New Harbor Investment Management, LLC. Investment Process: Quantitative and Qualitative Analysis





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We employ both quantitative and qualitative resources to generate investment ideas. Our quantitative process involves computer screening for companies selling at below-market price/earnings ratios and trading below the midpoint of the stock's 52-week high-low. Our qualitative resources include trade press, corporate reports and financial publications. Together our qualitative and quantitative sources generate 200-300 investment candidates worthy of further analysis.

Idea Generating Process using quantitative and qualitative computer analysis

Our fundamental analysis seeks to understand the basis of the investment candidate's profitability. We evaluate potential catalysts which can rejuvenate companies: new products, new technologies or new management. We analyze a candidate's fundamental strength; we prefer companies with solid or improving balance sheets, positive cash flows, low cost structures, product differentiation, defensible franchises and effective management with an equity stake. Based on this analysis, we estimate the 3-5 year earnings growth rate potential for each candidate.

The next phase of the investment process focuses on valuation. We look for stocks trading at a low price/earnings ratio, low price/book, low price/cash flow, low price/sales or discount to private market value. Using the valuation parameter relevant to each company, we determine a target valuation range. From this range, we derive an upside price target as well as a downside price target. The result is a reward/risk ratio for each stock.

Fundamental Analysis, Valuation Analysis, Portfolio construction buy ans sell stocks.

The Reward/Risk Ratio depicted below is the stock's upside from its current price divided by the downside. This ratio is a tool we use to compare the attractiveness of different stocks within industry groups and across economic sectors. For example, it allows us to compare the attractiveness of a drug company to an electric utility. In a sense it allows us to compare "apples to oranges" as well as "apples to apples" in an effective manner.

Calculating Reward/Risk Ratio based on upside and downside risk.

We build portfolios in a bottom-up manner according to the attractiveness of each company's reward/risk ratio. We maintain diversification by usually having 20 to 50 stocks in the portfolio. Individual positions generally range in size from 1% to 5.0% at cost. Stocks with higher reward/risk ratios receive larger initial positions. Our discipline often leads us to average down while accumulating shares. In the course of our fundamental and valuation analyses, we often discover that many individual stocks in a given industry or sector are attractive. We think the market frequently misperceives entire industries and sectors, producing a cluster of investment opportunities. Consequently, our portfolios will often be overweighted or underweighted in certain sectors relative to our benchmark.

We attempt to control risk in the portfolio by normally limiting sector weightings to +/- 25% vs. the index. For example, if a sector is 10% of the index, we could have a weighting from 0% to 35%.

Our sell discipline is triggered under three different scenarios:

TARGET PRICE ACHIEVED -- A company's fundamentals recover as expected, the valuation rises and our price target is achieved. As there is no reason to modify our upside target, we sell the stock.

FUNDAMENTAL ACCELERATION -- A company's fundamentals improve beyond our original expectations. We reevaluate our upside and downside price targets, and trim accordingly.

FUNDAMENTAL COLLAPSE -- A company's fundamentals collapse unexpectedly, and our revised reward/risk ratio is unattractive. We eliminate the position.

The portfolio is continually renewed as stocks with low reward/risk ratios are replaced by candidates with high reward/risk ratios.

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