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23 Questions With François Rochon of Giverny Capital

'Well it is easier to know when you are right than when you are wrong. I want to be patient but not stubborn'

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PJ Pahygiannis
Dec 21, 2016
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1. How and why did you get started investing? What is your background?

I graduated as an electrical engineer. I always was interested in the stock market, even quite young. But the whole field seemed speculative to me so I was more inclined to study science.

When I started to work (and have some savings), I decided to look into the stock market world further. After reading Peter Lynch’s books at the end of 1992 and then

Warren Buffett (Trades, Portfolio)’s annual letters, I realized that investing could be done rationally and I became very passionate about this activity.

I started managing my own money in 1993. Then, I left the engineer profession in 1996 to work at a big money management firm. Two years later, I decided to start my own firm, Giverny Capital. Jean-Philippe Bouchard joined me in 2002. And in 2009, we opened an office in the U.S. We now have around 900 million Canadian dollars in assets under management.

2. Describe your investing strategy and portfolio organization. What valuation methods do you use? Where do you get your investing ideas from?

When I buy shares, I have the attitude of buying a whole company. So, our portfolio is basically the equivalent of a holding company that owns 20 or so divisions.

We value stocks based on the (estimated) earnings power in the next five years and what we believe is a warranted price-earnigns (P/E) ratio. So let’s say XYZ earns $1 per share in 2016 and I believe that they can earn $2 in 2021 and that a 20x P/E would be warranted, it would mean that I think the stock will be worth $40 in five years. If my goal is to earn around 15% on the investment, I would have to buy the stock today at $20 or less.

I get investing ideas from many places. I try to look at all companies that I can understand and that seem to have a strong business model. With the Internet and some good publications like Value Line, you can find lots of ideas quite easily (to be analyzed in depth afterwards).

3. What drew you to that specific strategy? If you only had three valuation metrics what would they be?

I was very much inspired by

Warren Buffett (Trades, Portfolio), Philip Fisher, Peter Lynch and Bill Ruane. So I would say that my strategy is a synthesis of their ideas, although stocks that I can fit into my personal “frame” can be very different from those investors.

I really have only one valuation metrics: what I believe the company will be worth in five years based on historical data and earnings growth projections. I tend to focus on companies that have high return on equity (ROE), a solid balance sheet, a strong competitive advantage and a management team that I believe is outstanding.

4. What books or other investors changed the way you think, inspired you or mentored you? What is the most important lesson learned from them? What investors do you follow today?

The first two I read were “One up on Wall Street” by Peter Lynch and “The Intelligent Investor” by Benjamin Graham. And then I read Philip Fisher’s four books, which were very important in the development of my investment process. Moreover, in my opinion,

Warren Buffett (Trades, Portfolio)’s group of annual letters – if put into a book – is the best teaching anyone could find in the history of business.

The most important lesson is to be rational and look at stocks as part ownerships of businesses; nothing else.

I follow

Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) of course. I also admire Todd Combs. I follow David Poppe and the team that manages the Sequoia Fund. I admire and respect Glenn Greenberg and Lou Simpson (Trades, Portfolio) a lot. I also like to read Chuck Akre (Trades, Portfolio)’s letters and like to follow his new purchases since we tend to have lots of ideas in common. Finally, I think very highly of Tom Gayner (Trades, Portfolio) at Markel.

5. How long will you hold a stock and why? How long does it take to know if you are right or wrong on a stock?

I will hold a stock as long as I believe the reasons I purchased it initially are still present. On average, I hold a stock for around seven years.

Well it is easier to know when you are right than when you are wrong. I want to be patient but not stubborn! I like to repeat to myself a rule of Philip Carret, written some 86 years ago: “Be quick to take losses and reluctant to take profits”.

6. How has your investing approach changed over the years?

I owned lots of companies in the early years that I have come to realize had business models that were not as resilient as what I thought they were. Some technology companies I bought twenty years ago do not really exist anymore (or are much smaller). It makes one think about the nature of long-term investing. So I am more focussed on the durability of the business model today.

I always have emphasized on the quality of management. But I have come to learn that it is even more important than what I previously thought. I would go as far as to say that buying a stock is to become partner with the top management of the company.

7. Name some of the things that you do or believe that other investors do not.

First, I believe I am very flexible. I like both small companies and large companies. I like to look everywhere around the Globe (although I end up with mostly North American companies). To take a hockey analogy: my goal is to win the Stanley Cup. I want to own the 20 best “players” I can find; wherever they come from and whatever their size or age (some young and some more mature).

In addition, I believe that I have a very long-term horizon, longer than most investors. I try to behave more like a true owner of companies than a typical equity securities manager.

8. What are some of your favorite companies, brands or even CEOs? What do you think are some of the most well-run companies? How do you judge the quality of the management?

Well I like companies that I believe have a durable moat. So companies like Google (

GOOG, Financial), Amazon (AMZN, Financial), Starbucks (SBUX, Financial), Disney (DIS, Financial), Coca-Cola (KO, Financial), Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial), etc.

I admire Jeff Bezos a lot, although I never (sadly) bought shares of Amazon. I think very highly of Howard Shultz at Starbucks and Bob Iger at Disney. In fact, I bought shares of Disney in 2005 the very day that Iger was named CEO. I think he did a fabulous job.

It sounds simple but to judge a CEO, you need judgment. And management assessment is necessarily subjective and there are no written rules really. Experience surely helps.

9. Do you use any stock screeners? What are some efficient methods to find undervalued businesses apart from screeners?

I rarely use screeners. To find great investment ideas, you have to study lots of companies. My “capitalist antennas” are always on! I try to have a look at every company that crosses my path. I do use simple filters that discard lots of companies quite rapidly (like profitability, clean balance sheet, understanding the nature of the business, low cyclicality, etc.).

Peter Lynch used to say that looking for great stocks is like looking for pearls: The more oysters you open, the better the odds of finding one!

10. Name some of the traits that a company must have for you to invest in, such as dividends. What does a high-quality company look like to you and what does a bad investment look like? Talk about what the ideal company to invest in would look like, even if it does not exist.

I like to find companies that have unique assets that cannot be easily copied. An example is the group of Disney’s characters. What I like about Mickey Mouse is that he is immortal and he does not have an agent. Disney own their stars.

Most of my big mistakes were of omissions. But some bad investments were made when I misjudged the solidity of a business (the moat was thinner that I thought) or the qualities of management.

In the book “Money Masters” by John Train, published some 35 years ago,

Warren Buffett (Trades, Portfolio) said that the best business to own is a “Royalty on the growth of others.” Today, one example would be – in my opinion – the credit card companies (like Visa). When consumers use their cards to spend, Visa (V, Financial) gets the equivalent of a small royalty on each dollar spent. Another example could be Google. As the number of Internet users grow, the number of Google searches increase without Google having to spend more money on marketing or build more “cyber-rails”. They have the equivalent of the nearly unique bridge that consumers that want to enter the “Island of the Internet” have to cross.

11. What kind of checklist or homework do you utilize when investing? Do you have a specific approach, structure, process that you use? Or do you have any hard cut rules?

I know many good investors and I would say that we all use basically a similar approach. We read annual filings and analyst’s reports. We also talk to all sorts of people related to the studied business (management, clients, suppliers, etc.).

I believe that it is really qualitative skills that often makes the difference. For example, the capacity to suffer while your style is out of favor (and not give in to the “fad of the day”). In an age of instantness, it is really hard to have an authentic long-term horizon. Those that have the capacity and the willingness to do so have a great advantage in the long run.

Another quality needed would be humility: the stock market requires lots of it. So – in a strange paradox – good investors have to be able to balance humility and self-confidence in just the right amounts.

12. Before making an investment, what kind of research do you do and where do you go for the information? Do you talk to management?

I like to read financial statements and CEO letters. I read some analyst reports and also unbiased reports like the ones from Morningstar and Value Line (although I am sceptical of ratings in all cases).

I do talk to management of many companies. I like to figure out their human values, the culture they nurture and their long-term goals.

13. How do you go about valuing a stock and how do you decide how you are going to value a specific stock? When is cheap not cheap?

Like I wrote before, we try to figure out the earnings power of the company in five years and the P/E ratio that would then makes sense. Obviously, you can put any number in the level of EPS in 2021 and fool yourself into believing that a stock is undervalued. Also, when you find a “cheap” stock, you can easily convince yourself that the long-term prospects of the company are great. That is why I try not to look at valuation at the beginning of the process.

If your focus is the long-term earnings power, the key question must be “How certain are you about your future estimates of growth?” Being able to rightfully assess the solidity of the business, the durability of its competitive advantages and the capital allocation skills of the CEO is at the heart of my valuation process.

Cheap is not cheap when you hope for an increase of the P/E ratio in the short-run even though the long-term economics may be poor.

14. What kind of bargains are you finding in this market? Do you have any favorite sector or avoid certain areas, and why?

We own three U.S. bank stocks. I believe they have better earnings power going forward. First, most of the regulation expenses have been dealt with. Secondly, the interest income margins are at record lows. At some point, interest rates will go up and it will help net interest margins. Their P/E ratios relative to the S&P 500 seems to me to be too low. I have to add that in November, many bank stocks rallied and now seem a little less undervalued.

I believe the market underappreciates the residential house revival. We are probably in the third inning of that cycle. I am not a big fan of buying cyclical stocks but we can find solid companies that have parts of their revenues related to housing like Mohawk Industries (

MHK, Financial).

15. How do you feel about the market today? Do you see it as overvalued? What concerns you the most?

I think that the stock market is fairly valued. When you think about it, 20 years ago, 10 year treasury bonds were yielding around 6% compared to 2.6% today. And the P/E ratio of the S&P 500 was similar to today’s. In the last 20 years, earnings for the S&P 500 tripled and so has the index. If you have reasonable expectations for the S&P 500 (like an annual return of around 8%, including dividends), I do not think you should consider the index as overvalued.

What concerns me is the level of debt in corporations. I realize that interest rates are low. The operating income to interest expense ratio is probably at historical levels. But many companies could not stand an increase of 300 basis points in the interest rates of their debt. So, if interest rates were to increase rapidly, the bond market would be hurt but so would many corporations. Hence, I would avoid what I believe could be labelled “rate-vulnerable” companies.

16. What are some books that you are reading now? What is the most important lesson learned from your favorite one?

The last one I read was probably Guy Spier’s “The Education of a Value Investor,” which I really enjoyed.

I sometimes reread older books like “So Far, So Good - the First 94 Years,” written by Roy Neuberger in 1997. It always fascinates me how things are basically the same on Wall Street. Sound principles do not change. And so is human nature towards money and markets.

I also like to read books on all sorts of subjects. I am a big fan of the philosopher Erich Fromm and I like to read his many books. Since I am a contemporary art collector, I love to read about the life of other art collectors. Many of them were businessmen (women) that used their wealth to acquire great works of art. They often had a fascinating life.

Some books I read are about great companies. And it is quite striking to realize how much companies change over time (some even disappear). It gives humility toward abilities of identifying superior enterprises for the next decade. It is not an easy task.

17. Any advice to a new value investor? What should they know and what habits should they develop before they start?

I like to say, “A painter aiming at being a master must paint. In the same way, an investor must invest.” I see lots of value investors waiting for a “better time” to enter the market. So my advice is simple: start investing today! There are always opportunities out there if you search for them.

A good habit is to know the history of our civilization. It will help in identifying what are probably fads in the markets. The phrase “this too shall pass away” applies to many “trends” in Wall Street.

Also, understanding human nature in depth is a useful skill that is acquired through reading, observations and experience.

18. What are some of your favorite value investing resources or tools? Are there any investors that you piggyback or coattail?

I have deep admiration for many great investors and will certainly take a close look at their favorite stocks. I would not use the word “piggyback,” but I would say that, like a painter is inspired by some art masters, I am indeed inspired by some money managers for whom I have great respect (like the ones listed above).

19. Describe some of the biggest mistakes you have made value investing. What are your three worst investments that burned you? What did you learn and how do you avoid those mistakes today?

The biggest mistakes are – by far – errors of omission. Stocks that did fit my criteria but I did not purchase. Companies like Starbucks or TJX Companies (

TJX, Financial).

I did make many mistakes in purchases over the years. The three main losers in terms of percentage of the portfolio were probably Callaway Golf (

ELY, Financial), Health Management Associates and WP Stewart.

What I have learned? In the case of omissions, the main error is usually not to pay a higher P/E ratio that turns out to be warranted by long-term economics. Purchasing mistakes were mostly misjudging the solidity of the business model of the company.

I have learned to be humble: it is not easy to assess the long-term prospects of businesses. It is inevitable to make mistakes but if I can learn something from each one, I can improve myself as an investor. To paraphrase Oscar Wilde: Experience is the sum of all our mistakes.

20. How do you manage the mental aspect of investing when it comes to the ups, downs, crashes, corrections and fluctuations?

I like to read a lot about financial history. It helps to have realistic expectations toward markets of all sorts.

Also, I do write a lot about investing through my annual letters (that are 20 pages long every year). I am sometimes amazed by things I wrote 10 or 15 years ago that can still apply in today’s market.

And when I need comfort in tough times (like in 2008), there are still the wise words of Ben Graham, John Templeton and

Warren Buffett (Trades, Portfolio) that I can reread.

21. How does one avoid blowups in value investing?

Well, I always like to say that companies that are profitable and with low debt levels rarely go out of business. So, a solid balance sheet and a profitable business model is a good start.

I think that most mistakes in value investing are basically buying a stock that is “cheap” in the hope of selling it at a higher price in the short term (a few years). I think if you buy a stock with the idea of owning it at least five years, you will look at valuations with a different point of view.

But I do not want to badmouth value investing in any way. I think it is an intelligent activity to acquire undervalued securities however you approach it. Many wealthy investors owe their fortunes to it!

22. If you are willing to share, what companies do you currently own and why? How have the last five to 10 years been for you investing wise compared to the indexes?

We own around 20-25 names and our turnover ratio is around 14% so we keep our stocks on average for seven years. For example, we own Disney, CarMax (KMX), Dollarama (TSX:DOL), Mohawk, Visa and Alphabet (Google). We bought those six stocks from 2005 to 2011 so they have been in the portfolio for eight years on average. We also own two other outstanding Canadian companies (in addition to Dollarama). And we own three solid banks.

My global portfolio has done approximately 5% better than its benchmark on an annual basis over the last five and 10 years (or 4% better if you would include our management fees). So, it has been a very good period for our style of investing.

23. Here is a fun one - What stock would

Warren Buffett (Trades, Portfolio) or Benjamin Graham buy today if he were you?

That is an interesting question. For

Warren Buffett (Trades, Portfolio), I think one company that would fit well in Berkshire Hathaway is CarMax. In my opinion, they have a great competitive advantage in their industry. And they have a long way to grow before maturity. And their financial division would profit from Berkshire’s umbrella. If Berkshire did not already own Shaw Industries, the other main flooring company, Mohawk, would be, in my opinion, a company that could fit well. I think Jeff Lorberbaum, Mohawk’s CEO, is an outstanding manager who would be in the same league as many of the all-star CEOs at Berkshire.

Ben Graham would probably buy some obscure undervalued securities that I have never heard of! And he would perhaps think that Apple (AAPL) is a financially sound company that looks quite undervalued at today’s price.

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