One of my favorite presentations during my week at Omaha is the conversation between Chuck Akre and Chris Cherrone from Akre Capital at the Value Investor Conference.
Over several posts, I will be sharing my lessons learned from the conference and from Berkshire’s AGM.
To read the first post on lessons from Dr. Robert Cialdini and Joseph Shaposhnik, click here.
To read the second post on lessons from François Rochon of Giverny Capital, click here.
Here are the lessons they shared at the Value Investor Conference!
Chuck Akre
On their biggest mistake
Their biggest mistakes involve businesses that did well, but they sold them early. According to Chuck, holding on to businesses that go through ups and downs is part of the job, and a tough one at that.
There are some cases when the business is sold and the problems are later resolved. However, they have already paid taxes (on capital gains) and lost the benefits of compounding.
Compounding is a wonderful concept, but it’s hard to practice and not disrupt it.
If the fund sold positions, it was usually due to uncertainty with top management, especially if they couldn’t communicate with management to clear these uncertainties. There have been many mistakes made in the past. The good businesses often surprise them on the upside.
Three-legged stool
Chuck Akre then described his three-legged investment philosophy. Their investment criteria are as follows:
(1) extraordinary business,
(2) talented management and
(3) great reinvestment opportunities and histories.
They are ultimately trying to determine if the business can produce a high return. Their goal is to achieve a 20% or higher return on the owner’s capital, run by people they want as family members, and finally, how the business and management can reinvest all the free cash they generate in a way that will compound capital at a rate over 20%.
Chuck then referred to Robert Phelps’ books 100 to 1 by Thomas Phelps and 100 Bagger by Chris Mayer. In both books, they point out instances where a company goes down 90% in value, but even if you bought before the drawdown, you could still have made 100 times your money, and if you bought at the bottom, you could have made 1,000 times your money. That’s what they’re looking for.
The perfect portfolio for them would be one where they never made a trade since they’re happy with all the companies in it. In essence, these businesses compound capital rapidly.
Often, they spend a lot of time contemplating the disruption of their business model, and they may consider selling when a leg of the three-legged stool is “broken or injured”.
When to sell?
There are plenty of books that explain what stocks to buy, but few that explain how to sell them. Chuck acknowledges that there is no clear way to know, and so investors should consider:
– Is the business model still intact?
– Are the people behaving in ways that you think they ought to behave?
– Are they acting in the best interest of our shareholders?
– Is there an opportunity to reinvest capital?
– What’s their record on reinvestment in the past?
– How well have they done with their reinvestments?
That’s pretty much what they consider when making judgments. There’s a common saying within Akre Capital: Good judgment comes from experience and experience comes from bad judgment.
Even God would be fired
Chris went on to share a research study, that it’s inevitable to periodically underperform the market. Based on backtesting, the study created what a God portfolio would look like and created these portfolios knowing what had already happened.
Even though these portfolios maximized returns over time, they occasionally underperformed the market over time.
With the short termism of most investors, even God would have been fired, even if the returns were amazing in the longer term.
It is inevitable that we will experience periods of underperformance as investors. Almost no business is guaranteed to succeed year after year. It’s going to be hard not to sell.
Their favorite question for management
Meeting management is a key part of their due diligence, and Chuck often asks: How do you measure success?
Then let them talk about it, leaving it open-ended and broad.
This is done in order to better understand management’s temperament. They spend a lot of time learning about management. Thus, a change of management is challenging for them, since they must adapt to the new team from scratch.
Chuck also shared that meeting with management one-on-one is much more productive. As a result, they are much more open to sharing and he is able to read their body language and read all sorts of things about them.
When meeting with three to four managers (including the CEO), it’s important that the executives do not look at the CEO before replying. If they do so, it means they don’t have the freedom to speak their mind in the company.
Would they sell a great business that’s overvalued?
It’s not easy to zig and zag out of great businesses, like Mastercard and Visa. In addition, he has to pay taxes on the capital gains. Many times, you won’t be able to buy them back since they continue to perform well.
Mastercard and Visa generate returns on capital north of 40%, which is remarkable. In order to minimize the impact of regulators, they’re trying to cram as much expenses as possible into there. Yet, their returns on capital are phenomenal.
That’s all I have for you today!
I hope you have been enjoying the lessons from my trip to the Value Investor Conference…
And I look forward to sharing with you my key thoughts and take away from the greatest investing duo- Buffett and Munger soon!
Stay tuned.
Thomas
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Love this post. I have read both the 100 books and understand their methods and philosophy. I like the idea that Buffett once mentioned about having to imagine that you only get 20 buys and 20 sells in your entire life. And that this would force you to think long and hard about making each decision. Giving something an extraordinary amount of thought from every conceivable angle helps you to make a better decision.
Yeah the 20 punch card framework is a neat one. Because the stock market makes it easy to buy and sell, we often lower our hurdle. This forces us to really think hard about the robustness of the business.
Don’t you think businesses like Berkshire & Markel are better investments than mutual funds because they have a constant source of free cashflow ? During market recessions, they have the cash to buy cheap stocks. Whereas, mutual funds might have to actually sell stocks to timely honor redemptions. For instance, when was the last time Berkshire had less than $100 billion in cash or cash equivalents?
Love the post! Thank you for sharing!
My pleasure!
Great post, and summarization on Chuck Akre’s approach.