Honors Capstone Project
Date of Submission
Capstone Prize Winner
Won Capstone Funding
Corporate Finance | Finance and Financial Management
Our project bundles investment research reports spanning the authors’ time in the Orange Value Fund (OVF), a student run hedge fund in the Whitman School of Management. Each report exemplifies the fund’s unique, bottoms-up investment style. In contrast to traditional valuation methods that focus exclusively on projecting company earnings, the OVF adopts a micro-level approach to analyzing investment opportunities. Analysts study company documents such as annual reports, credit agreements, and proxy statements to identify safe and cheap opportunities.
A safe company has access to capital markets, a super-strong financial position, honest and competent management, and an understandable business. We define strong finances as the absence of liabilities and presence of high quality assets on the balance sheet. OVF analysts look for marketable assets such as income producing real estate, cash, and natural resources such as oil and gas reserves. Honest and competent management protects and enhances long-term shareholder value. Managers should focus on long-term wealth creation instead of short-term stock price fluctuations. In addition, we do not invest in businesses that require continual access to capital markets. Businesses that need daily short-term financing to fund operations fare poorly when credit dries up. Finally, we avoid businesses we don’t understand.
A business must be cheap to be considered for investment. Businesses are cheap when their stock price trades at a substantial discount to intrinsic value. We look for wide margins between 30% and 50% between market price and intrinsic value to shield against analyst mistakes. We prefer to be approximately right rather than exactly wrong.
OVF analysts use several valuation methods to determine intrinsic value. Generally, we prefer to use valuation methods that minimize assumptions. For example, we value real estate companies using Net Asset Value (NAV), which is the intrinsic value of assets less liabilities. We use market capitalization rates and sales data to determine asset values. In other industries, such as oil exploration and production, we value natural resource reserves based on industry merger and acquisition activity. We may also apply a multiple to normalized adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) after subtracting capital expenditures (CAPEX).
Due diligence in difficult economic times is important and the OVF’s investment style positions us to profit from incredible opportunities with minimal investment risk.
Li, Moon and Burrow, Brian, "Safe & Cheap" (2009). Honors Capstone Projects - All. 474.
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