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Norman Rothery is the value investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.

Many people go to New York to try to make a fortune on Wall Street. But value investors often thrive in smaller cities, where they're insulated from the groupthink that can infect those in the big city.

Warren Buffett is a famous example. He became one of the wealthiest people in the world from his home base in Omaha, Neb.

Problem is, Mr. Buffett's fortune has grown so big that he isn't able to invest a meaningful amount of his portfolio in moderately sized stocks because they simply can't absorb the amount of money he has to deploy. It's one reason he expects to outperform the market only slightly these days. He once said he could generate 50-per-cent annual returns if he ran a smaller portfolio.

It's a claim that brings me to Keith Smith, an investor who achieved nearly those levels of returns from his home in Rochester, N.Y. Mr. Smith figures his stock portfolio grew by an average of 49 per cent annually over the past five years and by 38 per cent a year over the past decade. It's an extraordinary record, but I've seen the brokerage statements (from two accounts) to back it up.

Mr. Smith didn't expect to achieve such strong returns when he started out, but I think a few factors contributed to his success.

First off, he knows how to size up a balance sheet because he works full time as a managing director at Empire Valuation Consultants, which specializes in business and financial valuation. He has the training and expertise needed to estimate how much a company is worth.

He also focuses on only a few stocks, which means any big winners can make a significant difference to his returns. (On the other hand, losers can really hurt.) These days, his top five stocks represent more than half of his portfolio and more than 80 per cent of his holdings are in his top 10 stocks.

He further tilts the odds in his favour by leaning toward smaller companies. He particularly likes stocks with market capitalizations between $100-million (U.S.) and $500-million. But he's willing to go outside that range when an opportunity presents itself.

Finally, he's not afraid to buy long-term options on his favourite stocks, under the right circumstances. For instance, he made a great deal of money by investing in Fairfax Financial Holdings Ltd. and its related options.

One of the main tools Mr. Smith uses to size up a stock is its EV/EBITDA ratio. EV, or enterprise value, reflects the market value of a business, including both its equity and debt, while adjusting for cash. It's an estimate of what a private buyer might have to pay for a firm while settling its debts at the same time. EBITDA, or earnings before interest, taxes, depreciation and amortization, is a rough measure of a firm's operational profitability that's independent of its capital structure.

You can think of EV/EBITDA as being roughly analogous to the more familiar price-to-earnings ratio. In both cases value investors like Mr. Smith prefer stocks with low ratios.

As a bargain hunter, he's often drawn to stocks that other people are giving up on. In an interesting twist, he keeps an eye out for stocks that other value investors are dumping.

These days Mr. Smith likes General Communication Inc. (GNCMA). It's an integrated telecommunication company based in Alaska. As you might imagine, there aren't many competitors in that northern state, which – as we know only too well in Canada – can result in something of a cozy oligopoly.

The company has grown its EBITDA by 65 per cent since early 2007, according to S&P Capital IQ, and Mr. Smith reckons it will continue to grow next year. He figures its stock is trading at an adjusted EV/EBITDA ratio of roughly 5.8, which is low compared with similar businesses.

If he's right, General Communication could represent another step on his path to building a long-term record of which Mr. Buffett would be proud.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 22/04/24 1:12pm EDT.

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Fairfax Financial Holdings Ltd

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