The 4 Gs of Investing

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Chanticleer Investment Partners, LLC 11220 Elm Lane Suite 203 Charlotte, NC 28277Phone: 704.366.5122 Fax: 704.366.2463 www.chanticleerinvestmentpartners.com

March 27, 2012

The 4 Gs of Investing

One of the things taught in college marketing classes is the four Ps of marketing, which consist of

product, price, promotion, and place. In a similar fashion, we like to think of the four Gs of investing,

which are key things that we look for in every investment.

Good Business

A good business, as we define it, is one that earns high returns on capital. We want to invest in businesses

that arent too capital intensive and ones that can handle significant increases in business activity without

significant increases in capital. As Warren Buffett has said, Time is the friend of the wonderful

company, the enemy of the mediocre. We prefer businesses that have a long runway of reinvesting at

those high returns on capital, but also realize that sometimes really good businesses just throw off more

cash than can be needed. In those cases, we look for companies that return that excess cash to

shareholders, either through dividends or share repurchases.

Good Balance Sheet

We look for companies that have little to no debt. We dont ever want to invest in a company where

theres a chance creditors can determine its fate. The future is too uncertain, Black Swans happen, and we

dont want to invest in a business where an unexpected turn or slowdown in business can put its staying

power at risk. Almost as importantly, we want businesses that can take advantage of opportunities that

may present themselves, and a good balance sheet goes a long way in making sure that one can capitalize

on such opportunities.

Good Management

We want management teams that understand capital allocation and whose interests are aligned with us as

shareholders in the company. We look for good track records, managers who do what they say they are

going to do, and ones that we think we can trust and admire. We want management teams that treat

shareholders as partners on the same team, and ones that focus on creating shareholder value and not just

getting big for the sake of being big.

Good Price

We want to always remember that the price we pay determines the return we get, and that the market is

there to serve us, not guide us. A business can have all of the other qualities we look for but be a lousy

investment if we pay too high a price. We want to buy a stock at a significant discount to what we think it

is worth and one that provides us with what we think is considerable margin for error.


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Although there are many other things we consider in the investment process, the 4 Gs presented above

provide a basic framework for where we like to start our search for stocks that could find their way intoclient portfolios. If we cant find enough stocks meeting these criteria, we are willing to hold cash while

continuing to search for new ideas that do.

Current Market Thoughts

We are currently able to find many stocks meeting the first 3 Gs, but very few of those that we believe

provide an adequate margin of safety in the purchase price. In our opinion, this is largely due to an

overvalued stock market as a whole, though many people disagree with this view. The main difference

between those we respect in the debate on overall market valuation revolves around profit margins. Those

that believe the market provides good value are basing their assessment on trailing earnings and/or

projections for earnings over the next year, both of which assume a continuation of record profit margins,

as the graph below from GMOs James Montier (What Goes Up Must Come Down!) depicts.

Yale professor Robert Shiller provides updated market data every month on his website and calculates a

Cyclically Adjusted P/E Ratio (CAPE or Graham and Dodd P/E) using 10-year trailing earnings in

order to smooth out some of the effects of the business cycle. The average multiple for this number over

time is about 16, versus a current reading of about 23. The chart below (from the same Montier paper)

shows the relationship of CAPE and the trailing P/E for the S&P 500.


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Of interesting note is that the market often puts a low multiple on depressed earnings. For example, using

the online data provided by Robert Shiller, the average CAPE from 1979-1982 was less than 9. Corporate

profit margins during that time were below their historical averages, and about half of what they are

today. So stock market investors during the late 1970s and early 1980s had two tailwinds: 1) a reversion

to a more normal multiple of earnings being paid by investors; and 2) a reversion to more normal profit

margins. Investors today have no such tailwinds, as an above-average multiple is currently being placed

on record profit margins.

Of course, we dont invest in the entire stock market. Most of our time is spent looking for individual

businesses to invest in. It is not that difficult to construct a portfolio of higher quality companies that trade

at a discount to the overall markets valuation, based on trailing earnings. But we dont just look for

relative value; we want absolute bargains when we put capital to work. A decent business whose earnings

we can buy for a multiple less than the market and below its historical average may not be enough. We

still see many risks that the world has yet to work through and believe there will still be many dislocations

in the markets over the next few years as a result of both high debt levels (deflationary force) and the

massive amount of money that has been printed around the world (inflationary force) to combat the crisis

over the last few years. The charts below (via Steve Keen and the St. Louis Fed) show the debt levels and

money supply for the U.S., and we think they are important illustrations for the potential risks that lie

ahead, even if we cant know the precise effects that debt working towards more normal levels and an

increased money supply will have on the markets and asset prices going forward.


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As Ed Easterling has shown and written about in a couple of books, the main driver of overvalued

markets getting re-rated to lower a lower PE ratio is a change from relatively stable inflation levels to

either inflation or deflation. It may sound a little counter-intuitive to hold a lot of cash when one is

concerned about the eventual erosion of the dollar's purchasing power (as we are!), but in a period when

inflation is still fairly stable and the risks to that changingwhether towards deflation or inflationover

the next few years are extremely high, we think a high level of cash, patience, and a diligent effort

preparing to put that cash to work when the opportunities present themselves is the prudent course of

action in today's market.

If the governments and central banks of the world are able handle the storms better than we expect is

possible, maybe high cash balances will just be awaiting opportunities that will never come. But if the

opportunities we can find today perform as we hope and the main cost of holding a lot of cash is the cost

of missed opportunity while having that cash yielding close to nothing, that is a cost we think is worth

taking compared to being too fully invested as stocks get re-rated when price stability reverses course.

For information on investing or to sign up to receive future letters, please visit our website at

www.chanticleerinvestmentpartners.com.

All the best,

Joe Koster


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Legal Information and Disclosures

This letter expresses the views of the author as of the date indicated and such views are subject to change

without notice. Chanticleer Investment Partners, LLC (CIP) has no duty or obligation to update the

information contained herein. Further, CIP makes no representation, and it should not be assumed, that

past investment performance is an indication of future results. Moreover, wherever there is the potential

for profit there is also the possibility of loss.

This letter is being made available for educational purposes only and should not be used for any other

purpose. The information contained herein does not constitute and should not be construed as an

offering of advisory services or an offer to sell or solicitation to buy any securities or related financial

instruments in any jurisdiction. Certain information contained herein concerning economic trends and

performance is based on or derived from information provided by independent third-party sources. CIP

believes that the sources from which such information has been obtained are reliable; however, it cannot

guarantee the accuracy of such information and has not independently verified the accuracy or

completeness of such information or the assumptions on which such information is based.

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The 4 Gs of Investing