One thing I’ve been reflecting on lately is…
What kind of investments will most likely be successful in the long term for me?
Notice that this question is subtly different than both of the following questions that sound similar:
What investments or factors do I think will return the most over a long period?
What is most likely to give me huge returns over the following short period?
It’s plainly clear that I’m moving away from thinking in terms of optimal strategy that would require more decisions, rely on predicting short term market trends, being contrarian + right, or something else that I’d be likely to fail at. The difference is between trying to be the best, and trying to be good. Sometimes, it’s easy to forget that I don’t need to be the best. But I do still want/need to be good. We live in a competitive world with animalistic instincts to prove our worth and be the Alpha at seemingly all cost. This behavior is likely to ruin me. I’ll be more likely to make errors in judgment (over-optimizing and committing errors due to psychological biases) and need to be smarter and better than a lot of VERY smart people trying to do similar things. I don’t run a fund. I don’t need to attract investors with super high returns. I have no desire for fancy cars or a bigger house. So why risk being good for the sake of trying to be the best?
Never risk what you have and need for what we don’t have and don’t need.
— Warren Buffett
I’m trying to find a strategy that allows a narrower range of good (but not necessarily absolute best) outcomes, while eliminating some of my behavioral shortfalls that I’m likely to succumb to. I’m fortunate that I have a good income that I can rely on to continue to invest over the next couple of decades (hopefully). This is a structural advantage. I have no need to be concerned about short term market movements. I won’t go hungry if the stock market enters a long bear market. The flip-side to this is that I can focus on collecting nothing but the best long term businesses when they are at attractive prices.
People are trying to be smart—all I am trying to do is not to be idiotic, but it's harder than most people think.
— Charlie Munger
So, what kind of business would be ideal?
Simple to understand - The business model and the key drivers to the success, not the nitty gritty details.
Doesn’t require significant capital to grow - low capex needs. Not zero but not growing as fast as the profits grow (leverage).
Has a competitive advantage that is unlikely to be disrupted - a durable moat. Not a part of a new technology that is growing rapidly and attracting competition but is still growing and is likely to persist for a long time.
Adds value for the customer - This may not show up in financials but is key to long term success. Also makes it easier to have a good environment/culture for employees. In many cases should allow reasonable pricing power.
Able to reinvest at good rates of return for long periods - Length and consistency of reinvestment runway (organic or not) is more important than super high ROIIC over short periods that will then erode quickly.
Gushes cash flow consistently and is not permanently harmed by macro economic cycles. - Ideally, is anti-fragile and can rebound from downturns in a stronger position than prior. High margin, recurring revenue, mission critical to the customer, not a big purchase item and seen as the only option available.
This is a work in progress… but at first glance, it’s not too different than many other compounder/quality focused investors.
“Leg one is the quality of the business enterprise. Leg two is the quality and the integrity of the people who run the business. Leg three is what is their record and opportunity for reinvestment?”
— Chuck Akre’s “three legged stool”
The reality is that there are VERY few of these types of businesses that strictly meet these requirements. There’s no law that says capitalism is fair to all types of businesses. In fact, capitalism theoretically doesn’t work if it allows all businesses to handsomely reward its owners at the detriment to all other stakeholders.
I’m quite sure I own some that do not fit this criterion. That being said, I am not perfect and am likely to be wrong so still need to hold a number of businesses in my portfolio that are diversified in terms of how I get a return, business model and a balance between quality and valuation, etc. The reality is that most of the few “great” businesses are often too expensive. I am not suggesting merely buying all the “best” businesses at any price is a recipe for success. When buying, I will still considering the price I pay (I’m still not interested in being down for a decade based on stock performance despite what I’m writing here). So yes, I’m a bit of a hypocrite. That being said, where there are opportunities I will gladly sell some of my poorer businesses that I currently own for the gems.
Some of the names I currently own that I believe fit the bill include:
Constellation Software
Topicus
Couchetard
S&P Global, Moody’s
Danaher
Copart
Thermo-Fisher Scientific
Fastenal
Xpel
Autozone
Domino’s Pizza
I think these two small up and comers could develop into businesses that will fit the bill one day soon:
Wecommerce Holdings - individual businesses they buy are great, funding sources and dilution is the only concern I have as they grow.
Vitalhub - good recurring revenue models, relatively simple business, but profitability as they grow is a concern. Long term competitive advantage is unknown.
And for the sake of being self-critical, these are some I hold that I’m unsure or know don’t fit the bill:
Facebook (Meta) - Unsure. concerns over deteriorating business model
Lockheed Martin - Know it doesn’t. Capital intense to grow, perhaps not consistent high returns and questionable customer value
Altria - Unsure. potential terminal decline in customer base, regulation
British American Tobacco - Unsure. potential terminal decline in customer base, regulation
Vitreous Glass - Know doesn’t. Solid monopoly business with good cash flow at an attractive price and aligned management incentives. Not a lot of amazing long term reinvestment opportunities.
Dentalcorp - Unsure. Growth not profitable yet. Not a high margin or high organic growth business and operational risks with integrating acquisitions.
Patrick Industries - Know doesn’t. Exposed to cycles, capital intense, not recurring revenue, not sure much of a competitive advantage (cheap, growing and good management).
Some businesses that I don’t own yet and would potentially fit the bill:
Adobe
Visa
Mastercard
FICO
OTC Markets
MSCI
Microsoft
Google
Heico
Jack Henry
Roper Technology
American Tower
Some of the European/Nordic serial acquirers - Lifco, Vitec, etc.?
Of these, Adobe and Google are both starting to seem like reasonable price points (Adobe not yet a fat pitch but getting there). I don’t know enough to feel comfortable buying yet but they are on my list to try to understand. The interesting thing for these is that there’s no chance I will have any real edge in terms of understanding the fine details of their operations. The good news is that this strategy doesn’t hinge on this kind of knowledge. While I’d prefer to find smaller businesses that I could potentially identify prior to big funds buying, I’m not going to let that get in the way from owning some of the best businesses in the world if they are attractively priced.
What businesses am I missing on my list? Let me know where I’m wrong or missing something here!
Some inspirational reading related to this subject:
Akre Capital Management on the art of not selling
Yen Liow of Aravt on unfair fights
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