Learnings from Chuck Akre’s Value Investing Conference Talk

Introduction

Few years into investing, I realised one important truth that altered my entire investing framework. I believe, out of the entire listed company, we should focus on the top 20% in terms of business quality. In the entire S&P 500 index, there are a handful of stocks which contributed to the majority of the gains. Luke Kawa from Bloomberg posted this article, “These 10 Stocks Account for All of the S&P 500’s First-Half Gains”. They are Amazon.com, Microsoft Corp, Apple, Netflix, Facebook, Alphabet, Mastercard, Visa, Adobe and Nvidia. This is aligned with the 20/80 Pareto principles where 20% of the companies generate 80% of the results. Let’s focus on the 20%.

On my Twitter feed, I saw this article entitled “Chuck Akre Value Investing Conference Talk: ‘An Investor’s Odyssey: The Search for Outstanding Investments’. In this article, I am going to summarise a bit plus share my own views on his conference talk.

My job is to find for such companies in the “small to middle” capitalisation range. They are not too small, and not too big. This creates ample opportunity for growth because size is the enemy of performance.

I choose to invest selectively with a strict requirement by allocating my capital to high-growth companies only. My key motivation as an investor is not to just beat inflation, but to compound his wealth enormously.

Take this idea, if you double a dollar daily for 21 days, guess what would be the results?

It’s over $1 million. Most of us do not start with $1, we start with $10,000 or more. Just imagine how much money we could compound? We have our life time to grow our wealth. Given the right framework and approach, we tend to underestimate how much money we can compound.

The Search for High ROEs Business

[1] Business Model 

It begins with… a business model. Many investors fail to appreciate the business model of a company. Ask yourself, whether this business model makes sense? Can it grow healthily among the competition? Are its products/services differentiated? Is it a patent, is it a regulatory item, is it a proprietary, scale, or low-cost business?

A business model, after a careful construction, decides whether it is going to earn 15% ROE or above 20% ROE. A company selling proprietary product will always earn more than a commodity product. It’s just like Starbucks versus your normal coffee shop. Starbucks would earn more on the basis of perceived branding which translates to pricing power. Selling coffee at $8 is more profitable.

After ascertaining these facts, how long can this ROE likely to last? It involves understanding how big is the addressable market. Best World International was able to grow its market cap multiple-fold because it chose to expand overseas. Had it stayed in Singapore, their profits would be stagnant and ROE would start to decline.

All companies are not made equal. Think about a fruit store or supermarkets, it has to compete with thousands of similar businesses. Why would we want to invest in such companies? It’d make sense to invest in toll-gate companies such as Google, Microsoft or Facebook. When we want to use office, the default choice is Microsoft office. When we want to search, the default choice is Google. For our social needs, we go to Instagram and Facebook. These are scalable, fast-growing and has strong market leadership. For a supermarket to expand, it has to scout for a suitable location. If the location is popular, the rents are not cheap and the supermarket might not be able to mark up its prices. For Facebook, it monetises well. ROE is a byproduct of high profitability as well, so that’s one source all of us can search better. 

[2] Management’s Integrity

“My life experience is: once someone puts his hand in your pocket, he will do so again.”

You would not let someone incompetent to run the business. You want someone that you could trust, someone who takes care of the business like it is his life’s work. When a management abuses his position by taking up unnecessary debt, overpaying himself and performs related party transactions, you may want to reconsider the company. Similarly, I favour management with high shares ownership of their company.

[3] The Long Runway and Valuation

You want to buy a business that grows over time. Growth is a necessary component for a business to add value. A business that you can envision to grow for the next 5 – 10 years. Finally, it is not about overpaying for the company.

Pulling out a past interview I did with ZuuOnline, I concluded this formula: Management x ROE (Return On Equity) x Industry. You need a strong management to lead the business, to earn high ROEs and extend the length of ROEs by operating in a big market.

“When we are analysing small cap companies, apart from the usual fundamentals analysis, the management is key to determine the long-term success of the firm. A founder-led business tends to be more visionary. They are hands-on, grounded and highly involved in the operations of the business. It also helps when their interests are aligned due to their significant shareholdings in the company. They are frugal too,” said Seetoh, raising the example of Walton of Walmart, Tony Tan Caktiong of Jollibee Foods, late Steve Jobs of Apple and Ma Huateng of Tencent.

“The most important financial metric for a small company is Return on Equity. This metric measures how much profit the company is able to generate per dollar of equity. Finally, we would need to see a company with a significant runway to grow in the industry. A company may not necessarily need to operate in a fast-growing industry in order to achieve that. A company can grow very well when it offers better products or services even in a slow growing industry.”

Conclusion

I guess, end of the day, we need to have a framework to sieve out the best businesses out there. This is what I devote my time and energy. Out of 20 stocks, select 1 or 2 outstanding businesses and wait patiently for the right valuation. It is far more productive than purchasing any companies you see.

Stocks mentioned in Chuck Akre’s letter: American Tower, Ross Stores, TJ Maxx, Dollar Tree, Lamar, Berkshire Hathaway, Microsoft, International Speedway, Visa, Mastercard, Penn National Gaming,