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Ask Wedgewood Partners' David Rolfe Your Investing Question for GuruFocus Reader Q&A

Holly LaFon

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David Rolfe, chief investment officer of the $1.3 billion investment management firm Wedgewood Partners Inc., is joining GuruFocus for a reader Q&A. Rolfe has also been a Premium Member of GuruFocus since 2007. Readers are welcome to submit their questions – regarding Wedgewood’s process, their personal investing or the economy at large – by entering them in the comments box below.

Over the past 15 years – Wedgewood’s preferred measurement range – it has beat the S&P 500 316.1% to 124.3%, cumulatively. A patient, focused and disciplined value approach has driven the superior performance.

As Wedgewood Partners’ managers explain in their third-quarter letter, they think so like business owners that they virtually ignore short-term market price fluctuations of their holdings and instead concentrate on “the long-term appreciation of equity, relative to the underlying growth of the business.” This inevitably results in an increase in equity value that reduces the risk of permanent loss of capital. In short, they “believe the philosophy of the business owner repeatedly trumps the whimsy of the easily influenced speculator.”

To find the right companies, they look for five fundamental factors in each prospect: 1) sustainably superior competitive advantage 2) compelling valuation 3) double-digit growth 4) exceptional financial strength and 5) limited overlap with existing portfolio holdings.

They are so selective about what they include in the portfolio that they don’t mind waiting, sometimes years, for companies they find attractive to finally exhibit all of these criteria before they invest.

Their overall investing strategy is summarized below:

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Over the past 12 months, only two new stocks merited inclusion in the Wedgewood portfolio: Charles Schwab (SCHW) and Coach (COH).

Their largest holdings as of the end of the second quarter are Apple (AAPL), Berkshire Hathaway (BRK.A)(BRK.B), Google (GOOG), Express Scripts (ESRX) and Qualcomm (QCOM).

To learn more about David and Wedgewood Partners, read their recently released third quarter shareholder letter and outlook or visit their portfolio.

Don’t forget to ask David your question in the comments section below. Answers will appear shortly.

Sign up for a GuruFocus Premium Membership here.

Rating: 3.3/5 (14 votes)

Comments

cirros
Cirros premium member - 2 years ago
Hi David

Do you use any macro global views in your sector allocation mix and if so where do you see the global economy going in the next 3 to 5 years and what do you think is the best way to postion a portfolio to benefit from it?

Thanks
drolfe
Drolfe premium member - 2 years ago
Hi Cirros,

Thanks for your question.

We rarely use macro global views as a significant factor in our stock selection process. Admittedly, we do not have an edge in such analysis. That said, by "investment philosophic" design, given that we only invest in twenty companies we largely eliminate such macro considerations in our investment process. By focusing on what we consider to be best-in-breed businesses we are in sense abdicating navigating the complex macro scene to the managements of the companies we invest in. They no doubt know their end markets better than we can ever hope to. Now, that said, all of our invested companies are either a beneficiary or driver of a key "macro-industry" factors and themes. A few global examples... Apple: global mobile internet. Cummins: global fuel standards. Visa: global payment processing. Schlumberger and National Oilwell: global oil drilling services and well technology. Varian Medical: global cancer radiotherapy.
valueradar
Valueradar - 2 years ago
A few questions:

1. Where do you generate your ideas?

2. You have Apple as your largest holding. How confident are you about the durable competitive advantage of Apple? are you not worried that what happened to Research-In-Month will happen to Apple?

3. Berkshire is certainly undervalued. You mentioned in your recent Barron's interview that Berkshire is worth $180K a share. How did you come up with the number?

4. Why do you like Google? How much do you think it worth?

drolfe
Drolfe premium member - 2 years ago
Dear Valueradar,

Thx for your questions.

1. New ideas come from a myriad of sources...independent and street research, 13F filings of managers we respect, financial publications, etc. Our new idea generation process is not designed to generate a systematic flow of constant new ideas. Actionable ideas - those that include both a terrific company AND a terrific valuation are, by definition, rare -- except in extreme market environments like late 2008-early 2009. Indeed, over the past 20 years we have owned little more than 90 stocks. That's why are focused investors. We believe we can repeatedly invest 20 compelling ideas in nearly every market environment; if we were trying to the same with a 40-60-80 stock portfolio we believe that our task would be geometrically more difficult. The stock market is quite efficient...but not perfectly efficient. Stay focused!

2. We are always worried! Investing is a worrying thing!! Apple has a very rare competitive position. They have built a terrific moat. In the global mobile internet world, Apple has built a vertically-integrated business model based on both hardware and software. This moat has been significantly enhanced with their global Apple store footprint. Their moat is their best-in-class ecosystem. We have not seen the likes of such a vertically-intergrated ecosystem, profit-generating business since the heyday of John D. Rockefeller's Standard Oil Trust.

3. We consider the investments per share plus a conservative valuation of the non-insurance subsidiaries (Buffett's Two-Column Intrinsic Value Method). We check this valuation against a sum-of-the-parts valuation which includes comparing BNSF to Union Pacific and GEICO to Progressive, etc. BRK shares will no doubt suffer from a "Buffett Discount" and the "Conglomerate Discount."

4. We believe that Google is worth considerably more than current prices. We like Google's dominant competitive position in paid search, as well as their Android mobile strategy. The trials and tribulations of mobile search and their Motorola purchases have, in our view, been more than discounted in the current share price.
drolfe
Drolfe premium member - 2 years ago
Hi Lbrian.flores,

Thanks for your questions too.

1. We do very little regular screening. Apropos my earlier related answer, if we did screen say, every week and/or month for the high hurdle rates of profitability we require, then the resultant screen would likely not change much. That said, gurufocus has terrific screeners.

2. Our fave is free-cash flow as a % of enterprise value, but all of the metrics you mentioned are all part of the valuation mosiac we employ at Wedgewood.

3. Not much. Low turnover is a key tenet of our investment philosophy. Our turnover averages 25-30% per year. The fiscal cliff is very real and very dangerous. Given the fact that U.S. GDP growth is barely above historical stall speed, the risk of recession in 2013 is very real too.

4. Sell your losers and let your winners run! Losers take you out of the game (Buffett). Mulityear bagger-winners move the needle (Lynch). Tend your mistakes first...the winners will take care of themselves.
strei
Strei - 2 years ago
Hi David,

Has your opinion of Express Scripts changed considering their latest earnings report and their reservations about new year?

Thanks
gurufocus
Gurufocus premium member - 2 years ago
David,

could you please comment on Coach? It seems that you bought into Coach?
Bartvp
Bartvp - 2 years ago
Dear Mr Rolfe,

First and foremost thanks for offering to take our questions.

I believe investing is more about being a business analyst than being a financial analyst. Your "invest as owners process" picture seems to share that believe; the hardest part in the process probably is evaluating whether the business fits your "quest for future excellence". So what would you advise to a finance student hoping to once work for such a focused value fund as yours; get into finance and get more expertise in financial markets, or get into strategic management consulting to learn more about how businesses operate and learn about their strategies?

Thanks for your time.
drolfe
Drolfe premium member - 2 years ago
Hi Strel,

Thanks for your question.

We have certainly recognize that the profitability structure on ESRX has changed materially over the past 5 years. Where once ESRX generated an incredible ROIC of +30%, they now generate a significantly lower amount. The culprit is the huge capital outlay for the NextRx and Medco acquisitions. ESRX has matured and this once fantastic business is simply not as great as it once was. The market will always worry about competitive pricing issues and punk enrollment growth. The current economic environment is no doubt challenging on this score. The stock is quickly discounting such worries, in our view.
drolfe
Drolfe premium member - 2 years ago
Dear Gurufocus,

Thank you too for your question.

This is what we wrote on Coach in our most recent mutual fund commentary:

In July 2012, we initiated positions in Coach as we are convinced that the Company managed to solidify its competitive edge, evidenced by the fact that they have maintained a return on invested capital far superior to its competitive peer group of publicly traded suppliers, rivals & substitutes. The Company’s competitive edge has been strengthened over the past decade as Coach has maintained rigorous contact with consumers, interviewing tens of thousands per year. Of course, this helps with short-term fashion trends, but more importantly and more sustainably, we think this helped Coach understand that luxury consumers were less interested in exclusivity related to physical shortages of a product and more interested in exclusivity related to “virtual rarity” – or the abstract feelings of privilege and of exclusivity. Elements like country of origin and even the quality of materials have been deemphasized in favor of accessibility.[url=#_ftn1][1][/url] As a result, Coach now manufactures about 75% of its products in China, which reduces cost of goods relative to European and American made luxury products. Further, Coach sells 90% of its products through direct channels which protects gross margins from the pricing pressures of wholesalers. Prior to the Coach acquisition, the Fund lacked a holding that was focused on retail apparel and accessories, so we think this position adds diversity.

Coach exhibited most of our process factors as early as 2008, but at any one time, our list of potential holdings that exhibit four out of five factors, usually hovers in a range of about 15 to 25 names, with the majority of those names exhibiting an unattractive valuation. But valuation is a very dynamic element and it can change especially rapidly in volatile markets. On the other hand, during market rallies or other periods of market placidity, the valuations of our potential ideas generally maintain their unattractiveness.




[url=#_ftnref1][1][/url] Jean-Noël Kapferer, Abundant rarity: The key to luxury growth, Business Horizons, Volume 55, Issue 5, September–October 2012, Pages 453-462, ISSN 0007-6813, 10.1016/j.bushor.2012.04.002.

Carol Nadon
Carol Nadon premium member - 2 years ago
Hi Mr Rolfe,

I'm looking for Canadian value stocks to hedge against a potential sinking US dollar (Seth Klarman, Marc Faber, Jim Rogers).

1. Are you worry about a possible collapse of the US $ ?

2. Do you have any canadian stocks in your portfolio ?

Thank you for your time.
drolfe
Drolfe premium member - 2 years ago
Dear Bartvp,

Thank you...

You are on your way...get into the game and get hired by a money management firm...preferably a focused one...now, if you want to excel then you need to consider a very narrow lifestyle path...take a career-page from elite athletes, elite musicians, and elite investors...you must devote your life to investing..."practice" (read/study/think) nearly every waking hour you have...the sacrifices you must make outside of your investment/business will be extreme...if you want to be an elite investor, you probably won't have the time be be your kids soccer coach, etc...read and study the great investors...study their current and former portfolios...get your CFA...build an investment library of books and classic writings (here are a few http://wedgewoodpartners.com/investor-resources/selected-reading)...anything investment related must "happily" consume your life...notice that I didn't say "work"...if any of this sounds like "work" then it will be a struggle...if you truly have a passion to excel at investing then it should never feel like work...(Buffett would take his reading to dinner parties and excuse himself after dinner to get to his beloved reading)...start by reading/studying/memorizing Buffett's Partnership and Shareholder Letters.

Good luck,

Dave
drolfe
Drolfe premium member - 2 years ago
Dear Carol,

Thanks for your questions...

I'm afraid that I do not have any edge on the macro to give you a cogent answer...and we do not own any Canadian stocks.

Sincerely,

Dave

ry.zamora
Ry.zamora - 2 years ago
Hey David,

Thanks for being available to answer Gurufocus questions. Having the opportunity to speak with an established manager is a godsend.

Please forgive me if my questions aren't about the nuances in investing, your current positions, or the ongoing market environment. They concern mainly the non-investment operations of a fund. I have two queries for you:

(1) At a time when so many opportunities are popping up everywhere (I have seven businesses in my analysis backlog for the US market, and about three for the Philippine market), it is imperative to utilize other people as leverage to speed up analytical clout simply because one or two people cannot analyze everything at once for informed decision-making.

Now, I'm coming from the perspective of DATA ENTRY. All annual reports are, to an extent, opaque and unfriendly to analyst-investors. So dependent are we on the companies' largesse, if we are lucky enough, the companies will report specific information... yet it's incredibly scattered throughout the 10K, the annual report, and other filings, and it's not always found in a table that the 10K Wizard can export for you.

My partner had a couple people under us to look up information for two Shoe Carnival's competitors. Specific information that requires a deep reading. These people couldn't find the info we wanted -- and they're masters students of well-known schools down here in Texas (e.g. SMU) -- yet when I had to turn away from my current project to help my buddy out, we were finished in 30 minutes.

My question to you is, if you're the one who built your "model" -- using the word in reference to Charlie Munger's usage, NOT the QUANTS -- how do you go about teaching the people under you to properly do the data entry?

(2) Second question. Client retention. You may have followed Berkowitz's turmoil last year, and you may have been forwarded some links about increasing investor apathy towards their personal finances (and reckless risk-taking in the search for yield).

So how do you find clients who have the same mindset as you do? Where would you meet them? How rare are institutional investors who DON'T operate on short-termism?

I look forward to your reply.

Yours,

Ry Zamora

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