Owner's Manual: Silver Ring Value Partners

Owner’s Manual
Silver Ring Value Partners
Silver Ring Value Partners Limited Partnership • One Boston Place, Suite 2600, Boston, MA 02108 www.silverringvaluepartners.com
The purpose of this Owner’s Manual is to introduce the partnership and its guiding principles, explain how I plan
to invest the partnership’s capital, and establish mutual expectations with the partnership’s partners. It aims to
provide a clear roadmap for what a partner can expect and for how a partner should assess the partnership’s
progress over time. The Manual has four parts:
Part 1: Business Principles – Describes the principles that will guide my operation of the partnership and
business in general.
Part 2: Investing Philosophy – Explains the philosophy underlying my approach to investing. It also explains the
basic premise for why I believe it is possible to occasionally find undervalued investment opportunities.
Part 3: Investment Process – Defines how I will go about implementing my investing philosophy in a systematic
and repeatable way. Implementation aims to identify and analyze investment opportunities from which I can
construct a portfolio that seeks to generate attractive long-term returns while minimizing the risk of permanent
capital loss.
Part 4: Establishing Expectations – Describes how a partner should measure the progress of the partnership, and
establishes expectations for how I will communicate with the partners going forward.
I greatly appreciate you taking the time to learn more about my investment process and how the partnership will
operate. While results can never be known ahead of time, rest assured that I will work diligently on the
partnership’s behalf and that my family’s capital will be invested in the partnership. I welcome any questions or
comments that you might have.
Sincerely,
Gary Mishuris, CFA
Silver Ring Value Partners Limited Partnership • One Boston Place, Suite 2600, Boston, MA 02108 2
Table of Contents
Why Silver Ring Value Partners? ...................................................................................................................4
Business Principles ......................................................................................................................................... 5
Investors are Partners ................................................................................................................................................ 5
Broad Interpretation of the Meaning of Fiduciary Duty ........................................................................................ 5
Alignment..................................................................................................................................................................... 5
Success ........................................................................................................................................................................ 5
Doing Business in an Exceptional Way ................................................................................................................... 6
Investing Philosophy .......................................................................................................................................7
Introduction ................................................................................................................................................................. 7
Why Attractive Investment Opportunities Exist ..................................................................................................... 7
Intrinsic Value .............................................................................................................................................................. 9
Margin of Safety.......................................................................................................................................................... 9
Assessing Quality ...................................................................................................................................................... 10
Long-Term Time Horizon.......................................................................................................................................... 10
Rigorous Adherence to Process ............................................................................................................................. 11
Portfolio Diversification ........................................................................................................................................... 12
Cash Management ................................................................................................................................................... 12
Investment Process ...................................................................................................................................... 13
Introduction ............................................................................................................................................................... 13
Idea Generation ........................................................................................................................................................ 13
Security Research and Valuation ........................................................................................................................... 16
Portfolio Construction .............................................................................................................................................. 22
Conclusion.................................................................................................................................................................. 26
Establishing Expectations ........................................................................................................................... 27
Introduction ............................................................................................................................................................... 27
Assessing an Investment Manager ........................................................................................................................ 27
Assessing the Partnership’s Performance............................................................................................................ 28
Communication......................................................................................................................................................... 31
Conclusion.................................................................................................................................................................. 32
Disclaimers ................................................................................................................................................................ 33
Why Silver Ring Value Partners?
When I was a small boy growing up in the former Soviet Union, my mother gave me a gold ring that had been hers
since childhood. Later, when we immigrated to the United States, we were allowed to take only one ring per
person. And so the ring my mother had given me was left behind to make room for more valuable ones.
As part of the immigration process, we lived in Italy for five months while awaiting permission to enter the United
States. While there, my mother and I had to sell some of our things at the local bazaar to cover living expenses.
During that process I encountered a jewelry store that, by luck, had a small gold ring similar to the one that I had
been forced to leave behind. It was very inexpensive, the equivalent of about $4, and much cheaper than similar
rings in the store. After obtaining my mother’s permission I proudly returned to the store and purchased it using
some of the money that I had made in prior months. I soon discovered why that ring was so inexpensive: within
two weeks the gold plating wore off, revealing silver underneath.
That “silver ring” experience taught me three important lessons: that careful research must precede every
significant purchase; that quality should be an important component of the investment decision; and that if
something is conspicuously cheap there may be a reason for its low price that merits investigation. “Value”
reflects that at the core of my investment approach is a belief that intelligent investing involves a comparison
between the value of what we are getting and the price that we are paying, with a need for a large margin of
safety between the two. And “partners” reflects my belief in treating investors as true partners who will share a
common aim of safely compounding our capital over the long-term rather than merely as clients.
Business Principles
As in many other service industries, the investment business is characterized by an asymmetry of information and
domain expertise between the investment manager and most investors—with the manager having the larger share
of both. This is true with respect to both individual investors and the savviest institutional investors. This
asymmetry is a two-edge sword. On the one hand, greater expertise allows the investment manager to provide
investors with a valuable service. On the other hand, it can tempt the same manager to use his greater expertise
for personal benefit, frequently at the investor’s expense. The drive to maximize the manager’s profits can
frequently create an unhealthy tension between the profession of investing and the business of investment
management. This is where principles come in; a principled manager strictly adhering to the right set of values
can avoid this temptation.
My Business Is Guided by Five Principles:
Investors are Partners

Partners have mutual obligations to each other. My obligation to investors is to do my very best on their behalf
while doing business in an exceptional way. I am also obliged to provide investors with clear and timely
communication on how their capital is being managed and how my investment process is being implemented. For
their part, investors should understand the long-term nature of investing and, within reason, maintain a long-term
time horizon. My goal is to have the right investors, not the most investors.
Broad Interpretation of the Meaning of Fiduciary Duty

I believe that when I take on the responsibility of managing someone else’s money, I owe them my best effort to
achieve the agreed upon goals. Any conflict between the long-term best interest of the investor and any other
consideration, including my own financial interest, will be resolved in the interest of the investor. The standard to
which I hold myself is not whether the investor would agree to something or not (which may be biased by the
asymmetry of knowledge and expertise between us), but rather whether I, with the expertise that I have on a
topic, would agree to something if I were in the investor’s shoes.
Alignment
Alignment of my economic interests with those of investors is the best way to assure that my actions will always
aim to advance the long-term interest of investors. Alignment must permeate all aspects of the investment
operation, from the fee structure, to terms, to how success is defined.
Success
I define success as the safe compounding of investors’ capital at attractive long-term absolute rates that exceed
their opportunity cost of comparable risk. “Safe” means minimizing the risk of permanent capital loss. A number
of ways to increase returns (e.g. using borrowed money), while boosting returns if everything works out as
planned, can lead to substantial losses in other scenarios. My approach is based on protecting capital ahead of
reaching for extra returns. “Attractive rates” refers to rates that are better than other generally available
alternatives than can be obtained without sacrificing safety of principal. “Long-term” means over a full market
cycle spanning 5-10 years that includes a recession, a recovery and a peak in both general economic and market
conditions. I intend to focus on long-term results, rather than on trying to manage short-term volatility, and I can
add the most value when investors’ goals are aligned with that long-term time horizon.
Doing Business in an Exceptional Way

Sometimes it is easy to discern the line between right and wrong. Other times there are shades of gray among the
choices that we face, where we can honestly say we are not sure if something is problematic or not. It is my belief
that the mere need to ask whether something is the right thing to do or not usually implies that it is not.
Consequently, my practice is to stay far away from anything that is remotely questionable, even practices that are
considered ‘industry standard’ or ‘widely accepted.’ A manager’s actions must pass his personal litmus test of
ethical behavior, which may represent a higher standard than common industry practices.
In summary, I believe that partnering with the right investors and executing my process in an ethical and
disciplined fashion will produce long-term success. That success will be fairly shared, and my profits from the
business of investment management will reflect only a minority share of the value I bring to investors. The
tension between the profession of investing and the business of investment management will thus be minimized,
resulting in genuine alignment of interests and shared success.
Investing Philosophy
“The market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal
mechanism, in accordance with its specific qualities. Rather… the market is a voting machine, whereon countless
individuals register choices which are the product partly of reason and partly of emotion.”
- Benjamin Graham, Security Analysis
Introduction
My investing philosophy is based on several important concepts:
 Intrinsic Value: A stock is a partial ownership interest in a business with its worth determined by the
underlying business’s long-term economics, not a piece of paper whose value is derived from what others
are willing to pay in the short-term.
 Margin of Safety: An investment’s margin of safety is determined by the combination of the quality of the
underlying company and the discount from a conservative appraisal of intrinsic value offered by the price.
 Long-term Time Horizon: The focus is on achieving the best possible safe compounding of capital over a
period of many years rather than managing short-term volatility of returns.
 Rational and Disciplined Execution: The market occasionally misprices securities for behavioral reasons.
These arise due to market participants reacting to developments emotionally rather than rationally and to
some market participants’ misaligned incentives. By remaining rational and disciplined in the
implementation of my process, I can both take advantage of the market’s mistakes and guard against
making mistakes of my own.
 Concentrated Portfolio: Investment opportunities that combine a company of high quality with a price that is
at a material discount to intrinsic value are infrequent. After constructing a portfolio where being wrong on
any single judgment should not result in a material loss of principal for the portfolio as a whole, additional
diversification is more likely to increase rather than reduce risk by forcing the inclusion of increasingly
inferior investments.
These concepts provide a solid foundation upon which investors’ assets can be confidently invested.
Why Attractive Investment Opportunities Exist

Though much has been written about the efficiency of modern securities markets, experience tells us that
attractive investment opportunities—that is, underpriced securities—exist. Two broad categories of causation give
rise to these opportunities. The first consists of behavioral biases that lead to incorrect pricing of securities. The
second consists of misaligned incentives that encourage some investment managers to put their personal
interests ahead of the interests of their investors.
Examples of behavioral biases that cause investors to incorrectly price securities include:
 Recency Bias: Investors frequently over-extrapolate recent trends into the distant future.
 Glamour Bias: Companies perceived to be doing well attract disproportionate attention, while companies
with problems usually repulse the majority of investors. The former leads to higher market prices on average
than a dispassionate analysis would merit; the latter leads to prices below those suggested by such an
analysis.
 Fear and Greed: It is more pleasant to continue to own a security whose price keeps going up, providing the
investor with daily positive reinforcement, even if analysis suggests that the price is now too high.
Conversely, it is emotionally draining for most people to continue to own or increase their holdings in a
security whose price continues to decline. This can make investors shun, and therefore undervalue, stocks
of companies that have experienced large recent declines in price.
Examples of misaligned incentives that cause investors to misprice securities include:
 Short-term Time Horizon: Business incentives and considerations of job security often prevent professional
investors from taking a multi-year view. They are driven to adopt a short time horizon in order to maximize
their own financial outcome. The result may be market prices that differ from those that would prevail if
these investors were operating with a long-term horizon.
 Asset Bloat: Most fee structures reward gathering assets more than investment performance. This
frequently causes professional investors who are maximizing their financial outcomes to manage portfolios
too large to be able to invest in small securities, leading to the latter being neglected and sometimes
inefficiently priced.
 Fear of Failing Unconventionally: The limited business impact of having mediocre investment performance
while investing in well-known ‘blue-chip’ stocks that are both household names and are meaningfully
represented in indices used as benchmarks for professional investors’ performance cause disproportionate
focus on these securities and conversely cause some managers to avoid less well-known opportunities for
fear of being blamed if those investments do not work out.
The best way to minimize the effects I describe above is to:
1. Set up the investment operation in a way that aligns incentives with maximizing investors’ long-term
returns.
2. Practice behavioral defense by creating and strictly adhering to a rigorous investment process, even when
it is mentally uncomfortable to do so, in order to minimize behavioral biases.
3. Practice behavioral offense by devoting a disproportionate share of effort to situations where it is likely
that the securities are being mispriced due to one or more known behavioral biases.
Intrinsic Value
Every security has an intrinsic value that is determined by future fundamental developments rather than by the
opinion of the market. For most securities, even if the markets were closed for an extended period of time, their
intrinsic values would be largely unaffected. The implication of this view is that the markets are there to serve
rather than instruct – to provide with opportunities to buy or sell when there is a material gap between the value
that is calculated based on facts and analysis and the price that market participants are transacting at any given
point.
Because the future is uncertain, it is best to think of intrinsic value as a range of values under different possible
fundamental scenarios rather than as a point estimate. For example, when estimating a value for a business, I do
so within a range that reflects the worst case, base case, and best case scenarios, where:
 The worst case represents a scenario in which most key future developments will be as unfavorable as can
be reasonably expected, given the nature of the business;
 The base case representing the most likely outcome; and
 The best case assumes that most key future developments will be as favorable as can be reasonably
expected given the nature of the business.
Value is an estimate, not a fact. Therefore, as new developments occur it can be quite rational to revise the
assessment of value up or down. These changes can be higher or lower than the accompanying changes in the
market price, but most importantly, they are arrived at independently from the market.
In theory, there is a value for everything. In practice, some businesses are easier to appraise than others, and so
there are securities for which my range of values based on my best analysis would be so wide as to be almost
useless. It is my practice to pass on these securities and put them into the proverbial ‘too hard’ bucket.
Margin of Safety
Margin of safety is the idea that I can be partially wrong in my assessment and still have a favorable outcome.
The concept originated in engineering, where it is easy to see that when building a bridge designed to handle ten
tons of weight at a time it is better to make the bridge that is capable of handling fifteen or twenty tons rather
than exactly ten. Similarly, since value is by its very nature imprecise, it is far better to invest in a security trading
far below my estimate of value than one that is only slightly below it. In investing, my margin of safety is based on
two factors:
 The discount offered by the price relative to my estimate of value, and

 The quality of the underlying company. Quality is important, because some businesses can be valued more
precisely than others, and high quality permits a higher confidence in my estimate of value than I would
have in a company of lower quality.
Investments will typically be required to have sufficient margin of safety to have the expectation of a double-digit
annualized rate of return over the long-term. I will cover the specifics of how I determine whether and how much
to invest at a later point when I describe my investment process.
Assessing Quality
For my investing purposes, I define quality as the degree to which a company’s future fundamentals are
predictable. Since valuation is a lens on long-term expectations of business fundamentals and some businesses
are more predictable than others, it is only factors which increase predictability that affect my assessment of
quality. Everything else can be handled through requiring an appropriate discount to my estimate of value.
Some factors that affect the predictability of a company are:
 Industry Structure – The slower the current and potential pace of change, the more predictable a business
in a given industry is likely to be.
 Competitive Advantage (a company’s ability to earn superior economic results that others cannot easily
replicate) – Companies with stronger competitive advantages are better protected against unexpected
adverse economic developments.
 Management – The degree to which management can operate and allocate capital in the best long-term
interests of the shareholders reduces the risk of competitive position erosion and destruction of value
through the misallocation of capital.
 Balance Sheet – The ability to withstand temporary financial adversity guards against unexpected
circumstances that could force the company to take financial actions that could reduce its intrinsic value.
Long-Term Time Horizon

My focus is on achieving the best possible safe compounding of capital over a period of many years rather than
managing short-term volatility of returns. This is not to say that short-term volatility is completely irrelevant for
everyone. For some investors for whom it is irrelevant financially (e.g. those who are investing for retirement goals
10 or more years into the future), the emotional drain that results from high volatility can be quite real. For others,
such as endowments, foundations and others using their investment portfolios for a combination of current
consumption and accumulation or preservation of capital for the future, lower volatility is financially preferable
since it lowers the probability of being forced to sell investments at unfavorable prices. I believe that in the
overwhelming majority of cases somewhat bumpier but higher long-term returns are preferable to smoother but
lower ones. I also don’t seek volatility nor do I have a specific reason to believe that my approach, with its focus
on capital preservation, should be particularly volatile. I am merely defining my priorities – I will not consciously
trade off accepting a lower return just to decrease short-term volatility.
Rigorous Adherence to Process
I have developed a disciplined, replicable process both for researching individual investments and for
constructing the portfolio. While there is certainly room for qualitative judgment in investing, I believe that by
following these investment guidelines consistently I am most likely to achieve long-term success. I will cover my
investment process in-depth later on, but at this point I want to provide an overview.
Idea Generation Process: The goal of idea generation is to find potential investments that are likely to be
undervalued. It is important to have a multi-pronged approach to searching for potential opportunities in order to
maximize the chances of uncovering a diverse set of candidates for investment.
Research Process: The goal of my research process is to thoroughly assess the quality of the company and
rigorously estimate a range of values for it. In analyzing and valuing a company, I always follow the same set of
steps, although company-specific circumstances dictate that the emphasis on each step will vary.
Portfolio Construction Process: The rigorously analyzed and valued companies form the basic ingredients for
portfolio construction. Investments are made based on a minimum margin of safety which combines the
qualitative assessment of the company, the discount from the Base Case value estimate, and the downside to the
Worst Case value estimate. Additionally, risk is further managed by thinking through the correlation of long-term
business outcomes among potential investments. Since the goal is to be able to avoid material portfolio
impairment if I am wrong on any one judgment, it is important to understand the degree to which the long-term
economic drivers of the underlying investments are similar, so that the combined exposure can be sized
accordingly.
One of the greatest challenges in investing is the tension between conviction and flexibility. One needs conviction
in order to make investments based on a differentiated view from the consensus implied by the prices of
securities being purchased, and to stay the course during periods of temporary adversity. On the other hand, one
needs to be flexible and be able to update value estimates as new developments occur or new analysis is
performed. My attempt to balance these different requirements is to be rigid on process and flexible on the
specific conclusions that the process leads to in any specific situation. The process should also incrementally
improve as a function of additional experience and insight. However, any changes to the process will occur after
much deliberation and without connection to any specific investment decision. In this way, at any given time the
current process will be followed, while the cumulative lessons of experience will still gradually influence the
improvements to the process.
Portfolio Diversification
Hubris is the enemy of good investing, and any one decision, no matter how well considered, can still result in a
mistake. Therefore, diversification is an important way to mitigate the risk of permanent capital loss. On the
surface it would seem that all else being equal, the more diversified the portfolio, the better. That would be true,
but all else is not equal. There are two factors that act as the implicit cost of diversification:
 Adding an extra security to the portfolio can mean adding one that has a margin of safety lower than that of
the rest of the portfolio, since during most market conditions there is a finite number of high margin of
safety investments available.
 Investing the time and effort required to find an additional investment potentially reduces the time spent on
analyzing the original investments.
What is the appropriate degree of diversification? For me, effective diversification makes sure (a) that no one
decision can materially impair the portfolio and (b) that once the prior criterion has been achieved, adding
another investment would likely lower the prospective return of the portfolio. The exact number of securities
needed to meet these conditions can vary based on the opportunities provided by the market. My experience has
led me to believe that a portfolio consisting of 10 to 20 investments will offer sufficient diversification without
giving up too much return across most market conditions. Diversifying beyond that number of investments is
more likely to increase rather than decrease risk by necessitating investing in securities with lower margin of
safety. I will go into much more detail on portfolio construction and position sizing in the investment process
section.
Cash Management
Cash levels in the portfolio will be a residual of bottom-up investment decisions rather than based on a top-down
macro view. When investments that have sufficient individual margin of safety and which would maintain
appropriate degree of diversification for the portfolio are found, cash will be invested in them. If such
opportunities are temporarily unavailable, then capital will remain in cash or equivalents until such a time when
those opportunities become available. This is the key difference between an absolute value approach and a
relative value approach. The former considers not just today’s opportunities but also tomorrow’s likely
opportunities and does not lower investment criteria merely because of an insufficient availability of investments
that meet them today. The latter chooses to deploy capital in the best of what is currently available, even if the
absolute level of future returns being offered is lower than desired. As a result of my approach to cash
management, it is possible that cash levels will be elevated at times, although it is not my goal to have that be the
case over the long-term. This approach also limits the impact of the timing of when funds are invested into the
partnership on the quality of investments in which these funds will be deployed.
Investment Process
“Time is the friend of a wonderful business and the enemy of the mediocre.”
- Warren Buffett, 1989 Letter to the Berkshire Hathaway Shareholders
Introduction
An investing philosophy helps to answer the question of “why,” whereas the investment process is mostly
concerned with the question of “how.” A good investment process allows the investor to implement his investing
philosophy in a systematic and repeatable way.
My investment process has three stages:
 Idea Generation – Idea generation aims to find investments that are likely to be undervalued. It is important
to have a multi-pronged approach to searching for potential opportunities in order to maximize the chances
of uncovering a diverse set of candidates.
 Security Research and Valuation – The goal here is to thoroughly assess the quality of each company and
rigorously estimate a range of intrinsic values for it. In analyzing and valuing a company, I always follow the
same set of steps, although company-specific circumstances dictate where the emphasis will be placed.
 Portfolio Construction – The main purpose of portfolio construction is to manage risk, which I define as the
potential for permanent capital loss. Positions are intended to be sized so that an adverse outcome on any
single investment will not impair the portfolio to a degree that a reasonable return on the rest of the
portfolio should not offset it over time. Risk is also managed by thinking through the correlation of long-term
business outcomes among multiple investments. Since the goal is to avoid material portfolio impairment if
any one judgment is wrong, it is important to understand the degree to which the long-term economic
drivers of the portfolio’s underlying companies are similar, so that the combined exposure can be sized
appropriately. My aim is to allow the overall process to drive long-term results rather than being over-reliant
on any individual investment decision.
Idea Generation
Given the high bar I set for making an investment, it is important to cast a wide net. A diverse set of potential
investments is needed in order to construct a portfolio that minimizes the risk of permanent capital loss. On the
other hand, given the time it takes to apply my rigorous research and valuation process to each security, it is
impractical to do it for too many investment candidates. I narrow the list of candidates by means of the three-step
idea generation “funnel” described below. As candidates progress from one step to the next, their likelihood of
meeting my investment criteria increases. This three-step approach quickly narrows the opportunity set to the
most promising securities and reduces time spent on studying those that are unlikely to meet my criteria.
Three-Step Idea Generation Funnel
1. Include a diverse set of potentially undervalued securities
2. Exclude those failing any of

a number of specific
quality criteria
3. Prioritize based
on quality and
valuation
Step 1: Include a wide array of securities likely to be undervalued. At this step, I rely predominantly on the base
rate probability that a given security is undervalued based on financial metrics or the source of the idea. In other
words, I make sure that I am fishing in the right ponds as opposed to examining each security in-depth. This step
is intended to take very little time per security and produce a large, diverse set of potential investment
candidates. Sources for ideas include:
 Previously identified high-quality companies. I maintain a watch-list of high quality companies and
consider for investment those that have recently become statistically inexpensive or experienced recent
sharp price declines
 Screens that identify securities that are statistically cheap based on a variety of valuation metrics
 Special situations, such as spin-offs, post-bankruptcies or recapitalizations
 Securities purchased by other investors who have both a track-record of beating the market and an
approach compatible with mine
It is important to note that Step 1 selects securities based on both a purely quantitative and a purely qualitative
basis. This is superior to an approach that relies exclusively on financial metrics. Those metrics are likely to miss a
number of potential opportunities that, on further examination, might be attractive.
Step 2: Eliminate from the above list of securities any that:
1. Have unsustainably high financial leverage
2. Have not earned their cost of capital over the prior business cycle
3. Have failed over the prior business cycle to generate free cash flow equal to at least two thirds of
reported earnings
4. Whose business models are unlikely to have predictable long-term economics
Step 1 errs on the side of allowing too many securities through my screen. This is acceptable as long as there was
reasonable basis for thinking that those securities might be undervalued. Step 2 errs on the side of exclusion,
based on criteria that are intended to make it unlikely that I will invest in a security even after further research.
The list of potential candidates is greatly reduced by the end of Step 2.
Step 3: Prioritize the remaining candidates by considering:

1. Company quality as determined by financial metrics such as Return on Invested Capital (ROIC) and by
initial qualitative assessment of the business
2. Statistical cheapness of the security relative to historical free cash flow and profits
3. Special considerations such as: a large management ownership stake; material insider buying; events
that are likely to have caused a behaviorally-driven market over-reaction (e.g. recent dividend cuts or
removal from an index); or future events likely to shorten the time required to unlock value (e.g. an
announced change in the capital structure that is likely to increase security value)
Security Research and Valuation
This stage produces a thorough assessment of the quality of the company and a range of intrinsic value estimates
for each security. To achieve this, I consistently follow the following five-step process. Adherence to this process
ensures focused attention on the most salient aspects of each investment candidate and reduced potential for
behavioral bias.
The Five-Step Research Process
•Company Quality Assessment

Step 1
•Analysis of Key Economic Variables

Step 2
•Financial Modeling
Step 3
•Valuation
Step 4
•Behavioral Checklist
Step 5
Step 1: Company Quality Assessment

This step aims to answer the question, “How predictable are the long-term economic characteristics of this
company?” This is accomplished by analyzing the quality of the underlying business, its balance sheet, and its
management. Each of these three aspects of the company is then rated on a scale from 1 (best) to 5 (worst), with
3 representing average. The goal is not to reduce largely qualitative attributes to a falsely precise quantitative
measure, but to group companies into rough qualitative tiers.
Business Quality
It is worth considering what an ideal business may look like. In my view, it would embody the following
characteristics:
 A structurally attractive industry characterized by: fragmented buyers with inelastic demand; fragmented
suppliers with little bargaining power; substantial barriers to entry; little or no competition based on
differentiated product characteristics rather than price; growing demand; a slow rate of change in industry
structure and product offerings; and limited government interference
 An insurmountable competitive advantage that could only be overcome by enormous capital investment by
rivals over long periods of time. Usually this advantage would be based on durable differentiation or
economies of networks, or occasionally on an unassailable low-cost position
 A high return on current capital employed
 A high return on incremental capital that can be reinvested back into the business
 A large amount of capital that can be reinvested at those high rates of return
In reality, no business is likely to meet each of the above criteria, but having defined the “ideal” makes it easier to
assess real-world businesses that possess some but not all of the above strengths. Admittedly, this is an exercise
in which judgment plays the greatest role in my entire process; however, I do not know of any mechanical way to
assess business quality that does not heavily rely on judgment. This, however, is not an arbitrary exercise, as my
experience in analyzing hundreds of businesses over the last fifteen years has shown that some companies are
definitely better than others and will remain so for a long time. The litmus test for deciding whether a business
meets my minimum criteria for further analysis is this: Can I look out five to 10 years and approximately estimate
the economics of the business with confidence? If the answer is no, then no other favorable characteristics (high
growth rate, high current return on capital, etc.), can entice me to proceed with the analysis.
Balance Sheet Quality

How well can a company withstand temporary financial adversity without being forced into actions that would
reduce or eliminate the value of the security being analyzed? Factors considered in answering that question
include:
 Financial leverage in the context of the cyclicality of the company’s profit stream
 Financial covenants governing profit levels the company must exceed
 The company’s liquidity profile
 Structure of the company’s debt maturities and whether it has undue refinancing or interest rate risk
 Off-balance sheet financial commitments that are likely to constrain the company similarly to outright debt
 Free cash flow characteristics and company’s ability to fund growth without having to raise additional capital
The overarching purpose of balance sheet analysis is to make sure that (1) the company can withstand a high
degree of adversity without a negative impact on the value of the security being considered and (2) that it is not at
the mercy of capital markets but, rather, in control of its own destiny. I typically rate a company’s balance sheet a
1 on my 5-point scale if it has no or little net debt. A rating of 3 would represent a properly utilized balance sheet
that would usually translate into an investment-grade rating and the ability to withstand substantial external
adversity. Ratings of 4 or 5 would imply that the company is currently over-leveraged. Such a company needs to
use some of its free cash flow to reduce debt, so that cash flow cannot be considered truly “free.”
Management Quality
I assess management on two dimensions: competence and alignment of incentives.
 Competence – I rely heavily on the company’s track record of operating the business and its past capital
allocation decisions. The operating track record is evidenced by historical returns and growth in economic
profit – both in absolute terms and relative to industry peers. Capital allocation is best assessed by
considering the management’s framework and by assessing the company’s returns on major past capital
allocation decisions. Ideally, the framework management uses to allocate capital is geared towards
maximizing long-term intrinsic value per share.
 Alignment of management incentives – An ideal set of incentives combines large (relative to net worth)
direct equity ownership, with future compensation linked to long-term economic profit. Incentives like these
make it difficult for management to maximize its own financial outcome without also maximizing intrinsic
value per share. My ideal management team treats their shareholders as partners in both words and deeds.
Performing the Analysis

My analysis begins with reading a company’s historical communication: its annual reports, and other in-depth
filings in which management details its financial progress and provides a qualitative narrative about company
strategy, the external environment, and results relative to goals. A thorough understanding of a company’s history
is a necessary point of departure for assessing its future. Once I understand the company’s basic business model
and how it has gotten to where it is today, I then determine what other information would be helpful in assessing
the three qualitative factors described above. No single source contains all the answers – consequently one must
gather the different pieces of the “mosaic”. Those pieces contribute to a fuller and more valid picture.
 Judging business quality starts with thinking through the company’s basic competitive advantage. Michael
Porter’s framework for competitive analysis is a useful tool for this purpose. Analyzing other companies in
the value chain, such as customers or suppliers can provide important insights about the nature of the
industry. Primary research can supplement the analysis and help answer questions left unanswered by
other means. It might be useful to talk to customers to verify the value proposition that the company claims
in its communication with shareholders. Speaking to competitors can help to get a different point of view on
the market and the competitive positioning of the various players than that put forth by management. The
goal is to focus the research on what is most likely to impact my assessment of the company’s business
quality given the specific details of each situation.
 The balance sheet can be assessed from financial statements by analyzing the balance sheet data
disclosed in them as well as additional footnotes in the annual report and filings containing credit
agreements and similar information.
 The proxy statement is an excellent starting point for evaluating the management of U.S. companies, as they
reveal how the management team is compensated and management’s ownership stake in the business.
Combining that information with how honestly the management has communicated through shareholder
letters, and with how well they have constructed and executed their strategy provides substantial insight
into management’s ability and its alignment with shareholders.
Step 2: Analysis of Key Economic Variables
This step aims to (1) identify the handful of economic variables that will have the greatest impact on the
business’s long-term economics, and (2) estimate a reasonable range of outcomes for each variable. In doing this
I endeavor to be as company/industry specific as possible because generic variables (e.g. margins, sales growth
and capital intensity) add less insight. Some examples of variables that drive company value include:
 For a retailer, the three key variables might be the total potential number of stores that its concept and
target market can support, the capital required to build each store, and the incremental return on capital
that each store generates at maturity.
 For a homebuilder the key economic levers might be the cycle-average number of new houses that will be
built nation-wide, the company’s share of that market based on geographic and competitive position and
the margin the company can expect to average through the cycle based on its scale and cost position.
 For a pharmaceutical company the key variables might be the patent life of its marketed drugs, the possible
impact of competitive entry on them, the addressable market for the drugs in the company’s pipeline and
the probability of success of those drugs.
This analysis forces a deeper understanding of the business and provides an opportunity to terminate the
analysis if key variables cannot be identified or if analysis cannot determine a reasonable range of values. When
combined with deep qualitative understanding of the business from the prior step, analysis of key variables allows
me to know both the ‘what’ and the ‘why’ of the company’s history. At this point, I try to answer the questions:
“Why should this company’s future be similar or different than its past, and what historic drivers of performance
are likely to be different going forward?” Conversations with competitors, customers or suppliers may be needed
to complete the analysis.
Finally, I attempt to engage the company’s management to understand their strategic perspective, what they see
as the key economic variables driving the business and their capital allocation plans. Thorough prior preparation
allows me to ask the right questions. Equally important, preparation allows me to avoid getting behaviorally
anchored on the management’s usually optimistic assessment of the company’s prospects. In most cases I put
little weight in management forecasts of future results, focusing instead on plans for actions that are within their
control, and their overall approach to the business. This approach assures an independent, fact-based
assessment.
Step 3: Financial Modeling

The third step of the process begins where the second step ended. Having identified the key economic variables
and a reasonable range of values for each, I use that analysis to model the company’s income statement, balance
sheet and cash flow statement, and then create three scenarios:
1. Worst case, where each key economic variable has its worst likely outcome
2. Base case, where each key economic variable has its most likely outcome
3. Best case, where each key economic variable has its best likely outcome
In modeling the company, I do not simply focus on the income statement, but on how the three financial
statements interact. This produces a deeper understanding of how a company’s balance sheet will fare under
different scenarios, and whether it will be a source of additional financial flexibility or require the company to put
money back into the business to avoid financial distress. The most important output is a set of free cash flow
projections for each scenario. Free cash flow is the amount of money that can be taken out of the business
without negatively impacting its long-term economics.
Step 4: Valuation
Estimating future fundamentals is often challenging, but once that has been done valuing the resulting cash flow
streams is not difficult. My basic valuation tool for stocks is the discounted cash flow model (DCF) of equity free
cash flows forecasted in the prior step. I use the same discount rate – 10% – for all companies and all scenarios.
That discount rate implies that buying a company’s stock at my estimate of value would result in a 10% rate of
return if I were to own the stock forever, and if the company were to return my share of the free cash flow. The
rationale for selecting 10% is that over the very long-term, U.S. equities have produced approximately that rate of
return, which serves as my opportunity cost for making an investment. Since I aim to buy a stock with a
meaningful margin of safety to its estimated value, the future annual expected return built in to my purchase
price if the stock were to be held forever starts at 12%, as I will explain in the section on portfolio construction.
Finally, I add the value of any assets not used to generate the free cash flows to the output of my DCF. These
assets may include excess cash on the balance sheet and the value of investments not currently generating
profits already included in the free cash flow streams.
The DCF can be an imperfect tool. A reasonable criticism is that it is overly sensitive to small input changes and to
user manipulation of assumptions. To guard against these, I cross-check DCF-derived values against other
measures. For instance, I estimate a company’s normalized mid-cycle earnings, and sanity check my DCF value in
terms of the normalized P/E ratio that it implies. Other measures I consider are trailing free cash flow yield,
enterprise value (EV) to EBITA, and where appropriate price to book value (P/B). I also consider private market
transactions for similar businesses, taking care to understand the qualitative difference between those and the
company being analyzed.
The output of this step is the full range of values – worst, base and best case – for the company, each cross-
checked against other measures to make sure that they make sense.
Step 5: Behavioral Checklist

Before investment analysis is complete, I apply a checklist designed to identify things that I may have missed as
well as behavioral biases that may have influenced my analysis. This is a dynamic list; it has been evolving over
time, reflecting lessons learned from past mistakes made by me and by other investors. This checklist also
reflects my extensive reading in the field of behavioral economics. Some of the checklist questions asked are:
 Do I have emotions – positive or negative – towards this investment? My goal is to base investment
decisions on rational analysis. Any hint of emotions is a warning flag to dig deeper to make sure I am not
making a biased assessment.
 If the markets closed and I couldn’t sell this security for five years, would I be comfortable owning it?
 Have the most recent developments – positive or negative – colored my analysis of the company’s
prospects disproportionately to their long-term significance?
 Is this company path-dependent? That is, if external circumstances, such as the path of the economic cycle,
were to end up at the same long-term point but via a different path, would that impact the intrinsic value?
For instance, if the economy were to temporarily decline, would the company be forced to issue equity at
disadvantageous prices or file for bankruptcy? I typically avoid path-dependent investments as they require
overly precise timing and I want time on my side.
 Is this security reflexive? The basic premise of intrinsic value investing is that price and value are separate,
and that value is not affected by price. However, this is not always true. Consider for instance a company
that frequently needs to raise capital by issuing new stock. In that case, the price at which it can raise that
capital will affect its intrinsic value. Other examples include businesses where confidence is important, as
was the case with the now-defunct Bear Stearns during the great financial crisis. When markets began to
lose confidence in Bear Stearns, a vicious cycle ensued as lower stock prices drove lower confidence and
lower confidence in turn drove still lower stock prices, eventually causing the company’s funding to dry up,
and greatly reducing the value of Bear Stearns’ stock.
Portfolio Construction
In constructing a portfolio, why not put all of our money in the single best idea? The answer is simple: even the
most thorough and thoughtful analysis is subject to error, and the future may hold developments that are
impossible to foresee. Fortunately, a perfect batting average is not required for investment success. If one can be
approximately right the majority of the time while limiting losses on the inevitable mistakes, the results are likely
to be quite satisfactory. Recognizing my own fallibilities and the uncertainties inherent in investing underpins my
approach of putting an emphasis on protecting capital against permanent loss that guides my portfolio
construction process.
Minimum Criteria for Investing

Every investment should be purchased with a margin of safety. That margin of safety is a function of the quality of
the underlying business and the discount to intrinsic value at which it is purchased. The higher the business
quality, the more confidence I can have in my estimate of intrinsic value. Below-average businesses are difficult to
value, and their future is subject to substantial economic uncertainty. I usually pass on those businesses, barring
some special situation where the downside is substantially reduced by well-defined balance sheet assets, or
where the price is so low that the likely cash flows from the next few years will be more than sufficient to produce
an attractive return. In most cases, my investments are in the securities of businesses of at least average quality,
with the resulting quality bias helping to protect the portfolio against permanent capital loss. The table below
summarizes the minimum discounts to intrinsic value that I typically require to make an investment:
PURCHASE GUIDELINES
Business Quality
Average Above Average Excellent
Price as % of base case value <55% <65% <75%
The reason for choosing 75% of base case value as the minimum threshold is that since my values are calculated
using a 10% discount rate, that cut off translates into approximately a 12% internal rate of return if I were to own
the business forever. The 55% threshold for a business of average quality translates into approximately a 15%
rate of return. While markets are sufficiently efficient to close the price-value gap over time and allow me to
reinvest capital in other undervalued opportunities, it is reassuring to know that I should be able to earn a double-
digit annualized rate of return if I had to own those securities forever if my fundamental assumptions are correct.
One thing to note is how the above discounts relate to my long-term investing horizon. For example, even if the
value of the business were to stay constant, and it were to take the market three years to recognize the value of a
security purchased at 65% of value, the resulting annual compounded return will equal approximately 15%. In
practice, my preference for above-average quality companies frequently leads me to invest in businesses whose
value will grow over time, which makes a long-term time horizon even more advantageous. Time is most on my
side when I invest in companies that are growing in value that I purchase at a large discount to a conservative
appraisal.
Selling Discipline
There are three potential reasons why I might sell an investment:
1. Price increased to my value estimate – The gap between price and value closes due to the price
increasing to my estimate of value.
2. Better opportunities become available – If a better opportunity comes along and I do not have cash
available to make a purchase. As a rule of thumb, I require a security of equal quality to be 20% lower in
terms of the price-to-value ratio before making a swap. As an example, if a security purchased at 60% of
base case value now stands at 80%, I would need to have another security that is no more than 60% of
base case value before making a swap (assuming that the post-swap portfolio would still remain
appropriately diversified).
3. Future developments and analysis invalidate the original thesis – Additional information or analysis may
lead to a downward revision of my initial estimate of intrinsic value and, perhaps, lead me to believe the
security is no longer attractive. While I expect this to happen a minority of the time, it is important to be
vigilant and to recognize one’s mistakes as quickly as possible rather than to remain behaviorally
anchored to the original thesis.
During my career I have frequently sold profitable investments too early. The increased potential for permanent
capital loss as the security approaches intrinsic value and the diminished margin of safety make me very
uncomfortable. While on the one hand selling early helps avoid the occasional permanent loss, taken to an
extreme it causes me to forego too much of the return that it is possible to capture within my intrinsic value
framework. So, what should be done?
I have developed a solution that addresses this issue and that I believe allows me to capture close to full value
from my investments. In the absence of more compelling uses of capital, my general practice is to sell positions in
three equal tranches. The goal is to exit on average close to my base case value estimate, while reducing risk as
the position approaches full value. I take quality into account, and err on the side of selling higher quality
investments closer to intrinsic value than those of average quality. The table below summarizes the price-to-base
case value ratios at which I sell a security as a function of business quality:
SELLING GUIDELINES
Business Quality
Average Above Average Excellent
Sell First One Third ~85% ~90% ~95%
Sell Second Third ~90% ~95% ~100%
Sell Last Third ~95% ~100% ~105%
Position Sizing
Investment opportunities that meet my criteria can have different characteristics with respect to expected return,
potential downside and company quality. These differences suggest using varying position sizes to optimize the
portfolio. Three principles are used to size positions within the portfolio:
1. Portfolio at Risk (PaR) – PaR is the position size multiplied by the downside to the worst-case value
estimate. As an example, a 10% position with worst-case downside of 30% would have a PaR of 3%. The
maximum PaR I am generally willing to take on an individual position is 5%; 3% is more typical.
2. Risk of permanent capital loss declines as company quality increases. Increasingly higher quality
parameters are a prerequisite for larger positions in the portfolio.
3. No position size should be so large that a complete loss, however improbable, would result in capital
loss that the rest of the portfolio would be unable to overcome. It is important to combine confidence
with humility in investing, and I intend to construct the portfolio with the assumption that I could be wrong
on any single investment.
Below are the guidelines that I use for position sizing at the time of purchase. Most of the time the portfolio will
contain a mix of positions that were initially sized as small (5%) and medium (10%), as well as cash equivalents.
The large, 15%, position size is only intended to be used infrequently, and only when especially compelling
opportunities present themselves.
POSITION SIZING GUIDELINES

Position Size
Small (5%) Medium (10%) Large (15%)
Price as % of Base case value <75% <75% <75%
Business quality Average+ Average+ Above Average+
Balance Sheet quality Any Average+ Above Average+
Management quality Any Average+ Above Average+
Downside to Worst case Any <35% <35%
Cash Management
Cash and its equivalents in the portfolio are a residual of bottom-up buy and sell decisions. Their main purpose is
to provide safety and the liquidity to take advantage of future opportunities. I do not stretch for return from this
portion of the portfolio. Since both my buy and sell decisions are made on an absolute value basis, using the
criteria outlined earlier, an occasional imbalance may occur – as when there are more good ideas than capital, or
vice versa. When the latter occurs, I am comfortable keeping capital in cash or equivalents. Doing so allows me to
remain disciplined in keeping investment criteria high; it also gives me an important option to invest in tomorrow’s
opportunities at distressed prices without having to sell other investments that the market might temporarily mark
down as well. The main point is that there is no top-down market-timing element in my thinking. Timing the
market, in my view, is both difficult and not something for which I have expertise or advantage. My expertise is in
assessing the micro-economic characteristics of companies and in valuing securities. Investing in the best of what
is currently available regardless of how attractive those investments are on an absolute basis is contrary to my
philosophy and would likely lower my long-term returns.
Risk Management
Is there a magic number, or set of numbers, that perfectly quantify risk in a portfolio? I do not believe that either
exists. While metrics can be helpful in assessing elements of risk, the ones most frequently used suffer from the
drawbacks of being both backward looking and short-term oriented. “Beta” exemplifies both negative traits, yet it
is still used in the industry. Beta measures a security’s historic volatility relative to the market, typically over short
time intervals. It tells us very little about a stock’s likely future volatility relative to the market over long future
periods, or, more importantly, about how its underlying business characteristics relate to those of others in the
portfolio. So is there a better way to manage risk? As unsatisfying as it might sound to some, I believe there is no
substitute for thinking thoroughly about both individual investments, and how they fit together in the portfolio. As
for individual securities, my investment process, described above, addresses the first part of risk management:
1. Prior to purchase, I thoroughly analyze the characteristics of each security’s underlying business from
both a qualitative and quantitative perspective
2. Strict guidelines are observed when purchasing each security, to seek a sufficient margin of safety
derived from a combination of the discount to intrinsic value and the quality of the underlying company
3. Each position is intended to be sized so that an adverse scenario, or a misjudgment on my part, will not
jeopardize the overall portfolio
The second part of risk management involves analyzing and managing how the different positions in the portfolio
relate to one another. For this purpose, I think through the underlying long-term economic drivers of each
company (based on Step 2 of my Five Step Research Process above), and understand how those different drivers
are directly or indirectly correlated. Examples include:
1. Two broadly diversified U.S. homebuilders are exposed to the same economic drivers. There are some
differences in regional mix and management’s capital allocation choices, but if I am wrong in my analysis
about the long-term prospects for the U.S. housing market I will likely be wrong on both investments.
Therefore, I would keep all such closely correlated companies within the constraints of the 15% maximum
position size at the time of purchase.
2. Two global drug discovery companies with little overlap among the drug classes in which they compete
would have a moderate degree of long-term business outcome correlation. Correlation might, for
example, result from regulation of industry-wide pricing, or from lack of opportunities for meaningful
innovations being available across both companies’ areas of research. On the other hand, these two
companies might have very different economic outcomes because of the micro-economic realities of their
specific products and research pipelines; thus treating them as perfectly correlated would be
inappropriate. I handle this type of situation by limiting any one industry to no more than 25% of the
portfolio at the time of purchase.
3. A less obvious example of correlation would be the overlap between a global consumer company selling
alcoholic beverages to developing markets, and a global technology company selling consumer
electronics. The long-term economic outcome for both companies will likely be influenced by the degree
to which the middle class in emerging economies continues to grow and prosper, as that is where a
meaningful proportion of the incremental buyers for the goods of both companies is to be found. On the
other hand, micro-economic factors specific to each industry and company will influence the long-term
outcome of each. In this case, I intend to limit risk by limiting the combined position size to the 25% I use
as the maximum for each industry at the time of purchase.
My job in managing risk is to continually examine my investments, and look for the type of hidden correlation of
long-term outcomes described in example #3 above. I do this in ways that extend beyond thinking deeply about
underlying businesses. These include:
1. Tracking the weighted average business quality score for the portfolio over time, and ensuring that any
decrease in overall business quality towards the average side of my range is intentional.
2. Tracking the weighted average balance sheet quality score for the portfolio over time, to spot any
deterioration in overall balance sheet quality.
3. Limiting investments with a downside to worst case larger than 35% to no more than 25% of the portfolio
at the time of purchase.
4. Limiting the portion of the overall portfolio devoted to investments with below-average balance sheet
quality at the time of purchase to no more than 20%. In times of crises a weak balance sheet can become
a major correlating factor of business outcomes irrespective of other micro-economic considerations.
These measures leverage the ability of my thorough and repeatable investment process to identify micro-
economic drivers of companies and industries and to value securities appropriately. It is my objective to make
these strengths be the predominant driver of the long-term investment success, and to limit the influence of
factors that are beyond my ability to predict on the portfolio.
Conclusion
The process I have described here is the one I follow consistently in analyzing companies, valuing their securities
and constructing the portfolio. It involves much hard, detailed work, and focuses attention on areas where I
believe my training and experience can add real value. Its discipline is intended to keep me out of trouble and
helps me to take advantage of the behavioral mistakes of other market participants while minimizing my own
errors. If this process comes across as tedious or boring, mark that down as a good thing. It is not as glamorous
as one that attempts to make broad calls about macro-economic forces or that claims to pick the next Microsoft
out of a haystack of companies barely making a profit. Nevertheless, it has been the foundation for the success
that I have achieved thus far, and I believe that it will continue to generate both safe and attractive long-term
returns in the years ahead.
Establishing Expectations
Introduction
The first three parts of the Owner’s Manual described the Business Principles, Investing Philosophy and
Investment Process that guide my thought and action. The goal of this part is to:
1. Provide my perspective on how I would track progress if I were a prospective investor. It is important to
define this before the partnership is launched, both to avoid any temptation to be affected by early
outcomes, and to give prospective investors a chance to clarify anything that might be unclear before
investing.
2. Share my thoughts on how I will interpret the partnership’s performance over time.
3. Outline how I plan on communicating with you going forward.
Assessing an Investment Manager

I am sometimes asked how I assess investment managers in general and how I will judge my own progress
following the launch of the partnership. The general framework I use is provided here, followed by a description of
how I hope my performance will be judged over time.
My general framework for assessing investment managers has four elements:
1. Integrity – Is the person motivated purely by money? How passionate is he about what he does? Is there
evidence of integrity and alignment in the structure of the firm and the investment vehicle? How
consistent are the manager’s actions with his stated principles? Has the manager ever chosen a course
that was less advantageous for him but that was better for the investors?
If the person to whom you are entrusting your capital lacks integrity, or will not consistently act in your
best interest, stop the assessment right then and there.
2. Philosophy – What is the investor’s basic philosophy on finding and exploiting market inefficiencies? Is it
logical? Have others succeeded following a similar philosophy? Successfully investing capital is difficult,
and unless the person doing it has a robust framework that is logical, it will be very hard for him to
succeed.
3. Process – What is the investor’s process for implementing his philosophy in practice? How rigorous and
systematic is that process? Have there been examples of deviations, and if so why? Does it make logical
sense that skillful implementation of the stated process is likely to produce a good long-term outcome? A
sound philosophy is a necessary starting point for investing, but even the most sensible philosophy is
unlikely to generate good returns without a disciplined, well-implemented process.
4. Experience – What is the investor’s experience with implementing his philosophy and process? Has that
experience included, at a minimum, a complete economic cycle with both up and down markets? How do
the investor’s results compare to general market indices through that cycle and relative to inflation? What
risk of permanent capital loss was taken in achieving the results?
Investing is an enterprise where experience matters. Someone who has honed his approach over a long time, and
through a variety of market environments, is better positioned for future success than someone with the same
theoretical knowledge but without the first-hand experience. As an old poker adage goes: “When a man with
money meets a man with experience, the man with the money leaves with experience and the man with
experience leaves with the money.”
Whenever I have been asked for advice on selecting a manager, my counsel has been that if you are not
comfortable with the elements described above, then you would be better off not investing. It is better to err on
the side of not investing with someone than to entrust your capital to someone in whom you do not have
complete confidence.
Assessing the Partnership’s Performance

If I were an investor in the partnership (and I will be), I would track its progress using the framework elements I
outlined above. Specifically:
1. Integrity – My principles are outlined in the first part of this Owner’s Manual. You should find that my
actions are consistent with those principles, beginning with the structure of the partnership, which is
designed to achieve alignment, and continuing with the many actions taken on the partnership’s behalf.
2. Philosophy and Process – My Philosophy and Process are described in the second and third sections of
this Owner’s Manual. If anything is unclear, now is a good time to ask questions that I will do my best to
answer. If there is a question whose answer will benefit everyone, I will update the Owner’s Manual so
that all of the Partnership’s partners share the same understanding on how the partnership’s capital will
be invested. Partners should be able to interpret all my investment actions in the context of the process I
have outlined, and those actions should be clearly consistent with that process. Any unexplained
deviations from the process should be a source of concern, and a matter to which you are entitled to a
clear explanation from me.
3. Performance – In the short term, any assessment of “performance” will be fairly meaningless given the
long-term nature of the partnership’s investment operation. My approach is based on investing in
securities where I see a wide gap between the market price and my appraisal of value, therefore short-
term market price changes of the partnership’s securities are more likely to reflect market sentiment and
“noise” rather than meaningful incremental information about whether my investment thesis is correct or
not. On the other hand, over the very long-term it will be of little consolation to you if performance is sub-
par, but I have followed what I believe to be an excellent process. In the short-term, therefore, attention
should be focused on assessing process, while as in the long-term you should hold me accountable for
results, as measured by long-term returns adjusted for the amount of risk of permanent capital loss taken
to achieve them.
Thoughts on Assessing Performance
At what point does the “short term” end and “long term” begin? There is no easy answer, but ideally results
should be evaluated over a full market cycle that includes a peak in economic performance, a recession and a
recovery to a normal economic environment. Historically, that has been a 5-10 year period. I consider results from
a period of less than a year to be mostly “noise”, and even a year to not be particularly useful in separating
investing skill from randomness. [As an aside, if you believe that quarterly or single year results will allow you to
meaningfully assess my skill or serve as rationale for making capital allocation decisions with regard to the
partnership, the partnership may not be the right investment for you.] In between one year’s results (not very
meaningful) and a full cycle’s results (meaningful) lies a time continuum. As the time horizon increases, you
should put more weight on the outcome and less on the process, but always consider both together.
It is worth noting that some of the world’s best investors have had 3 years out of 10 during which they have
underperformed the market. In analyzing a speech given by Warren Buffett in 1984 (“The Superinvestors of
Grahamsville-and-Doddsville”), Eugene Shahan published an insightful article titled “Are Short-Term Performance
and Value Investing Mutually Exclusive?”1 that analyzed the results of Buffett’s “superinvestors.” One of his
conclusions was that all of these investors, who all had overall superb records of long-term outperformance,
underperformed the market 25% to 40% of the years. A number of them had consecutive three-year periods
during which their performance was substantially worse than the markets.
Will the partnership experience periods of unexciting, or worse, performance? If history is any guide, it is likely that
it will. The only certainty is that my focus will be on generating long-term results, and I will have little ability to
influence when the market will decide to mark the portfolio in a way that results in a sub-par quarter or year.
What constitutes good performance? Is it best measured in absolute terms or relative to the market? According to
data presented by Nobel laureate Robert Shiller for the period beginning in 1871 2, the U.S. equities market has
generated long-term returns of 6% to 7% in excess of inflation depending on the time period. However, as we can
see from graphing market returns from Shiller’s data on a 10-year rolling basis after adjusting for inflation, there
have been wide deviations, even among 10-year periods:
1 Shahan’s article can be found at: http://gdsinvestments.com/wp-content/uploads/2015/07/The-Superinvestors-of-Graham-and-

Doddsville-by-Warren-Buffett.pdf
2 http://www.econ.yale.edu/~shiller/data/chapt26.xlsx
Approximately 13% of the 10-year periods since 1871 produced negative returns after adjusting for inflation,
while 24% of the 10-year periods had annual returns of less than 3% after adjusting for inflation. I have no
expertise in broad market forecasts, nor do I spend any time on them; but if I were forced to estimate the likely
returns of the U.S. market over the next decade using today’s valuation levels as the starting point, I would think
they would fall between 0% and historical average of 6% to 7% in excess of inflation.
In making investments, I always focus on the absolute rate of return that the investment is likely to generate. I
also demand a minimum hurdle rate below which I prefer to stay in cash to wait for tomorrow’s opportunities
rather than intentionally committing capital today to long-term investments at sub-par rates. For me, a low-cost
market index fund is a reasonable measure of our opportunity cost. Therefore, I would be disappointed if the
partnership failed to outpace the return of a passive index fund over a full market cycle in most environments. An
exception might be an overheated bull market, like the one we witnessed in the second half of the 1990s. The
partnership would probably not keep pace with that type of market, even over a full cycle, due to its focus on
capital preservation. Conversely, I would be disappointed if the partnership failed to outpace inflation over a
market cycle, regardless of the market’s performance over that period. To summarize, I would consider a good
long-term outcome one in which partnership returns meaningfully exceeded both inflation and the market while
not exposing the portfolio to material risk of permanent capital loss.
On Risk-Adjusted Returns
Is a 25% annual return better than a 15% return? The answer depends on how much each portfolio was exposed
to the risk of permanent capital loss. Consider the following hypothetical scenario:
Portfolio A generated a 25% annualized return by investing in a single deep out-of-the-money option. This type of
option is highly likely to produce a total loss of invested capital, with a small probability of a spectacular return.
Portfolio B achieved a 15% annualized return by investing in fifteen securities of above-average businesses
purchased at prices that made permanent capital loss for the portfolio as a whole very unlikely.
Was portfolio A’s performance superior to portfolio B’s? Portfolio A’s investors certainly ended up with more
money than those who invested in Portfolio B. On the other hand, there might be many other investors who put
their money in portfolios similar to portfolio A and who have now lost all of their capital. In this scenario I have a
strong preference for results generated by Portfolio B, and would consider a good return achieved with low risk to
be far superior to one in which a higher return is achieved at high risk. This is one of the reasons I am not going to
be using margin or portfolio leverage in investing the partnership’s capital.
While the partnership’s performance cannot be known in advance, it would be useful to describe the types of
environments in which the portfolio is likely to do particularly well or poorly relative to the market. This description
is intended to help you interpret intermediate results in proper context and provide an indication that the portfolio
is being invested in a manner consistent with the philosophy and process outlined earlier. With the caveat that in
a concentrated portfolio, such as the one I anticipate, material movements in the price of one or two investments
are likely to overwhelm other factors in the short term, I would expect the portfolio to act as follows. The two types
of environments where I would expect performance to lag that of the broader market would be (1) a heated bull
market, and (2) the initial recovery in prices following a protracted economic downturn. In the case of the former,
my focus on buying undervalued securities will likely make it difficult for results to keep pace with a market driven
by momentum in which stocks have gone from fair value to well above fair value. The reason that the portfolio is
likely to lag during the initial recovery phase is my emphasis on quality. Securities that initially do best coming out
of the downturn are those that are of marginal quality with fragile balance sheets that have just barely avoided
bankruptcy. The Partnership is unlikely to have securities such as these in its portfolio. On the flip side, my
emphasis on quality and valuation discipline will likely result in declines that are less than those of the market as
a whole during market downturns. Make no mistake – a portfolio with only long positions will be marked down
during a broad decline in market prices. However, the magnitude of the mark-to-market decline should be lower
than that of the market as a whole.
Communication
Effective communication is an important element in every successful partnership. My goals in communicating
with you are as follows:
 Provide as much transparency as possible with respect to how I am implementing the partnership’s capital
deployment process
 Discuss investing topics pertinent to the market environment
 Assess the state of the portfolio and opportunity set in terms of my qualitative judgment and various tracked
metrics
 Provide periodic updates on non-investment aspects of the business to help you better understand the
operation
 Report on the partnership’s performance at appropriate intervals
 Answer partner questions
I intend to communicate with you through these channels:
 An annual letter detailing the prior year’s performance and how the process was implemented. This will also
be the only letter where I will explicitly discuss performance. (All partners will receive monthly statements
from the fund administrator). I do not find analyzing “performance” over short periods of time to be
illuminating, and would rather spend my partners’ time on things that will help them better understand the
process and the operation
 Brief quarterly letters that highlight the state of the portfolio
 As circumstances warrant, unscheduled letters
 An annual meeting with a dial-in option for those who cannot attend in person
 Direct conversations to discuss topics not covered through the above methods. If questions come up that I
feel will help other partners better understand the partnership’s investment operation, I will include the
question and answer in an anonymous fashion in the next letter for everyone’s benefit
My goal in communicating with you is to provide as much transparency as possible, but not to the point that it
could damage the results of the partnership. For example, given the disciplined way in which I use my estimated
value ranges to make buy and sell decisions, I will be hesitant to disclose those estimates for individual
investments if I think that doing so could hurt the partnership. My goal is to use my judgment as circumstances
evolve as to where that line will be drawn in specific situations, and I will be upfront with you if that is an issue
that prevents me from fully addressing a question you might have.
Conclusion
I greatly appreciate you taking the time to learn more about my investment process and how the partnership will
operate. While I cannot guarantee results, be assured that I will be working hard to implement the process I have
described, and that my family’s capital will be invested in the partnership.
Sincerely,
Gary Mishuris, CFA
PLEASE SEE IMPORTANT DISCLAIMERS THAT FOLLOW
Disclaimers
This document does not constitute an offer to sell or a solicitation of an offer to buy securities. Any such offer will
be made only by means of the Confidential Private Placement Memorandum (the “Memorandum”) for limited
partnership interests in Silver Ring Value Partners Fund LP (the “Fund”). Prospective investors should read the
Memorandum carefully before deciding whether to purchase interests in the Fund and should pay particular
attention to the information set forth under the heading “Certain Risk Factors and Conflicts of Interest” therein.
This document is subject to the more complete information contained in the Memorandum and is qualified in its
entirety by the Memorandum.
This document and the information contained herein is confidential and is intended solely for the information of
the person to whom it has been delivered. It is not to be reproduced, used, distributed or disclosed, in whole or in
part, to third parties without the prior written consent of Silver Ring Value Partners Limited Partners, the sponsor
and the investment manager of the Fund (the “Manager”). Each person accepting this document hereby agrees
to return it promptly upon request. General solicitations, prospecting by mail and advertising are strictly
prohibited.
An investment in the Fund is speculative and involves a high degree of risk. There can be no assurances that the
Fund’s investment objective will able to be achieved or that its investment program will be successful. The Fund
is intended for long-term investors who can accept the significant risks associated with investing in the Fund and
illiquid assets. Limited partnership interest in the Fund will be illiquid as there will be no secondary market for
such interests and none is expected to develop. There will be restrictions on transferring limited partnership
interests in the Fund. A prospective investor who has preliminary interest in the Fund should understand these
risks and have the financial ability and willingness to accept them for an extended period of time before
considering making an investment in the Fund.
Neither the Manager nor any principal or agent of the Manager guarantees or makes any representations as to
the performance of the Fund, the repayment of capital, income payments or any particular rate of capital or
income return.
There can be no assurance that the Manager’s strategy will achieve any targets or that there will be any return on
capital. Historic performance is not necessarily indicative of future performance, which could vary substantially.
No due diligence process can guarantee a manager’s integrity or performance results.

Owner's Manual: Silver Ring Value Partners

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Owner's Manual: Silver Ring Value Partners

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Owner’s Manual

Silver Ring Value Partners

Gary Mishuris, CFA

My Business Is Guided by Five Principles:

Investors are Partners

Broad Interpretation of the Meaning of Fiduciary Duty

Doing Business in an Exceptional Way

Why Attractive Investment Opportunities Exist

Examples of misaligned incentives that cause investors to misprice securities include:

The best way to minimize the effects I describe above is to:

 The discount offered by the price relative to my estimate of value, and

Some factors that affect the predictability of a company are:

Long-Term Time Horizon

My investment process has three stages:

1. Include a diverse set of potentially undervalued securities

2. Exclude those failing any of

Step 3: Prioritize the remaining candidates by considering:

The Five-Step Research Process

•Company Quality Assessment

•Analysis of Key Economic Variables

Step 1: Company Quality Assessment

Balance Sheet Quality

Performing the Analysis

Step 3: Financial Modeling

Step 5: Behavioral Checklist

Minimum Criteria for Investing

Average Above Average Excellent

Price as % of base case value <55% <65% <75%

POSITION SIZING GUIDELINES

Assessing an Investment Manager

My general framework for assessing investment managers has four elements:

Assessing the Partnership’s Performance

1 Shahan’s article can be found at: http://gdsinvestments.com/wp-content/uploads/2015/07/The-Superinvestors-of-Graham-and-

I intend to communicate with you through these channels:

Gary Mishuris, CFA

PLEASE SEE IMPORTANT DISCLAIMERS THAT FOLLOW

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