“I don’t want to belong to any club that will accept me as a member.”
- Groucho Marx
Groucho Marx, widely considered one of America’s greatest comedians, once said this well-known line when trying to cancel his tennis club membership back in the 1940s. Fast forward to today, and we believe that the quote makes a lot of sense when applied to the stock market.
Basically, what Groucho Marx's words suggest to us, the equity investors, is to focus on businesses that do not need our money and to be wary of ones that seek external funding or buyers.
The obvious example of the latter crowd would be recently-IPO’ed companies, though there are a few exceptions. Statistics show that as a group, these companies generate disappointing average returns over time. One of the primary reasons is that more often than not, businesses go public when the pricing by Mr. Market exceeds the current shareholders’ estimate of intrinsic value. In other words, IPOs usually aim to make money for the existing investors who want to sell. Indeed, another possible factor could be the requirement of capital to sustain operations and grow in excess of what can be obtained internally and from banks or other external means, which may imply inferior quality.
Likewise, companies consistently issuing new shares should seem suspicious in most cases for the same reasons: i.e., being overvalued or having low-quality fundamentals. In our view, most investors should generally take a pass on these situations.
Terry Smith, who is often called the "English Warren Buffett," once described his Fundsmith Equity Fund as the “Groucho Marx of the investment world” in that he would prefer to invest in a company that never needs his fund’s money. Specifically speaking, he searches for industries (or niches) that have at least one long-lasting, resilient player that does not care to go public. For example, Bacardi is the largest privately-held spirits company, which has existed for more than 150 years. This should tell favorably about the “hard drink” category, where we can see the prosperity among century-old publicly-listed distillers like Diageo (LSE:DGE, Financial) and Brown Forman (BF.A, Financial) (BF.B, Financial). Similarly, Subway, owned by Doctor’s Associates, grew to become the largest fast-food chain without its parent company accessing the capital in the stock market, giving credit to the franchise model – the same model used by many other compounding machines, such as Domino’s Pizza (DPZ, Financial).
At Urbem, our Groucho Marx Club of Investments is composed of member companies that earn a high cash return on capital alongside a healthy balance sheet, grow their earnings power through a portion of internal funding, increase dividends over time and buy back their own stocks when opportunities arise. Our quantitative model also tends to be underweight, by design, on businesses with a limited post-IPO history.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Domino’s Pizza.
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