“I'm lucky I didn't visit Iscar's Israeli plant before Berkshire purchased that business. I would have paid a lot more for Iscar if I had!!!”Warren Buffett (Trades, Portfolio). Chairman. Berkshire Hathaway. 2006.
Buffett made that remark after Berkshire had purchased 80% of Iscar in 2006 for $4 billion! Iscar produces unique, small, consumable, tungsten carbide cutting machine tools. Iscar's tools allow its customers' expensive, large machine tools to earn more money. Iscar's executives, whom Buffett judged to be extraordinarily talented and unquestionably ethical, visited Buffett in Omaha before the acquisition was completed. Buffett did not visit Iscar's Israeli facility until three months after its acquisition by Berkshire! Eitan Wertheimer was Iscar's CEO. His family was the principal owner of that generational family business. Soon after Berkshire acquired Iscar, Eitan visited me in New York. When Buffett ultimately did tour Iscar's Israeli factory, Eitan described to me Warren's surprised reaction. “How can a factory that manufactures tools that use greasy lubricants be as spotless as a factory that manufactures drugs?!!!” Warren then remarked he was lucky to have not visited previously since he would have paid a much higher price had he done so.
Although Buffett and Baron both invest for the long term in exceptional people who operate unique, competitively advantaged businesses, we visit before we invest. And we keep visiting them...and their competitors...and consultants after we invest. Charlie Munger, Buffett's late business partner who recently passed away at age 99, attributed his and Warren's success to identifying and investing in “businesses that have unfair advantages.” We, too, look for unfair advantages…and find they often becomeglaringly obvious during our research visits.
On Sunday afternoon, April 7, we visited Vail Resorts, Inc. (MTN, Financial) in Vail, Colorado; Space Exploration Technologies Corp. (SpaceX) in Los Angeles the following Monday morning and Tesla, Inc. (TSLA, Financial) in Palo Alto that Monday afternoon. We returned to New York City that evening. Whew. So, what did we learn? Plenty.
We first met Bill Rock, Vail Resorts' data driven, Chief of Mountain Operations on Sunday. We were interested in how data and AI, what I teasingly call alien intelligence, could enhance Vail's operations. Vail had struggled with heavy arrival traffic on weekends. Using data, Vail now dynamically charges for parking if fewer than three people arrive in one vehicle. It also instituted parking reservations. The impact? 60% of skiers arrive by carpool or shuttle! Further, skiers don't like to wait in lift lines. Vail now uses data to load and operate lifts more efficiently. This has reduced uphill time for each skier by more than 10 minutes…which has eliminated the need for four chair lifts! Chair lifts cost on average $10 to $14 million each. Mobile tickets enabled by Vail's scalable resort network also help in this regard. Finally, a super cool subscription revenue generating idea…Vail Epic Gear subscription memberships. Epic Gear equipment supply chains enabled by AI can potentially contribute several hundred million dollars annually to high-margin revenue.
On Monday morning in L.A., one of our analysts and I met a recently hired 23-year-old SpaceX engineer. Her new job was to work on the SpaceX Star Shield satellite network that protects our homeland. She had nine interviews since December before she was hired! The last was with a retired four-star general, the former commander of NORAD and Elon's special advisor on space. “What did he ask you?” was my question to her. “If you were going to design a satellite network, how would you do it? What coding would you use? Why?” “Seriously?” was my response. “You're just 23!!!” My colleague's reaction to that meeting? “She was one of the most impressive young individuals I have ever met.” The next two hours we spent at SpaceX were with financial executives. That discussion centered on how SpaceX is able to accomplish so much so fast and at so much lower cost than its competitors. It seemed to us that it's all about SpaceX question everything and first principles culture that Elon has instilled. Starting from ground zero on all projects…how should each mission best be accomplished? Its focus is not on small incremental changes.
We spent the afternoon at Tesla's factory in Palo Alto. Speaking to engineers in charge of autonomous driving and compute. I have written a lot about Tesla over the past 10 years, so I won't do that again now. But I did appear on CNBC's Squawk Box on April 25 and spent a lot of my 25-minute interview discussing Tesla and our recent visit. That Squawk Box interview is posted on the Baron Funds website. As impressive as the two Tesla executives with whom we met, the afternoon ride in a Tesla full self-driving (FSD) car was as incredible. Actually, the meetings were the highlight…as they always are…it is so much fun to learn every day from awesome people...in this case, the awesome engineers who made this ride possible. The FSD ride was eye opening. We recommend you try it.
On April 19, 2024, Barron's published an interview with Jerry Sullivan, a Putnam portfolio manager. During that interview, Jerry described his work as a Fidelity summer research intern in 1985. At Fidelity, Jerry was mentored by my friend, Peter Lynch. Jerry's summer project was to research European chemical companies. He had the difficult task of “navigating differences in languages and accounting and reporting standards.” It soon became obvious to Jerry all those years ago that the European businesses he was studying were far cheaper than their publicly owned U.S. counterparts. When he described his research to Peter, Peter invested in the companies. Jerry was puzzled. How could Peter possibly invest in those businesses when no research except Jerry's was available? Peter's response? “You don't know a lot compared to me. But you know a lot more, maybe, than anyone else.” Those chemical stocks became among Fidelity Magellan Fund's top performing investments.
“If we had founded Netflix to compete against Blockbuster by renting movies through the mail instead of in stores, I would have named the business ‘Movies Through the Mail.' We named the company Netflix!” Reed Hastings. Co-Founder. Netflix. 2002.
That was how Reed described his vision for Netflix (NFLX, Financial) to me when I visited the Netflix warehouse in Queens, New York, with him in 2002. That visit took place soon after the Netflix initial public offering on May 23, 2002. May 23, by the way, is my birthday, so the Netflix offering obviously had good karma. For the five years following its IPO, Netflix provided a DVD movie subscription service to its customers. That was because 22 years ago, the internet was not sufficiently robust to stream movies online. Netflix customers then ordered DVD movies sent from that warehouse facility through the mail. When Netflix subscribers returned their movie DVDs by mail, new DVDs were sent to the customer.
In 2007, Netflix inaugurated its disruptive Watch Now streaming service that we all now know as Netflix. Netflix' business valuation in 2002 was $300 million. Its current market value is more than $240 billion! We owned Netflix part of the way...but not long enough. Another great lesson about investing in visionary exceptional people...who create what we deem competitive advantaged growth businesses? Invest for the long term. Even if those businesses in the shortterm may seem expensive.
Charlie Munger was interviewed by Becky Quick on CNBC's Squawk Box five weeks before his 100th birthday. “Is there anything left on your bucket list? Anything you'd like to do?” Becky asked him. “Yes, Becky. I've always wanted to catch a 200 pound tuna. But I'm not as strong as I was four years ago!” I took that remark asencouraging. When Charlie was asked why he had been so successful as an investor, he answered, “I'm very good at recognizing unfair advantages.” That's how we think we are distinctive as well. That and our assessment of people and our very long investment time horizon…and how much we enjoy our analyst “jobs” which are not impacted whether or not we can catch a 200 pound tuna.
Mike Minikes is a good friend. Mike is the Vice Chairman of Prime Finance at J.P. Morgan. That means he heads hedge fund prime brokerage, finance, custody, and transaction processing for the bank. Mike had previously been a senior executive at Bear Stearns where he held the same position. Bear was acquired by J.P. Morgan for nominal consideration after Bear went bankrupt in 2008 during the Great Financial Crisis. Not long after Bear Stearns' demise, Michael and his wife were driving to their summer home in East Hampton that Spring. As they passed a Carvel ice cream store in Bridgehampton, which rarely seemed to have any customers, Mike turned to his wife. “Can you believe it? Bear Stearns, one of Fortune's most admired companies...GONE!...but Carvel lives on!!!!” Clearly, Mike missed the competitive advantage Carvel had created with its Cookie Puss and Fudgie the Whale ice cream cakes. You can't make this stuff up. One more thing. Before Bear's collapse, few investors recognized the reason Bear had become so profitable and admired was due to the extraordinary leverage it used to invest in speculative debt securities. The strategy worked in good times, though not during the Great Financial Crisis. The lesson? The most distinguishing characteristic of Bear was its decision to risk its balance sheet.
“If you are doing the same thing as everyone else, you will not be hard to compete against.” Sam Altman. Co-Founder and CEO, OpenAI. January 24, 2019.
We, like Sam, believe that if your business is not distinct from others, you will not be difficult to compete against. Baron has investments in about 400 businesses. Only 30 represent about 58% of our Firm's $43 billion AUM. All these growth investments have become significant Baron holdings because their underlying businesses have been successful. Not because we initially made large investments in those businesses. All are clearly different from their competitors and, as Charlie Munger liked to say, have unfair advantages over those competitors.
By the way. We founded our Firm in 1982 with $10 million in AUM. In 1992, we had approximately $100 million in AUM. Baron Capital has earned more than $44 billion in realized and unrealized gains since 1992!
Since their respective inceptions as mutual funds, 15 funds, representing 96.7% of Baron Funds' AUM, have outperformed their benchmarks and 12 funds, representing 94.6% of Baron Funds' AUM, rank in the top 20% of their respective Morningstar categories. Five funds, representing 45.7% of Baron Funds' AUM, rank in the top 1% of their categories. Baron Partners Fund is the top performing U.S. equityfund (out of 2,091 share classes) since its conversion in 2003 from a partnership to a mutual fund!*
Several examples of what we characterize as competitively advantaged businesses:
Interactive Brokers Group, Inc. (IBKR, Financial) has littlecompetition. About 80% of this financial firm's clients are not U.S. citizens. About 80% of Interactive Brokers' customer assets are invested through Interactive Brokers in well-known U.S. growth businesses. Many of this firm's customers have become wealthy in their native countries and seek to diversify their investments to assure that their families will remain wealthy. Most Interactive Brokers' competitors long ago abandoned those markets. That is since compliance with continuously changing local country regulations is extraordinarily difficult. Interactive Brokers has invested significantly in coders and technology to keep up with rule changes and to provide terrific services at attractive prices to its customers in those geographies. Similar services provided by banks domiciled in those countries charge layers upon layers of fees.
Verisk Analytics, Inc. (VRSK, Financial) was founded as anot-for-profit data and analytics business by a consortium of insurers. Verisk's purpose was to consolidate and organize U.S. property and casualty insurance industry data to help digitize P&C insurers. P&C companies contribute their data to Verisk for no compensation. They then pay Verisk to use that data after it has been combined with data of other providers! Nearly all U.S. P&C companies contribute their data to Verisk, repurchase that data, and use Verisk analytics. Accordingly, Verisk services are deeply embedded in P&C workflows. Following Verisk's conversion to a for-profit business, its competitive advantage was substantial. Verisk's contributory databases are virtually impossible to replicate. The amount paid by P&C insurers toVerisk is less than 0.4% of the insurers' annual expenses. Further, Verisk's client revenue retention rates approximate 99%. Since Verisk continues to add analytics, software, and services to augment and enhance its contributory databases, Verisk's prospects for double-digit revenue and free-cash-flow growth remain strong.
Following adoption of regulations that limit construction of locals casinos in Las Vegas communities (e.g., near homes, schools, playgrounds, houses of worship, and hospitals), the Fertitta family's Red Rock Resorts, Inc. (RRR, Financial) owns virtually all the casino developable land in such communities. Locals casinos, whose patrons are principally local residents and Strip hotel employees, earn dramatically higher returns on capital invested than Strip casinos. Las Vegas's Strip casinos generally cost four to five times the construction cost of locals' entertainment venues.
Vail Resorts, Inc. is the largest ski resortcompany in the world. Before winter snows, Vail sells season lift ticket passes that can be used at any of its worldwide 41 mountain resorts network. Vail's Epic ski passes purchased in the summer now account for more than 70% of annual skier visits. Vail's goal is to have more than 90% of its lift tickets purchased pre-season! Using data and analytics, Vail is able to more effectively market and invest in its properties. Vail's management team has begun a capital-light European expansion. Annual ski visits in Europe are three times those in the U.S. Other geographies also beckon.
Arch Capital Group Ltd.'s (ACGL, Financial) exceptionalmanagement team compensates its sales representatives based on profits produced over the term of its policies...not on how much additional premium revenues they produce in a given year. This is an unusual practice in the P&C insurance industry and incents careful underwriting not just premium growth. Accordingly, when rates are low, Arch doesn't grow much. When rates are high, like now, Arch grows a lot. One more thing. Arch management employs a cycle management strategy and depends on other insurance products like mortgage insurance...not just property and casualty. This diversification is how Arch stays rich...after it had become rich.
I will continue to write about the unfair competitive advantages, returns, and growthprospects of Baron Capital's Top 30 Holdings...as well as opportunities of more recent Baron Capital purchases in future “Letters from Ron.”
“Warren and I played Monopoly when we were children. Warren always won. I saved money in little piles in front of me but as the game went on, I was landing on more and more properties with Warren's houses andhotels, and pretty soon all my money was gone. I realized it was a better strategy to buy property than to hoard money. He owes his success to me since I trained him to be a winner and he just kept going.” -Bertie Buffett Elliott. Warren's 91-year old younger sister. Berkshire Hathaway annual meeting, May 2024.
Bertie's perspective, of course, is in sync with Baron Capital's OWN IT! philosophy and the theme of the 2023 Annual Baron Investment Conference. We think of ourselves as part owners of the unfairly advantaged, growth businesses Baron OWNs. We believe over the long term these businesses will perform much better than market indexes...and inflation...because the businesses we OWN will grow much faster than markets and GDP, if we are right. We don't expect stocks of businesses in which we invest to outperform every year…just over the long term. To grow faster, businesses generally reinvest a substantial portion of their profits back into their businesses. In the short term, growth capital investments in factories...technology...hiring and training employees...research...hotels...rockets...and satellites...mask the profitability of current operations.
Just like Warren Buffett (Trades, Portfolio)'s hotels and real estate purchases in Monopoly reduced the cash horde in front of him while Bertie's was growing...his younger sister was bankrupt by the end of each game because she didn't invest and had to pay Warren rent. We believe, as Bertie learned, when you stop investing in the future, although your short-term profits may be fine...sooner or later you will go out of business.
I attended law school from 1966-1969 in the evenings and worked as a Patent Examiner in the U.S. Patent Office in the daytime. My position as an examiner was then classified as a critical skill position that required knowledge of science and law. My annual salary in 1966 was $7,729 and, in addition, I was reimbursed for a large part of my law school tuition.
It was then that I became really interested in the stock market. Uncertainty engendered by student demonstrations against the War in Vietnam...assassinations of President Kennedy...his brother Robert, the Attorney General...and Martin Luther King…race riots…100 of our cities aflame…marches on Washington for Civil Rights…women's rights…and high inflation and interest rates...kept stock prices relatively depressed.
The Dow Jones Industrial Average in 1970 hovered around 1,000. Then, like now, most market seers focused on macro developments rather than studying businesses. They carefully watched money supply on Fridays. Just like they watch non-farm payrolls...the Consumer Price Index...unit labor costs...core CPI ex-food and energy...personal consumption expenditures... average hourly earnings...Bitcoin prices... unemployment rates...labor participation rates... today which impacts markets instantly. Few consider that the Dow is now 39,000!...up 39 times since 1970...and GDP, which measures the size of our economy, is now $28 trillion...up 31 times since 1968. GDP was $900 billion when Robert Kennedy, the assassinated President's brother, campaigned for President...and was also assassinated!
One of my friends recently addressed a group of summer interns at a large Wall Street firm. After his brief presentation, he asked the group where they believed the Dow Jones Industrial Average would be in 50 years when they would retire. The average answer... “up 60%!” We think the economy will grow faster in the next 50 years than in the past 50. Due to the impact of technology and the same 4% to 5% annual inflation rate since WWII that has caused the prices of most items and services to double about every 14 to 15 years, the stock market has doubled about every 10 years during my lifetime. If that continues to be the case, the Dow in 50 years could be 30 to 40 times its current level…not up 60%! Investments in stocks have historically been a great way to protect your savings against inflation…
Thank you for joining us as investors in Baron mutual funds. We will continue to work hard to invest for you and your families as well as ourselves and our families...and to attempt to significantly outperform markets and the growth of our economy. We will also try to continue to provide you with the information about your investments that I would like to have if our roles were reversed.
Respectfully,
Ronald Baron
CEO
May 12, 2024
P.S. It is amazingly gratifying, as I am sure you must understand by now, for me to be recognized virtually wherever I go and be thanked by our shareholders for the returns that many long-time Baron Fund shareholders have earned…which have changed their lives. Thank you for trusting us to invest for you and your families.
