Our Investment Process

1. Idea Generation

Since our inception we have been able to consistently source many of the best performing stocks by identifying quantitative factors that we believe are highly indicative of success, and then qualitatively evaluating those opportunities from a real-world business perspective. This combination of quantitative screening and qualitative analysis has been the bedrock of our highly profitable stock selection process, allowing us to achieve the ultimate goal of value investing — higher upside with lower downside.

A sampling of the quantitative factors that have enabled Prime to identify a constant stream of investment opportunities:

Long positions:

• Significant increase in same-store sales or year-over-year revenue.
• Substantially increasing market share for its products/services.
• Relatively low advertising budgets relative to revenues, evidencing a sought-after product with additional upside potential, as opposed to one that is in a “cash cow” state with diminishing value.
• P/E ratios substantially below the overall market with relatively stable revenue or increasing net income.
• CEO has a major stake in company and/or is the company’s founder.
• CEO has demonstrated entrepreneurial success, with a proven knack for “outside the box” thinking, which has generated a personal net worth that exceeds a certain target threshold.
• ROIC, ROA, and industry specific profit margin expectations.

Short positions:

• Diminished net asset value or balance sheet as a result of an oversized payroll base.
• Negative or diminishing net liquidation value as a result of unsuccessful mergers.
• Relatively new CEO with net worth less than a certain threshold.
• Huge and increasing marketing budgets (due to a peaking product life-cycle without fresh blockbuster ideas).
• High infrastructure costs combined with an unimpressive return on invested capital, or loss of equity value as a result of protracted dividend pay-outs (in order to satisfy short-term shareholders) without the underlying growth in profits.
• Overvaluation reflected in continued high P/E or market capitalization as compared to other companies that have products, management, or ideas with substantially greater future potential.
  Prime’s approach to qualitative analysis is broad-based and takes into consideration the individual nature of each investment opportunity. Some of the elements we evaluate include:

Long positions:

• Is the company well established in an industry with significant barriers to entry?
• Is the company in an industry or field that provides tremendous growth opportunities?
• Does a significant “moat” surround the company, consisting of billions of dollars of needed investment (often combined with intellectual property rights that prevent competitors from easily entering the field)?
• What is the company’s track record for growth and innovation?
• Have there been significant political, regulatory, or environmental changes affecting the industry?
• Are the leverage levels and balance sheet ratios appropriate for the company’s long-term vision?

Short positions:

• Is there substantial market cap, with services and/or products that were once “industry-leading” but are not so presently?
• Does the CEO lack major ownership stake in the company and/or is primarily salary and incentive based?
• Does the CEO lack experience bringing an idea or enterprise to substantial heights?
• Are there emerging market threats due to structural or other competitive advantages that may not have been identified or appropriately factored in by the marketplace as reflected by the company’s market cap or P/E?

Prime frequently gains additional perspective on potential investments based on real-world, first-hand knowledge of the business and product or service – i.e., we patronize many of these companies and use their product or service on a frequent basis.

2. Liquidity Filtration

To provide our investors with ample liquidity and transparency, we weed out the investments that:

• Are not publicly traded with readily observable prices.
• Do not meet our minimum market cap requirement of $500 million.

3. Intensive Research

At this stage, we perform intensive fundamental research in order to establish a potential investment’s intrinsic value. Comparing that value to the current stock price allows us to determine the caliber of the investment opportunity.

We begin by analyzing quarterly and annual SEC filings, quarterly conference call transcripts, Wall Street Investor Conference Transcripts, press releases, management interviews, research reports, and company financials. When appropriate we use proprietary internal analysis tools to assess investment merit or visit the company’s stores/facilities in person.

We do the latter because we believe that no matter how much quantitative research you do, the human touch is still essential. We like to see the physical facilities and observe actual customer-employee interactions. When you synthesize data-driven research with down-to-earth human understanding, it brings a new dimension to your analysis. Also, we generally believe that if a business is too complicated for us to easily understand in person—or if we need to talk to management in order to understand it—it’s probably better to stay away from it. After all, there are plenty of other opportunities out there that can be easily understood.

It is our belief that all information is interrelated, and that the more we know about history, politics, the economy, social trends, science, technology, and the world in general, the better investment ideas we will generate. Thus, a substantial portion of our time is dedicated to reading from diverse resources such as Financial Times, Barron’s, Wall Street Journal, The Economist, IMF reports, Federal Reserve transcripts, history books, international publications and studies, select economic and investment blogs, economic reports, and more.

By the time we finish this research process—checking every premise and asking ourselves every relevant question we can think of—we come to view these companies as actual operating entities, as opposed to “ticker symbols” that we want to get in and out of. We then ask ourselves the question, “Would I actually purchase this company outright if I had the opportunity and wherewithal?”

We believe that if you get all the pieces and premises right, and find opportunities that are truly undervalued, then regardless of what the market thinks today, that value will be achieved. That is generally how things have played out for us when we go through this process. By following the above steps, we have been picking some of the best performing companies for our long positions and some of the worst performing positions for our shorts.

4. Selecting the Best Investment Opportunities We Can Find

Once a company has survived our rigorous review process, what we refer to as a “true P/E” is formulated by: a) backing out our estimation of “liquidation value” by using very conservative assumptions regarding the value of the company’s assets and liabilities in case of a fire sale, and b) looking at the sustainable portion of the previous year’s increase in revenues and net income figures, so as to back out the portion of revenues we think are not sustainable, or are onetime events. This approach is similar to obtaining a forward P/E, made more conservative since we assume no further growth, expansion or increase in revenue.

Often the “true P/E” will differ substantially from what is represented by the market. One company, for example, may have very limited or no debt and a lot of cash sitting on its balance sheet, while another company may look as if it has a low P/E, but when you add back a substantial negative liquidation value or substantially declining revenues/net income, the true P/E may be much higher, or much lower, than what it seems.

Based on our “true P/E” figure, we run 1-year, 3-year, 5-year, and 10-year growth projections to establish an anticipated future value of each investment. We then sort investments in order of which stocks have the most room to grow in relation to their expected price. Then we take a final look at the company to check what the downside potential of the investment might be, as well as the likelihood of our investment premises holding up, and invest accordingly, rebalancing as appropriate as those values are realized.

5. Reviewing our Investments

Our commitment to rigorous fundamental analysis does not end with the initial investment decision. We constantly review, rebalance, and reevaluate each of our positions, keeping close watch over company movements, industry developments, and changing market factors. In fact, more than half of our time is spent reviewing and re-evaluating investments we’ve already made.

Finding investments that meet our standards is not easy. The good news is that with thousands of public companies to choose from, there are plenty of opportunities to find stocks that have not yet attained their true market value. To identify them, you must use a combination of “outside the box” thinking and sound fundamental analysis.

Results

Our conservative long-term investment approach and disciplined risk management have produced superior risk-adjusted returns versus our index and peers since our inception.