To be successful, we believe an investment manager must have a timeless investment philosophy, because this philosophy defines the market anomaly the investment managers seeks to exploit on behalf of its clients. We believe the investment philosophy must guide the manager’s investment process, and executed with the discipline to follow both across all time periods. No philosophy or process will work in all environments, and it is impossible to know when those environments will take place, how long they will last, or when they will end. Therefore, regardless of the investment environment, the biggest contributor to our success will be faithfully following our investment philosophy and executing our process.
There is one philosophy across the firm, and ours is deceptively simple:
We break that out into two statements:
Stock Prices Are More Volatile Than Fundamentals
The human elements that drive market behavior are emotional, which leads investors to overreact in the short run to both positive and negative news. These often overly optimistic or pessimistic views about a company’s prospects can create substantial volatility in its stock price. We believe that many companies change gradually due to strongly embedded characteristics that help these companies overcome temporary challenges. These dynamics allow patient and disciplined investors to take advantage of the behavioral errors of others.
Fundamentals Determine Value
While company narratives and emotions can drive stock returns in the short run, over an extended period, we believe these returns will be driven by the performance of the underlying business. The juxtaposition of overly emotional prices with stable or growing fundamental value of companies can lead to wide differences between a company’s stock price and a conservative estimate of its value. Cornerstone’s process is designed to take advantage of these opportunities.
There are two other key tenets of our philosophy:
Information is a Commodity
We believe the market is efficient in so far as it incorporates all currently available information. There is no sustainable advantage to be derived from trying to uncover incremental material information that is not yet known by the market. However, the market price overly weights investor fears, hopes, forecasts, and expectations about the future that are often overly optimistic or pessimistic. We believe we have a better way of processing information and that is part of our competitive advantage.
Avoid Forecasting Inputs
Forecasting forms a precarious basis for any investment process. The ability to forecast the future accurately and consistently is extremely rare. Furthermore, to be profitable, a forecast must be not only correct, but it must also be different from the consensus (otherwise the forecast is already reflected in current prices). Relying upon forecasts interjects an over-confidence bias to security selection that puts value at risk.
Putting it Together
This chart of a stock’s price versus earnings and dividends per share over time is a strong illustration of our philosophy in practice. The stock has experienced a high degree of volatility, while two indicators of a company’s value, the earnings and dividends, have been both stable, and generally growing.
Source: Cornerstone Investment Partners, FactSet as of 3/31/23
An opportunity is created when a company’s stock price diverges from its value, and Cornerstone’s process is designed to capitalize when these opportunities occur. While our philosophy seems simple, it is that simplicity which enables us to integrate it throughout our firm consistently and with discipline.