Ongoing Research Builds Our Value and Growth Strategy

At South Texas Money Management, we make sure that our portfolios have four levels of equity diversification: Our equity portfolio includes two distinct styles: value and growth, sector/industry, size of company (capitalization) and individual names. This portfolio is based on a pyramid structure where the base of the pyramid (60%) will be invested in Low Multiple Value, the middle tier (30%) will be Quality Growth and the upper tier (10%) in Pure Growth companies.

In order to identify which companies would be good candidates for our portfolio, we have developed two distinct screens that filter through the Standard & Poor's Compustat database of over 10,000 publicly traded companies.

The companies generated from our value and growth screens are then carefully analyzed to determine whether they should be included in our equity portfolio. If we determine a company should be added to our portfolio, a target price is established and the security is monitored on an ongoing basis to identify any fundamental changes that would warrant removal from the portfolio.

Our methodology for choosing companies to own is based on a high degree of research and analysis. We have access to numerous sources of third-party Wall Street research, as well as several proprietary research products. Research analysts make recommendations for new additions to the portfolio, and our CEO and Chief Investment Officer makes the final determination of whether to add a stock to the portfolio.

Value and Growth Screens

Both our value and growth screens have key characteristics. We are generally looking at companies with a market capitalization greater than $1 billion and an S&P Quality Rating or a Value Line Financial Strength Rating of at least a "B." In addition, we pay very careful attention to the relationship between market capitalization and revenue. Whereby, the market capitalization to revenue cannot exceed a predetermined amount. The goal of both screens is to produce a list of quality companies whose price we would expect to appreciate over the next 12 months.

Finally, spurred by studies linking good governance with company/stock performance, we have added a corporate governance component to our equity portfolio process. Before the addition of a new stock we review its corporate governance rating. The data used to evaluate companies is provided by Institutional Shareholder Services (ISS), which spent 18 months developing a tool for monitoring and comparing the corporate governance structures of America's leading publicly-traded companies: the CGQ (Corporate Governance Quotient). The CGQ is comprised of eight core topics: board structure and composition, audit issues, charter and bylaw provisions, laws of incorporation, executive and director compensation, qualitative factors, director and officer stock ownership, and director education.

Value Screen
Our value screen identifies companies trading at low price-to-cash-flow multiples but showing improving gross-profit margin and cash flow. We also consider the company's relative P/E to the S&P 500 and other valuation characteristics.

Growth Screen
Our growth screen identifies companies with accelerating earnings and revenue on a quarter-over-quarter and year-over-year basis. We look at historical earnings and revenue growth rates, as well as future expectations for earnings. For a company to meet all of our growth criteria, it must have improving earnings and revenue over a five-year period.

Client Portfolio Review and Restructuring
Our goal is to invest all client equity portfolios in our core equity stocks. However, the timing involved will depend on individual considerations.  When we receive a new account that is funded with non-core securities it is our policy to structure the individual portfolio so that it reflects our investment strategy.  This is generally achieved by reducing concentrations in heavily weighted positions, reviewing financial quality ratings on current positions owned, and restructuring the portfolio so that it reflects our sector and capitalization exposure.  Within the restructuring process we are mindful of tax considerations as well as portfolio turnover.  Our expectation is that we create a highly diversified portfolio in a methodical, disciplined approach.  Structuring our client portfolios in this manner enables us to minimize performance dispersion from our core portfolio.  Although we try to transition a client’s portfolio in a timely manner, this process can take several taxable years given individual portfolio considerations.

Sell Discipline and Target Price Methodology
STMM's primary objective is to achieve long-term capital gains. The consideration to sell a security takes into account unique client factors, including tax considerations, the effect on the portfolio's industry weighting, specific client requests, and the client's overall asset allocation.

We monitor our stocks to make certain they meet our investment criteria. We review positions whenever noticeable changes occur in valuation, price movement or fundamentals.

At STMM, we believe that purchasing and selling securities based on a specific discipline is critical to performance. When we purchase a security, we establish a target price. Our target price is based on well-founded valuation criteria such as P/E, price to book, price to cash-flow and P/E to growth (PEG). The metric we use depends on whether a security is purchased as a growth or value name. The target price is a key variable in determining whether a stock is purchased, increased in portfolio weight or ultimately sold. Significantly, our target price is not a static number, but is monitored and adjusted to reflect fundamental changes. STMM's target prices reflect a company's fundamentals and our analysts' judgment on how these fundamentals should be valued.

Although we do not react to every market movement, we continuously monitor our stocks. If one of our names has a significant price movement, we evaluate the stock to determine if we should add to our current position or sell the stock.

Continuously reviewing fundamentals is critical to our investment process. At STMM we purchase securities based on a disciplined approach. If a stock no longer meets our criteria, we determine why it does not meet our investment parameters and whether action is warranted. Our reviews focus on a company's fundamentals.

If we conclude that the fundamentals of a given company no longer warrant exposure, we issue a sell recommendation. Similar to buys, sell recommendations are based on a rigorous review of key factors that impact the company. Ultimately, our CEO and Chief Investment Officer reviews the recommendation and makes the final decision on selling a security.

Performance Policy Statement
In building our core equity portfolio, the objective is to outperform the S&P 500 Index or the Wilshire 5000 Index by 100-200 basis points (1% to 2%) net of fees on an annualized basis over a three- to five-year period with 20% less volatility than such indexes during the period. We report to different investment databases, including Nelson Investments and Mobius M Search Managers Database.

Our accounts are generally included in one of six composites. These include:

Equity Only Tax Managed

Equity Only Core Strategy

Balanced Tax Managed

Balanced Core Strategy

Conservative Tax Managed

Conservative Core Strategy

We follow the Global Investment Performance Standards (GIPS®), the international, nonprofit organization of more than 50,000 investment practitioners and educators in over 100 countries. The GIPS's mission is to serve its members and investors as a global leader in educating and examining investment managers and analysts, and sustaining high standards of professional conduct.