Practical analysis for investment professionals
10 August 2016

Value Stock Picking: Finding “Horses with Legs”

“Ideally, the number of people you can have at a dinner party, if you want to have one single conversation, is six or less,” Leah Zell, CFA, explained. Any more than six and the conversation breaks down.

Zell applies this same “dinner table rule” at the investment firm she founded, Lizard Investors. Thanks to its small size, her lean, four-person team can have a continuous, focused conversation about the 30 stocks in its equity portfolio.

It’s not easy running a concentrated hedge fund, but Zell and her associates have mastered the art through an unrelenting due diligence process and strict rules for stock selection and risk management.

As Lizard’s lead portfolio manager, Zell discussed her firm’s strategy, its approach to fundamental analysis, and why identifying companies with good governance is imperative for managing risks during her presentation at the 2016 Financial Analysts Seminar in Chicago.

Horses with Legs

“Small- to mid-cap international stock investing may offer one of the last vestiges of outperformance through active management,” Zell explained. “We look for horses with legs.”

What does she mean by horses with legs? Sustainable businesses with good balance sheets that are poised for growth.

Lizard avoids turnarounds and companies with lots of debt or that are dependent on GDP growth. Instead, it looks for management teams that are aligned, understand how to allocate capital, and have good corporate governance standards. Finally, Lizard won’t overpay and requires the potential of a 20% compound return using its valuation model over a three-year time horizon.

“Our universe is dynamic, with lots of new companies coming in and out — broken IPOs, spin-offs, or stocks that stumble,” Zell said. “Perhaps something in the company or marketplace depresses margins and we don’t think that will continue. We take advantage of this ‘time arbitrage’ and look ‘over the valley’ to determine when/if a stock will return to our view of intrinsic value.”

Lizard has a “watch list” of 300 companies that meet all of its criteria save for valuation. “If one of the companies on our watch list issues a profit warning, we love that!” she said, and Lizard goes to work to determine if the warning is temporary, cyclical, or structural in nature.

Insisting on Good Corporate Governance

In equity markets, Zell noted that investors are paid for taking calibrated risks and one way to mitigate risk is to insist on good governance standards. In international small- to mid-cap companies, it’s much more common to have dominant shareholders or large family ownership and lower percentages of investable securities outstanding.

“There are two types of dominant shareholders,” Zell said. “Ones who look at minority shareholders as targets and ones who treat their ownership as they would ownership in a private company that they own forever.” Lizard, of course, prefers the latter.

In the United States, companies often go out of their way to return value to shareholders. This is not always the case in the international investing sphere, Zell explained. “We make a qualitative assessment based on quantitative behavior to determine if company actions are good for investors,” she said.

The focus on shareholder value is not the only area where US firms diverge from their international counterparts. Zell also noted that when investing in US companies, investment managers typically root around for information. “You talk to suppliers, customers, and multiple levels of management all the way to the top,” she said. “It’s an acceptable part of the game.” This approach is not so common outside the United States.

“If you ask to speak with senior management in Asia, they may say, ‘Who do you think you are?’” Zell said.

She compared it to buying Chinese art. “You go to an American dealer, and they show you their best piece first,” she said. “If you go to a Chinese art dealer in Hong Kong, you may not see the best stuff until you have had tea many times.”

It’s all about the relationship and establishing trust and credibility with management.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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Key Takeaways

  1. Small- to mid-cap international stock investing may offer one of the last vestiges of outperformance through active management.
  2. Portfolio manager Leah Zell, CFA, looks for sustainable businesses with good balance sheets that are poised for growth and management teams that are aligned, understand how to allocate capital, and have good corporate governance standards.
  3. In equity markets, investors are paid for taking calibrated risks, and one way to mitigate risk as an investment professional is to insist on good governance standards.


Searching the World for Value
Leah Joy Zell, CFA

View the full transcript (PDF).

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About the Author(s)
Julie Hammond, CFA, CPA

Julia S. Hammond, CFA, CPA, is Director, Events Programming on the Marketing & Customer Experience (MCX) team at CFA Institute, where she leads the content planning for the Alpha Summit series of events. Previously she was the lead content director for a number of annual and specialty conferences at CFA Institute, including the Fixed-Income Management Conference, the Equity Research and Valuation Conference, the Latin America Investment Conference, the Alpha and Gender Diversity Conference, and the Seminar for Global Investors, formerly known as the Financial Analysts Seminar. Prior to joining CFA Institute, she developed strategies for pension, endowment, and foundation fund clients at Equitable Capital Management (now AllianceBernstein), and she has also worked as an auditor for Coopers & Lybrand (now PricewaterhouseCoopers). Hammond served for a number of years as chair of the investment committee for the Rockbridge Regional Library Foundation. She holds a BS in accounting from the McIntire School of Commerce and an MBA from the Darden School at the University of Virginia.

1 thought on “Value Stock Picking: Finding “Horses with Legs””

  1. peter mcmullin cfa says:

    great article by James Grant. Leah Zell is married to one of the best small cap investors ever-Ralph Wanger & she is a great analyst as well-great combination,

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