We believe the key to successful investing is to compound capital at high rates of return for long periods of time. Businesses with this capability are extremely rare because competition and innovation drive down real pricing to the cost of capital, leaving little excess returns for investors. Therefore, we pay particular attention to identifying businesses with enduring pricing power, which we view as the single most important characteristic on which to focus.
Fortunately, because many investors want to “get rich quickly” and are overconfident about their abilities, we believe they tend to overvalue the stocks of businesses that possess speculative characteristics and to undervalue the stocks of businesses with high and sustainable returns. Thus, we utilize a proprietary framework to identify these rare and, we believe, often perpetually undervalued businesses, which tend to possess the following characteristics:
- Deeply entrenched in the economic system
- Globally-networked brand or service
- Geographically-diverse revenue streams
- High market share
ENDURING PRICING POWER
- Ability to charge a large premium for products or services that are virtually identical to those of their competitors and maintain or grow that premium for decades while maintaining volume growth
- Capability to overcome deflationary pricing that comes as a result of competition and innovation
- Prefer global network economics where the value scales exponentially as the network grows
- More immune to disruption due to slow changing industry and/or difficult to replicate competitive advantages
LONG-TERM VOLUME GROWTH OPPORTUNITIES
- Long runway of reinvestment at high rates of return
- Benefits from the growth in the global middle and upper classes
- Benefits from urbanization
- Pricing power combined with volume growth means they will be indexed to GDP growth or better
OWNERSHIP-MINDED MANAGEMENT TEAM
- High family, founder, or other insider ownership
- History of treating minority owners fairly
- History of wise capital allocation decisions
- Proven track record of ignoring short-term Wall Street pressures
- Focus on aligning employee incentives with owners (principal-agent problem)
- Can survive or even thrive in a deep recession
- Possess financial flexibility to fend off new and existing competitors
- Prefer businesses with high returns on tangible assets (thus not requiring leverage)
After winnowing the investment universe down to these dominant global champions, we seek attractive valuations as determined by our estimate of risk-adjusted forward rates of returns. Oftentimes the best investment opportunities are found when investors are over-discounting temporary macroeconomic or operational issues. Then, we construct a portfolio of these sustainably high returning businesses that is diversified across multiple dimensions including macroeconomic sensitivity, product category, and geography. We intend to benefit from the superior economics of these businesses by owning them for years to come, believing they may act as toll-takers on the rise of global wealth.
Once we have selected the stocks that will make up the portfolio, we may strive to utilize our option enhancement strategy.
This approach has served us well over the years, and we believe it will continue to do so in the future.
As such, we will be invested right alongside you. To read up more on our global champions, click here.