A: Let me begin with The First American Corporation (FAF), a title insurance company. Title insurance is a terrific business, albeit cyclical. Pricing is determined by state insurance regulators who also control licensing requirements, further protecting First American’s franchise. The title insurance segment, which makes up about half of the company’s profits, is declining in importance as its higher-growth, highermargin real estate information services ramp up.

First American has leveraged its competitive moat—the most complete collection of mortgage and property data available to lenders or brokers—and transformed itself into a real estate information services provider.

It is amazing to us that a lot of investors categorize title insurers as value stocks. First American has compounded revenues, earnings, free cash flow, and book value at rates in the high teens over the last decade, while expanding returns on capital to as high as 25%. This is a huge amount of underappreciated shareholder value growth.

Looking forward, we think the company is just beginning to leverage this database of information, which could prove to be very lucrative over the next 10 to 20 years. There is very little competition and few that could replicate the business model First American has built. Despite this terrific growth potential, the company only trades at 12 times free cash flow. Management has renewed its focus on unlocking the inherent value that the stock price doesn’t reflect. They have only begun to optimize the company’s operating structure.

Q: Can you give us another example?

A: Cooper Companies is a contact lens manufacturer that was a dominant player in the specialty contact lens market. In late-2005, the market shifted to a new, more comfortable material called silicone hydrogel. Cooper completely missed this product cycle as it was still perfecting the manufacturing process for the new lens. As a result, the stock went from low $70s all the way down to low $40’s because the company lost share and chronically missed and lowered estimates.

As we did our research and understood the hurdles facing Cooper, we believed it was a question of when, not if, it would launch its own silicon hydrogel lens. Whether it took six months or two years, the revenue growth, margin expansion and free cash flow growth justified a much higher stock price. Even if it required waiting two or three years to realize our estimate of fair value, we would generate an excellent return on our investment, while at the same time exposing ourselves to very little downside.

We took further comfort in the fact that Cooper is really the last independent contact lens manufacturer. There are a handful of companies that would love to enter this great growth business, so Cooper is a valuable asset. In a worstcase scenario, we felt Cooper would be acquired at prices well above those we were investing at.

As it stands today, the story still hasn’t played out yet. We think Cooper is only months away from launching its new lens, which should drive accelerating revenue and cash flow into 2008 and beyond. Once the manufacturing risks are behind Cooper, we also think potential acquirers will take a closer look at the company.

Q: How do go about constructing the portfolio?

A: We keep the portfolio relatively concentrated with 30 to 50 companies. We build the portfolio using a fundamental bottom-up process, filtering ideas oneby- one through the lens I discussed earlier. Any sector allocations or market timing decisions are purely residual effects of this process. Turnover has generally been below 30% and the top 10 positions normally make up about 30% of the portfolio.

Q: Do you measure yourself against any particular benchmark?

A: We are benchmarked against the Russell 1000 Growth Index. Our portfolio characteristics, like expected earnings growth, stack up favorably next to the index, though our strategy typically has had much less volatility despite better returns than the benchmark.

Q: What is your sell discipline and how do you monitor and mitigate risk?

A: On an individual stock basis, we think than the best way to control risk is to pay the right price in the first place. When you buy stocks at a discount, even if you’re wrong, capital loss will be minimized. Preservation of capital is very important to us. Avoiding losses is crucial.

Stocks are typically sold or trimmed when they approach our estimate of fair value, when the original thesis is altered, upon seeing a change in the fundamentals, or to make room for better ideas in the portfolio.

Stocks are reviewed on the basis of any price weakness, defined as a drop of 10% from cost or 20% from a recent high. Such activity may be an indication of important fundamental information making its way into the marketplace. More often than not, price weakness is often an opportunity to add to a longterm position.