Introducing River Road: Absolute Value Investing in U.S. Equities

We recently hired River Road Asset Management, LLC, based in Louisville, Kentucky, to manage our U.S. equity, value-style mandate. River Road employs 46 people, including 17 investment professionals. The two lead portfolio managers, Daniel Johnson, CFA, CPA and Matt Moran, CFA, have worked together for 15+ years and have delivered impressive results throughout their tenure.

This month, we are pleased to feature an interview with Daniel and Matt.

Alfred: Daniel and Matt, thank you for taking the time to speak with us and share your insights with our investors. We’re excited to welcome River Road to our multi-manager investment platform. We always like to start by asking: How did you get into the investment industry?

Daniel: I’ve been fascinated with the stock market since I was a kid, but my path to the investment industry wasn’t exactly traditional. I started my career as a CPA at PricewaterhouseCoopers—one of the Big Four accounting firms. I never planned to climb the ladder there; I just saw accounting as the language of business and a solid launchpad. When I spotted the equity research analyst opening at River Road Asset Management, I dropped everything to go after it. Turns out they wanted someone with an accounting skillset—no one on the investment team had an accounting background. I joined in 2006 as an equity research analyst covering the Small Cap and Dividend All-Cap strategies.

Matt: My journey began at the University of Chicago, where the prevailing dogma was that markets are perfectly efficient and individual stock picking is futile. I entered the industry driven to prove that academic consensus wrong, convinced that disciplined analysis could uncover value the market missed. Ironically, that very theory has fueled the massive shift toward passive investing, leaving fewer participants doing the real work of price discovery. Today, active stock picking is more attractive than ever; as the herd mindlessly buys the index regardless of valuation, the opportunities for those of us who actually analyze businesses have only grown.

Alfred: Since you started your careers, how has the investment industry evolved—and has your process changed along the way?

Daniel: The biggest shift has clearly been the migration toward passive investing and the compression of time horizons. The market has become faster, louder and more short-term focused. Paradoxically, this has been a gift to our process.

Matt: Exactly. As the industry moves toward algorithms and quarter-by-quarter trading, we believe it leaves more "inefficiencies" for fundamental investors like us to exploit. As for our process, the core philosophy hasn't changed—we still buy 80-cent dollars (buying investments at prices discounted to their intrinsic value ) —but our application of it has tightened. We are more rigorous now about "quality" than perhaps the industry was 20 years ago. We don't just want cheap; we want sustainable business models that can endure the volatility we see today.

Alfred: Your strategy is described as an “absolute value” approach. How does your investment process differ from “deep value” or “relative value” styles?

Daniel: This is a critical distinction.

"Relative Value" often means buying an expensive stock just because it is slightly cheaper than its peers—even if the peer group is trading at prices well above intrinsic values.

"Deep Value" often involves buying "cigar butts"—dying businesses that are statistically cheap but fundamentally broken. Deep Value was pioneered by Ben Graham and David Dobbs and practiced in Warren Buffett’s early career.

Our approach to value investing is called Absolute Value. While it overlaps with “Relative Value” and “Deep Value”, we try to avoid the common pitfalls of both styles of investing. For Deep Value, we try to avoid value traps by focusing on high quality companies that grow over time. For Relative Value, we avoid getting caught up in the momentum and additional volatility it brings to a portfolio by anchoring our valuations to intrinsic values and actively managing the individual positions based on risk–reward.

Matt: "Absolute Value", which is a unifying philosophy at River Road Asset Management, is a distinct style of value investing that is underpinned by four key tenets:

• One—and what I believe is the most important—we invest in excellent companies trading at compelling prices.
• Two, we build the portfolio from the bottom up, one stock at a time. By design, we look and perform different from the benchmark. If you want a manager with low tracking versus a benchmark index, we are not a good fit.
• Three, we seek the less efficient parts of the market. We acknowledge that the market becomes more efficient as you move up the market capitalization (cap) spectrum. We seek to offset this reality by employing a concentrated approach, which minimizes the number of inefficiencies we need to find to populate our portfolio and by taking advantage of the breadth of opportunities that exists within our investment universe by investing down to $3 B in market capitalization.
• Lastly, we are risk-averse investors with a structured sell discipline. One unique feature of our risk-averse philosophy is the fact that we do not average down on stocks because we want to minimize the losses on our inevitable mistakes. 

Alfred: U.S. equity markets have historically been difficult to outperform. In your view, what attributes increase the likelihood of success? How is your portfolio designed to capture those attributes?

Daniel: Our success comes from owning concentrated, selective names from the benchmark and a highly active approach. We believe a concentrated approach is the best way to outperform in large cap. To offset the idiosyncratic risk that comes along with a concentrated approach, we lean into our highest-conviction ideas, which tend to be higher quality and lower risk.

Matt: We believe active managers should be active. Large-cap equity markets offer exceptional liquidity, which value managers underutilize. Our portfolio activity is intentional and driven by disciplined risk management—specifically, valuation risk and execution risk.

Valuation risk management: As a holding approaches our assessed fair value, its risk–reward profile deteriorates. We systematically reduce the position size because the margin of safety is no longer there and the risk–reward has diminished. We fully exit the position between 100–120% of the assessed value.

Execution risk management: Every position has a documented investment thesis. When material facts invalidate the thesis, we exit promptly to minimize the damage from our inevitable mistakes. We try to approach the markets with humility. Over time, even the most successful portfolio managers will have a 55%–60% relative batting average on individual securities (success of active calls on the markets). Risk management is paramount in a concentrated portfolio and we seek to win by NOT losing big.

Alfred: In your opinion, what makes a company successful? Also, what destroys a good company?

Daniel: A successful company has a sustainable competitive advantage that allows it to maintain pricing power and returns on capital even in a bad economy. It’s usually a simple, boring business that provides a necessary product or service. We also want those businesses to be run by excellent management teams with interests aligned with shareholders and shrewd capital allocation skills.

Matt: What destroys a company is almost always debt and hubris. We look strictly at the balance sheet; leverage kills optionality. When a management team gets arrogant and takes on debt to fund an expensive, "transformational" acquisition, that is usually the beginning of the end. We prefer management teams that treat shareholder capital as their own—because often, it is.

Alfred: Can you share an example of a “hidden gem” from your portfolio, perhaps a past winner and explain what made it “hidden”?

Matt: A perfect one is CRH PLC (CRH).

CRH is a leading supplier of aggregates, building products and construction services in the U.S. and Europe. We’ve always loved its U.S. peers, Vulcan Materials (VMC) and Martin Marietta (MLM), but they’ve traded at rich valuations for years, so we never owned them. Most U.S. investors had never heard of CRH, even though roughly 75% of its cash flow comes from North America. That’s because its primary listing was hidden away in Ireland. Once CRH finally moved its primary listing to the U.S., it suddenly entered our investable universe, trading at a big discount to VMC and MLM. Since then, the valuation gap has narrowed as U.S. investors have discovered it and the company has executed flawlessly. We think there’s still plenty of runway: CRH keeps doing smart, accretive mergers and acquisitions (M&A)to boost scale and shift the mix toward higher-margin aggregates and integrated solutions. On top of that, we believe the $744 billion in Infrastructure Investment and Jobs Act (IIJA) spending will be a nice multi-year tailwind as the money flows to states. Lastly, we expect this hidden gem to get fully discovered once it’s added to the S&P 500 Index, which could happen in December.

Alfred: Value investing can face headwinds at times. How do you manage downside volatility for and during challenging periods?

Daniel: We believe downside volatility is a natural output of our approach to risk management. We manage risk at the portfolio level and stock level. For portfolio risk, we monitor correlations and build a portfolio with a principle of diversification. At the firm level, we have an oversight committee that monitors style and risk consistency metrics to ensure we are not straying from our Absolute Value philosophy.

Matt: We believe the best risk management occurs at the individual stock level. At the security level, we employ several important tools to assess and manage risk: 

• Seek to buy stocks at a meaningful discount to the assessed intrinsic value, which provides a margin of safety.
• Size positions based on a formal assessment of value AND conviction.
• Exit a position when it achieves/exceeds its assessed value or the invesment thesis is no longer intact.
• Avoid averaging down on losing positions once a target position is established (a 5% volatility tolerance is allowed).
• Practice intellectual honesty by continuously challenging our investment assumptions and acting decisively when our views change.  

Alfred: The rise of artificial intelligence (AI) is reshaping many industries. How is the AI trend impacting your assessment of companies?

Daniel: Most of the AI stocks are the Magnificent 7 (Mag 7) stocks or information technology companies. Large Cap Value Select currently owns none of the Mag 7 and has no exposure to the IT sector for two primary reasons:

One, valuations remain elevated. The Mag 7 and IT sector EV/EBITDA (Enterprise value/earnings before interest, taxes, depreciation and amortization) is in the mid-20s compared to our portfolio at roughly 12x times. We are disciplined value investors and will not overpay, even for high-quality companies. Better opportunities exist elsewhere today.

Matt: The other reason we have no exposure to the Mag 7 and IT sector is that the business models are evolving and becoming less predictable. The Mag 7 built dominant, capital-light franchises with fortress balance sheets. Their core businesses have matured, however and now several companies depend heavily on economically sensitive advertising revenue. At the same time, capital intensity has surged as they compete in AI. Historic mini-monopolies are converging into a single, highly competitive arena with new entrants (e.g., OpenAI), massive ongoing investment requirements, weakening balance sheets and uncertain future revenue models. While we respect Google’s structural advantages (distribution, data, AI expertise), underwriting this industry transition falls outside our circle of competence.

We prefer “boring” large-cap businesses—auto dealers, grocery stores, insurers—that trade at compelling discounts to intrinsic value and return capital through dividends and buybacks. These companies offer attractive risk-adjusted returns within our proven Absolute Value framework.

Daniel: We are observers of AI, but we are not speculators. We aren't going to pay 50 times future earnings for an unproven AI startup.

Matt: However, we are looking at how our portfolio companies use AI to defend their margins. Is a logistics company using AI to route trucks better? Is an insurer using it to price risk better? If AI reinforces a company's existing competitive advantage and improves efficiency, that’s a positive for our thesis. But we are wary of companies that simply add "AI" to their investor decks to pump the stock price. We stick to the cash flows.

Alfred: Thank you both for your time and valuable insights. We look forward to seeing River Road’s continued success on our platform.

Glossary

Leverage: An investment strategy of using borrowed money - specifically, the use of various financial instruments or borrowed capital - to increase the potential return of an investment.

Liquidity: The degree to which an asset or security can be quickly bought or sold in the market without affecting the asset’s price. Cash is considered to be the most liquid asset, while things like fine art or rare books would be relatively illiquid.

Return on capital (ROC): The amount of profit generated per dollar of invested capital. Return (risk-adjusted): A measure of investment performance taking into consideration how much risk/volatility was assumed to generate it. Consider two investments, both of which return 10% over a given time period. The investment with the greater risk-adjusted return would be the one that experienced less price fluctuation. Two of the most commonly used measures of risk adjusted returns are Sharpe and Sortino ratios.

Volatility: Measures how much the price of a security, derivative, or index fluctuates. The most commonly used measure of volatility when it comes to investment funds is standard deviation.

Intrinsic value: is the real value of an asset based on fundamental factors, as opposed to the price assigned by the market.

Intrinsic value: is the real value of an asset based on fundamental factors, as opposed to the price assigned by the market.

Inefficiencies: the state of not achieving maximum productivity; failure to make the best use of time or resources.

Idiosyncratic risk: refers to the risks an asset possesses due to its unique characteristics or other qualities.

Magnificent 7 stocks: Apple, Microsoft, Amazon, Alphabet,  Meta, Nvidia and Tesla.

Return (risk-adjusted): A measure of investment performance taking into consideration how much risk/volatility was assumed to generate it. Consider two investments, both of which return 10% over a given time period. The investment with the greater risk-adjusted return would be the one that experienced less price fluctuation. Two of the most commonly used measures of risk adjusted returns are Sharpe and Sortino ratios.

Tracking error: The divergence between the price of an investment or a portfolio and the price of the benchmark being compared to. In other words, tracking error is the difference in the performance of an investment and its corresponding benchmark. Its purpose is to measure how closely a portfolio mimics its benchmark.

Averaging down: is an investment strategy where an investor buys additional shares of a stock after its price has fallen, thereby reducing the average cost per share.

Mini-monopoly: is a term used to a company that has achieved significant market power.

EV/EBITDA: is a ratio that compares a company’s Enterprise Value (EV) to its Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA). The EV/EBITDA ratio is commonly used as a valuation metric to compare the relative value of different businesses.

About the Author

Alfred Lam, MBA, CFA

Alfred Lam, Senior Vice President, Co-Head of Multi-Asset, joined CI GAM in 2004. He brings over 23 years of industry experience to his portfolio design, asset allocation, portfolio construction, and risk management responsibilities, which include chairing the multi-asset investment management committee and sizing investment bets to drive added value and manage risk. Alfred holds the CFA designation and an MBA from York University Schulich School of Business. He is a recognized leader in multi-asset investing in Canada. During his tenure, his team has won multiple investment awards, including the Morningstar Best Fund of Funds, and saw assets growing four-fold.