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Does it make sense to invest in “great” capital allocators
Posted by: whopper investments (IP Logged)
Date: October 14, 2013 07:40AM

A few weeks ago, this article on a billionaire who invested in Berkshire’s stock in the early 80s, has held for years, and gotten tremendously wealthy was tweeted and retweeted by just about every value investor I follow. The bottom line most investors took from the article was, “Find a great capital allocator. Invest in the stock at (almost) any price. Never sell. Profit.” For example, you had this line from basehitinvesting,

Quote:
But compounders are different… in the case of the Berkshires, the Teledynes, the Markels, the Fairfaxes, they are almost perpetually undervalued.

All of this got me thinking about my own compounder “problem”. Let me explain.

At the beginning of the year, I invested in FRMO. At the time, it was trading around $2, but I thought it was worth substantially more given the optionality value of many of their revenue streams. In addition, I liked that the management team owned a substantial economic stake in the company and are widely regarded as some of the deepest and most creative thinkers when it comes to finance.

Fast forward to today. The stock’s trading for $6.50-ish. I’m kicking myself for selling a piece of my position at $2.50. But I see absolutely no way the current stock price is justified…. unless you factor in continued above average investment performance by the company. In other words, you need to envision a Berkshire Hathaway type future for the company to make sense at today’s prices.

But that doesn’t matter, right? The takeaway from the Berkshire story is that when you find one of these compounders you never let go!

I’m not so sure. These types of compounders are super rare. And I wonder if they can be reliably identified with any frequency.

Maybe that’s not the right term. I think you can identify them pretty relatively reliably if you look hard enough for management teams doing the “right” things. I just worry that for every one you properly identify, you will have multiple false positives.

Consider this: a few years ago, people were shouting off the rooftops that Sears (SHLD) was the next Berkshire. It had all the characteristics. Tremendous capital allocation. Hedge fund manager consider a genius with an impeccable track record. Dying business that threw off cash that would be used for reinvestment into more profitable lines.

Not too long ago, every microcap investor was talking about Biglari Holdings (BH) as a mini Berkshire. While results there have been solid, the stock has basically matched the market recently, and given the incentive structure I don’t think Berkshire like returns are in anyone but top management’s future. Not that shareholder won’t do well, but most of the excess returns will not go to them.

A big selling piece for the hedge fund backed insurance companies (Greenlight Re, Third Point Re) was the access to top investors managing money. While it’s still early in those processes, the results haven’t been promising.

To go back to the quote at the beginning of the article, when is the market no longer undervaluing a business with a potential great investor? Is it when they’re pricing in 8% per year long term performance from their investments? 12%? 15%? 20%? And how do you counter anticipated compounding against the potential for a false positive?

I have no good answers for you. Only questions. But the more I think about it, the more interesting of a question I think it is.

I’m holding my FRMO shares for now. Mainly because I don’t want to take the tax hit…. but also maybe because, in the back of my mind, I dream up a scenario 30 years from now where I’m bragging to people about having invested in the next Berkshire Hathaway when the stock was basically a penny stock.

Disclosure: Long FRMO

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Stocks Discussed: FRMO, BRK.A, BRK.B, SHLD, BH,
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