investment philosophy."
The firm's long-time horizon, allowing compounding to work in their favour, versus the mentality of greed or "getting rich quick" is another factor making their investment style unique compared to that commonly used by the rest of the market.
Palm Harbour Capital is driven by a value investing philosophy, which is defined by the firm as the strategy of investing in securities that are trading at an appreciable discount to the underlying intrinsic value of the business.
According to the manager, this investing philosophy is based on the following principles:
- Owner's perspective of the business, focusing on the long-term development.
- The market provides a price, which is not necessarily the value of the underlying business or cash flows.
- Focus on downside risk and demand a considerable margin of safety.
- Absolute return focus.
- Market price volatility is not risk but rather a source of opportunity.
The company believes that sometimes bargains might be found, especially after market or company-specific panics. Its definition of high-quality companies relate to those with high returns on tangible capital, strong margins, large, and stable market shares, and identifiable sustainable competitive advantages.
When searching for investment opportunities, the manager seeks strong management teams that operate as owners and invest for the long-term as they do. The research part of the process starts by using primary sources like financial filings to establish the nature of the business and to assess whether there might exist an opportunity.
Smith explains: "We analyse competitive advantages, finances, management, capital allocation, history, predictability of future cash flows and ultimately come to a range of valuations and their probabilities. The majority of situations analysed will ultimately be rejected."
When asked on how he finds the right stocks, the fund manager says: "Is a lot of work and there is no magic. I spend most of my day reading or talking to people in the industries.
"I just read all the day long and then I start making connections. Something you read reminds you to what happened eight years ago and you see kind of patterns.
"Sometimes you look at cyclical things and you see what everybody else is ignoring. if you read in the FT that everybody loves whatever, just look into the opposite direction.
"Sounds like common sense, but this isn't how most market participants think…"