SPENCE Asset Management

Green Machines October 2009

High school football season is in full swing in Las Cruces. With three of the best teams in the state almost every year and ten state championship trophies earned between our three high schools since 1995 including the last four, we like to think we have pretty good winning machines in place here in the Mesilla Valley. In fact, 2009 marks the beginning of Mesilla Valley Christian School’s participation in football and MVCS has started winning games already.

One of our schools (Mayfield) was recently named one of the top hundred high school programs in the nation by one publication. We remember asking former Mayfield Head Coach Jim Bradley how he was able to win state championships time and again. Predictably Coach Bradley responded that it was not with a secret playbook or a magical practice regimen. Instead he talked about instilling the idea of “basics” until the program became a virtual machine.

We like to think that our research process has become somewhat of a machine. The basics of football can usually be reduced to basics related to blocking and tackling; the basics of investing aren’t much different.

We have thirteen tenets that guide our selection process for individual equities: four fundamental business aspects tenets, two management tenets, four financial tenets and three relative valuation tenets. Adhering to these tenets and constantly testing our holdings for these tenets are our investment equivalent of football’s blocking and tackling.

The research process machine we maintain each business day takes us through many different industries, many different countries and many different trends. Some of those trends, by definition of our process, are to be ignored. Fashion trends- usually brief and difficult to predict- we fully admit will never be our strength, and our process is highly unlikely to bring forth a trendy fashion-forward idea. On the other hand, some trends cannot be ignored; we think the trend toward going “green” is such a trend and we aren’t referring to the color of our highly fashionable Spence Asset Management shirts.

Oil is a finite resource and clean air and water are essential to quality of life. The need to find long range solutions to world oil dependency has been a reality for decades. The emergence of China as a major oil and coal consumer exacerbates the world oil supply situation and it also jeopardizes clean air and water for more than a billion global inhabitants. It is undeniable that with each new day there are more financial incentives for those striving to develop “greener” energy sources. Investing in this sort of innovation in some form or another is likely, eventually, to become a more profitable proposition.

However, because legislation on a national as well as a global level is perhaps the most important variable in green investing, predicting which cleaner energy technologies will most likely be the solutions in the future, is as difficult as determining the fate of an American health insurance company. Simply put, the political winds are blowing wildly and in many different directions. At this stage of the game, trying to definitively choose which alternative energy source will be the winner is similar to trying to choose which car manufacturer will be the clear winner when the automobile was first invented. Or more recently, the dawning of the internet brought hundreds of dot-coms to the universe of available investments; while knowing which would be the clear winners at that time was nearly impossible.

Our research machine will continue to stick to our basic tenets, the ones that have brought us success in the past. We are convinced if we are diligent that using these same timeless processes can bring us to companies that will take part successfully in the green revolution. Constantly screening for companies with relatively low capital spending, strong historical track records, durable competitive advantages and scalability will continue to help us uncover opportunities. However, when it comes to green technologies, the process doesn’t stop there. With so many options currently being developed such as solar, wind, geothermal, hydroelectric and nuclear power sources, and likely many more options not yet developed, additional criteria for evaluation is necessary. Is the technology cost competitive? Will companies require constant government subsidies to operate long-term? Is the energy source sustainable? Is the energy source reliable? Can it provide base-load capacity (which is what is always “on” in our homes and businesses)? Is the energy source widely available? Does the energy source have a low sensitivity to input price fluctuations?

Often our processes lead to us companies that provide services to other companies. Or put another way, we are often led to the “middlemen.” In general, we feel it will be some time before profitable middlemen emerge in the green space. As of right now, innovators, legislators, and the world, for that matter, are in a sense still of “seeing what sticks” as various green technologies are introduced and explored.

One of our primary investment heroes, Warren Buffett, has begun to make investments in companies in possession of advanced battery technologies. What we glean from his investments in this area thus far is that: we must not limit our search to American companies and we must not make too many political assumptions in an era when those sorts of winds shift constantly.

In summation, the trend of humankind searching for alternative energy solutions is one that is here to stay. And we intend to work hard to improve our research process in this area because essentially intelligent research direction is our “green machine.” Understanding the best technological processes and particularly those companies that are using them to go green ultimately has the great possibility of making our clients some green as well.

—Jim Spence, Registered Principal, Spence Asset Management

The information contained herein is for informational purposes only without regard to any particular user’s investment objectives, risk tolerances or financial situation and does not constitute investment advice, nor should it be considered a solicitation or offering to investors. To determine if investment in a Separately Managed Account with Spence Asset Management is an appropriate investment for you please call 1.800.230.1840.

Investment Advisory Services are offered through Spence Asset Management, a federally registered Investment Advisor. Investment Advisory Services offered through IAR’s of Spence Asset Management, a Registered Investment Advisor to all residents of the United States.

The views expressed here are those of Spence Asset Management and are subject to change with market conditions. The information contained in this newsletter is derived from sources believed to be accurate. You should discuss any legal, tax, or financial matters with the appropriate professional. Neither the information presented nor any opinion expressed constitutes investment advice or a solicitation for the purchase or sale of any security. Market forecasts cannot be guaranteed. Past performance does not guarantee future results.