Moody Aldrich Partners, LLC

At Moody Aldrich Partners, our approach is carried out through independent research, bottom-up selection and experienced judgment. The firm’s rigorous research process draws on the investing experience of five investment professionals to thoroughly vet each new idea.

The research process is the same for all of our strategies and begins with an investable universe of 3800 companies (which include ADRs and shares of foreign companies traded on a U.S. exchange). Research ideas are found through our internal research, extensive network of contacts, and independent and sell side research. One successful method of finding new ideas is a proprietary quantitative screen that produces approximately 30 new ideas each month, which has been used for over 20 years.

Conducting Research and Assessing Investment Merit
The firm's bottom-up investment process relies on intensive company by company research to transform information into understanding and knowledge, enabling us to act decisively and with confidence. We never start with a macro or top down view. Our fundamental research concentrates first on a qualitative assessment of business and company strategy. Through contact with management, company reports and independent research, we try to identify hidden value and understand where a company is heading in its business cycle, the drivers of value, management's capital allocation strategy, skills and vision and competitive advantages.

We then gauge the levers of change, including an assessment of catalysts such as new management, a strategy shift, new products, better utilization of working capital, lower cost of capital or improved cost controls. It is our expectation that these factors will manifest themselves in better cash flows, capital efficiency, return on invested capital, margins and earnings. When coupled with undervaluation, improvements in these areas usually yield a higher stock price.

A visible path of end market expansion and a durable competitive advantage are also important factors that help us to anticipate a company's future prospects. We prefer companies which demonstrate sound and transparent accounting practices and good earnings quality. A close examination of company specific financial trends focuses on the key factors management can influence to boost return on invested capital (i.e., margins, efficiency ratios such as asset turns, accounts receivable turns, inventory turns and cost controls). Capital structure and profitability help us understand the sustainability of the business and growth potential. We want evidence that supports the stated business strategy and demonstrates sound capital allocation skills consistent with long-term shareholder value creation.

Valuation
Valuation plays the most important role in our process both on the buy side as a measure of future opportunity and on the sell side as a measure of risk. Drawing on our internal research and judgments, we employ a mosaic approach to valuing companies utilizing several measures in combination. Using intrinsic and relative measures, we develop a range of fair value under various conservative assumptions and scenarios. Adhering to principles, we are "bird in the hand" investors and are unwilling to pay very much for distant cash flows.

Earnings Estimate Momentum
Value investing, particularly when drawn to neglected stocks, involves significant "time" risk or the risk of holding "dead" money. To improve investment timeliness, we monitor a concept that is not normally associated with value investing - earnings estimate momentum (EEM). EEM measures the rate of change of analysts' estimates. On the buy side we use EEM as a filter after our research has identified an otherwise attractive investment idea. If, for example, the new idea exhibits exceptionally poor earnings estimate momentum, we will be patient and wait before committing funds.

A simplified value approach is often early in identifying the bottom of a stock's price. The "Sine Wave" below summarizes the impact of incorporating earnings estimate momentum in our process. We tend to buy (and sell) later than more traditional value managers, thus mitigating time risk and in many cases avoiding the final "washout" phase of a stock's normal bottoming process.

Sell Discipline
A juxtaposition of earnings estimate momentum (EEM) and value provides a very effective, unemotional sell discipline. Essentially, as fair value is approached, we become more demanding of EEM as experience has taught us to let our winners run. If the holding continues to exhibit positive EEM, we will sell a portion while retaining the rest.

Stocks are also sold based on qualitative judgments derived from fundamental research and tied to our investment thesis for each holding. Signals include an erosion of the business and/or balance sheet. We monitor key indicators continually and eliminate companies when catalysts expected to unlock value do not materialize or if our investment case breaks down. Occasionally, when research uncovers a great new idea, we will sell a weaker holding to fund the purchase.