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Ingrid R. Hendershot President Hendershot Investments, Inc. 8/22/2014 Hendershot Investments, Inc. 1 Investment Philosophy: We seek to buy HI-quality businesses at reasonable valuations and hold them for the long term. 8/22/2014 Hendershot Investments, Inc. 2 What is long term? • • • • For a high-frequency trader, it is a nanosecond. For a day-trader, it is between lunch and dinner. For Uncle Sam, it is one year For Hendershot Investments, it is a decade or more. 8/22/2014 Hendershot Investments, Inc. 3 Our favorite holding period is forever. Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years. 8/22/2014 Hendershot Investments, Inc. 4 HI-Quality Investment Criteria: A business which has a durable, competitive advantage as evidenced by consistently high ROE’s. Competitive advantages come in a variety of flavors, but they all yield pricing power and market expansion opportunities. COMPETITIVE ADVANTAGES = MOATS 8/22/2014 Hendershot Investments, Inc. 5 A few examples would be: Patents- Johnson & Johnson Proprietary Technology-Apple Strong Brand-PepsiCo, Coca-Cola Low-cost Provider- Wal-Mart, GEICO Networking Effect – Paychex . 8/22/2014 Hendershot Investments, Inc. 6 “The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.” Warren Buffett 8/22/2014 Hendershot Investments, Inc. 7 HI-Quality Investment Criteria: We also seek businesses with strong balance sheets, preferably with little or no long-term debt. The more cash and the less debt on the balance sheet, the better we like the business. 8/22/2014 Hendershot Investments, Inc. 8 Warren Buffett calls borrowed money: A dagger tied to a company’s steering wheel, pointed straight at its heart. Someday it may hit a pothole. Sorry, I’m just a pothole. 8/22/2014 Hendershot Investments, Inc. 9 HI-Quality Investment Criteria: We also like to see businesses which have predictable growth in sales, earnings, and dividends. 8/22/2014 Firm Dividend Yield Latest Dividend Increase Dividend Payout Years Div. Raised ABT 2.3% 57% 37% 42 ADP 2.5% 10% 61% 39 BDX 1.9% 10% 42% 42 BFB 1.6% 14% 36% 30 CLX 3.3% 11% 63% 36 HRL 1.7% 18% 35% 48 MSFT 2.9% 22% 35% 10 MMM 2.6% 35% 38% 56 PEP 2.9% 15% 52% 42 TJX 1.0% 21% 20% 18 TROW 2.2% 16% 39% 28 WAG 1.9% 15% 45% 38 Hendershot Investments, Inc. 10 HI-Quality Investment Criteria: Strong free cash flow Free cash flow = The cash flow a business generates from its operations Less the capital expenditures to maintain and grow the business . 8/22/2014 Hendershot Investments, Inc. 11 Focus on Free Cash Flow Seek intelligent capital allocation by management: Use cash flow for the benefit of shareholders •Grow the business through strategic acquisitions •Pay dividends •Buy back shares at reasonable valuations Better yet , find companies with the ability to do all three 8/22/2014 Hendershot Investments, Inc. 12 Focus on Free Cash Flow Free Cash Flow Yield= Free Cash Flow/per Share Stock Price Compare Free Cash Flow Yield to Alternative Investments 8/22/2014 Hendershot Investments, Inc. 13 Focus on Free Cash Flow Company Projected Free Cash Flow Yield Express Scripts 12.4% Gilead Sciences 11.4% Oracle 10.6% Emerson 9.0% Accenture 8.9% United Technologies 8.0% High Free Cash Flow Yields 8/22/2014 Hendershot Investments, Inc. 14 Express Scripts manages more than a billion prescriptions each year for tens of millions of patients of employers, health plans, unions and governments. Fiscal Year (000,000) 2012 $4,751 2011 2010 2009 Operating Cash Flow 2013 $4,769 $2,193 $2,105 $1,752 Capital Expenditures (423) (160) (144) (120) (148) Free Cash Flow 4,346 4,591 2,049 1,985 1,604 (15) (10,326) - - (4,673) - - - - - (4,055) - (2,516) (1,276) - Acquisitions Dividends Share Buybacks 8/22/2014 Hendershot Investments, Inc. 15 Gilead Sciences is a leading biopharmaceutical company with treatments for HIV and Hepatitis C among other life-saving therapeutics. Fiscal Year (000,000) 2012 $3,195 2011 2010 2009 Operating Cash Flow 2013 $3,105 $3,639 $2,834 $3,080 Capital Expenditures (191) (397) (132) (62) (230) Free Cash Flow 2,914 2,798 3,507 2,772 2,850 Acquisitions (379) (10,752) (589) (91) (1,248) - - - - - (583) (667) (2,383) (4,023) (998) Dividends Share Buybacks 8/22/2014 Hendershot Investments, Inc. 16 Oracle develops and supports database and middleware software , application software, cloud infrastructure, hardware systems and related services. Fiscal Year (000,000) 2013 $14,224 2012 2011 2010 Operating Cash Flow 2014 $14,921 $13,743 $11,214 $8,681 Capital Expenditures (580) (650) (648) (450) (230) Free Cash Flow 14,341 13,574 13,095 10,764 8,451 Acquisitions (3,488) (3,305) (4,702) (1,847) (5,606) Dividends (2,178) (1,433) (1,205) (1,061) (1,004) Share Buybacks (9,813) (11,021) (5,856) (1,160) (992) 8/22/2014 Hendershot Investments, Inc. 17 Emerson is a global diversified company that supplies products and technology and delivers engineering solutions to industrial, commercial, and consumer markets. Fiscal Year (000,000) 2012 $3,053 2011 2010 2009 Operating Cash Flow 2013 $3,649 $3,233 $3,292 $3,086 Capital Expenditures (678) (665) (647) (524) (531) Free Cash Flow 2,971 2,388 2,586 2,768 2,555 (19) (187) (232) (2,843) (776) Dividends (1,181) (1,171) (1,039) (1,009) (998) Share Buybacks (1,110) (797) (935) (100) (718) Acquisitions 8/22/2014 Hendershot Investments, Inc. 18 Accenture provides management consulting, technology, and business process outsourcing (BPO) services worldwide. Fiscal Year (000,000) 2012 $4,257 2011 2010 2009 Operating Cash Flow 2013 $3,303 $3,442 $3,092 $3,160 Capital Expenditures (370) (372) (404) (238) (243) Free Cash Flow 2,938 3,885 3,038 2,854 2,917 Acquisitions (804) (174) (306) (41) (27) Dividends (1,122) (951) (644) (824) (378) Share Buybacks (2,544) (2,099) (2,172) (2,071) (1,855) 8/22/2014 Hendershot Investments, Inc. 19 United Technologies provides technology products and services to the building systems and aerospace industries worldwide. Fiscal Year (000,000) 2012 $6,605 2011 2010 2009 Operating Cash Flow 2013 $7,505 $6,460 $5,720 $5,083 Capital Expenditures (1,688) (1,389) (929) (838) (773) Free Cash Flow 5,817 5,216 5,531 4,882 4,310 Acquisitions (151) (18,620) (372) (2,781) (676) Dividends (1,908) (1,752) (1,602) (1,482) (1,356) Share Buybacks (1,200) - (2,175) (2,200) (1,100) 8/22/2014 Hendershot Investments, Inc. 20 Reasonable Valuation Once we have identified a HI-quality company, the most important part of the investment equation is to only buy it at a Reasonable Valuation... as the price you pay will determine your return. If you pay too high a price, even for a great company, your returns won’t be so great. 8/22/2014 Hendershot Investments, Inc. 21 Reasonable Valuation Intrinsic value= present value of the future discounted cash flows that can be taken out of the business over its lifetime. We’d rather buy a great business at a fair value, rather than a fair business at a great value. 8/22/2014 Hendershot Investments, Inc. 22 The three most important investing lessons are: 1. Think of a stock as part of a business and seek to own a group of high-quality businesses. 2. Use the stock market to serve you, not to instruct you. 3. Always buy with a margin of safety. 8/22/2014 Hendershot Investments, Inc. 23 Mr. Market is like Dr. Jekyll and Mr. Hyde – with wild swings in behavior from calm and friendly to monstrous. 8/22/2014 Hendershot Investments, Inc. 24 Buffett’s Secret to Wealth Be fearful when others are greedy. Be greedy when others are fearful. 8/22/2014 Hendershot Investments, Inc. 25 Volatility is not Risk “Risk comes from not knowing what you are doing.” Risk = Permanent loss of capital 8/22/2014 Hendershot Investments, Inc. 26 In the short run, the market is a voting machine, but in the long run it is a weighing machine. Ben Graham 8/22/2014 Hendershot Investments, Inc. 27 The three most important words in investing: “Margin of Safety” 8/22/2014 Hendershot Investments, Inc. 28 Rule #1: Never lose money. Rule #2: Never forget Rule #1. 8/22/2014 Hendershot Investments, Inc. 29 Selling Criteria We sell for a few reasons: 1. 2. 3. 8/22/2014 If the business fundamentals deteriorate and the problem doesn’t appear temporary. If the stock price moves significantly ahead of underlying business value, trim the position. If we see a substantially better investment opportunity. Hendershot Investments, Inc. 30 Selling Criteria As Ben Graham said in The Intelligent Investor, “Price fluctuations have only one significant meaning for the true investor. They provide him with the opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.” 8/22/2014 Hendershot Investments, Inc. 31 Will Rogers had two rules for selling: Rule #1: When the stock doubles, sell it. Rule #2: If the stock doesn’t double, don’t buy it. 8/22/2014 Hendershot Investments, Inc. 32 Phil Fisher, Common Stocks and Uncommon Profits, said, “If the job has been done correctly when a common stock is purchased, the time to sell is almost never.” 8/22/2014 Hendershot Investments, Inc. 33 With HI-quality stocks sporting free cash flow yields significantly higher than low-yielding bonds, investors should follow the cash to build an investment stash!! 8/22/2014 Hendershot Investments, Inc. 34