Peridot Capital Management - Our Value Investing Philosophy

The Peridot Capital Investment Philosophy

Peridot Capital Management manages individual client accounts using a long term, contrarian, value-oriented investing approach. Our strategy is based on historical stock market data dating back to the 1800’s which shows a direct inverse correlation between stock valuations (measured by price-earnings, price-to-sales, price-to-book, and price-to cash flow ratios) and future share price performance. Simply put, the lower the valuation the higher the future return, on average. This seems logical; the better deal you get when you invest in something, the more profit you are likely to earn.

Of course, since these are historical averages there will always be cheap stocks that perform poorly as well as expensive stocks that perform well. Focusing on value stocks puts the odds in your favor, but you still need to pick the right ones to outperform the market over the long term.

When looking for new investment opportunities, our core strategy is to focus on stocks that the market is shunning in the short term, which results in depressed share prices and low valuations. With each passing day Wall Street is becoming more and more focused on the short-term. In the age of hedge fund traders and the rapid electronic exchange of information, people react quickly and strongly to new information. Data points like what an analyst had to say about a stock today, or how sales will be this month dramatically affect day-to-day stock price movements

This presents longer term investors with plenty of opportunities to find bargains. At Peridot Capital we seek to take advantage of this ill-advised obsessiveness over the short-term. Our best investments are made when we find a strong company that has a bright future but has hit a temporary speed bump. Successful investing involves finding stocks where the longer term fundamentals appear be more optimistic than near term market sentiment is indicating. When the bar for a company has been set very low, the odds of its future performance exceeding consensus expectations (which is the key driver for future stock price appreciation) are fairly high.

Over time, as investors see the true underlying fundamentals of the company, the stock should rise to a more reasonable estimate of fair value and substantial profits can then be realized. As for time horizon, we typically share the common "3-5 year" definition for "long term" investing, but predicting what the business landscape will look like 5 years from now is very difficult. Most of our stock investments have catalysts that should result in upward revaluation within 1-3 years of the purchase date.

The Importance of Valuation Cannot Be Understated

The following example illustrates why investing in companies that are simply doing well, without regard to the price of the stock, can often lead to disappointing investment returns. Consider Wal-Mart in 1999. The retailing giant was growing rapidly and gaining market share with their everyday low prices. Wal-Mart stock was a favorite among investors, due to its perception as a great company positioned well for years to come.

What happened? Well, the optimistic view on Wal-Mart's business proved correct. In fact, sales and profits at Wal-Mart more than doubled between 1999 and 2005. So the stock did well during that time too, right? Well, not exactly. Investors who bought the stock in 1999 had actually lost 30 percent of their money by 2006, seven years later.

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This is a perfect example of why great companies do not always make great stocks. Even when a company doubles its earnings in less than decade, its stock price is not assured of going up (and can actually fall by a large amount). How does this happen? Stock prices do not follow how well a business does, but rather how well it does relative to investor expectations and stock prices reflect investor expectations at any given time.

Investors expected big things from Wal-Mart in 1999 and the stock price already reflects that optimism. Even if such stellar performance materializes, the stock won’t neccesarily rise. In the case of Wal-Mart, the company did extraordinarily well, but not quite as well as investors were expecting. Simply put, investors paid too much for their stock, which rendered their correctly optimistic outlook for Wal-Mart's business irrelevant to their investment's future success.