By Tom Bradley

While plowing through my research pile, I had the pleasure of reading the year-end report of the U.S.-based Longleaf Partners Funds. I’ve followed Longleaf, which is an extension of Southeastern Asset Management, for more than a decade and long admired them. They have a good record managing U.S. and international equities, and have something I always look for - a defined investment philosophy and a set of business practices that are closely aligned with their clients’ best interests.

Here are a few morsels from the report.

They were a more active trader than usual in 2010 due to the extreme volatility in the stock market. They are unapologetic about it.

Volatility is a friend of long-term investors who know the value of the underlying cash flows and assets of a business.

The letter talks about high quality stocks. It makes the point that quality is too often equated to dividend yield, to the exclusion of other important factors.

“Cheap” is not enough to protect capital and earn adequate returns. Broadly used quality categories and metrics, however, do not adequately capture the strengths of many businesses.

In their search for quality, Longleaf goes beyond yield. They look for distinct and sustainable competitive advantage, high return on capital, a sound balance sheet and management that has demonstrated operating skill, capital allocation prowess and is properly aligned with shareholders through ownership-based incentives.

They strongly disagree with those who equate stock price volatility with low quality and high risk.

… in 2010, our best performers were some of the highest quality companies we own. None were among the most heavily levered (by any metric). The high returns generated involved little or no risk. (We define risk as the chance of permanent capital loss) Price movements have no bearing on capital loss unless one is forced to sell at a low point. Long-term investors who know the value of their businesses and intelligently take advantage of price volatility increase their return and lower their risk of loss.

In concluding, Longleaf points out that their clients are one of their competitive advantages.

Our clients’ stability and long-term investment time horizon have allowed us to be patient and successfully execute our disciplines.