In an environment where significant free cash flow generation, strong balance sheets, and superior management teams are crucial to company performance (and even survival), we believe our focus on high-quality enterprises with solid financials is more important than ever.
Strategic capital allocation is one of the most important activities management teams do based on our experience of nearly 50 years. We strive to invest in companies that, after paying business expenses, generate more cash than they need and in turn seek to increase shareholder value.
With excess free cash, leadership has five capital allocation choices.
1. Invest in the Business
- This includes building new plants, adding more stores, increasing inventory, and research and development.
2. Impact the Balance Sheet
- Put cash on the balance sheet.
- Pay down debt.
3. Conduct Mergers and Acquisitions
- Companies can acquire businesses to accelerate their growth.
- When they acquire another firm, this tends to increase sales, profits, and their stock price.
4. Pay a Dividend
- We seek companies that pay a dividend and consistently increase that dividend over time. We believe dividend growth is important because only businesses that are growing their cash flow are able to consistently grow their dividends. We favor investing in businesses that are growing their dividends quickly because it means the underlying operation is expanding.
5. Buy Back Stock
- A stock buyback is when a corporation purchases its own shares in the stock market and it demonstrates the management team’s confidence in their business.
- A buyback reduces the number of shares outstanding and this increases earnings per share and, frequently, the stock’s value.
- All buybacks are not alike. Just as we seek to purchase shares at a discount to a company’s value, we prefer businesses that repurchase their shares at reasonable valuations as well.
Across Fenimore’s three mutual funds (FAM Funds), 100% of our holdings are employing one or more of these strategic tools. This bolsters our confidence in their leaders and business.
