“Many people think of us as a 'value investor' and others ask whether we are a value or a growth investor. We’ve started to say, we’re neither, we are a compounding investor.” -Chuck Akre (Trades, Portfolio), quoted on his company’s website.
Investing guru Chuck Akre (Trades, Portfolio)'s firmholds the fifth spot for 10-year returns—among all the gurus followed by GuruFocus. The firm's average annual return over the past 10 years has been 11.2%, well above the S&P 500 Index.
His firm uses a disciplined and strategic approach based on finding companies that can deliver above-average returns at below-average risk. More specifically, Akre and his firm have articulated a three-pillar investment strategy that searches for businesses that compound value at high rates, with management that treats shareholders like partners and can reinvest free cash flow to generate above-average returns.
This article probes that strategy and its execution by Akre and his firm. It is one in a series of articles on the investing gurus; other guru profiles include David Tepper, Prem Watsa and Bill Ackman.
Who is Chuck Akre?
Charles T. "Chuck" Akre Jr. is managing member, CEO and chief investment officer of Akre Capital Management.
He grew up in Washington D.C. and later earned a Bachelor of Arts degree in English literature at American University. After completing his degree, he entered the securities business in 1968. Akre worked as a manager at Johnston, Lemon & Co. before starting Akre Capital Management in 1989. He operated the company as part of Friedman, Billings, Ramsey & Co. until 1999. The following year, the firm went out on its own.
Akre was deeply influenced by Thomas Williams Phelps' book "100 to 1 in The Stock Market" and by Warren Buffett (Trades, Portfolio)'s shareholder letters. Chris Mayer of Mayer’s 100x Club explains that a stock which grows by 20% per year and is allowed to compound (no withdrawals) will be worth 100 times as much as its initial value after just 25 years.
Akre is a veteran of the financial industry, but perhaps his degree in English literature put him on a different path within that industry. In following Phelps, he works toward a very distant horizon.
What is Akre Capital Management?
On its website, the company describes itself as “an asset management firm located in Middleburg, Virginia, with over $6.5 billion in private funds, mutual fund (the Akre Focus Fund) and separately managed account assets as of Feb. 28, 2017.” The business is managed and operated by Akre and three associates. With its office in Virginia, Akre says on the company website, “We are both philosophically and geographically removed from Wall Street.”
The Annual Report for 2016 lists three funds:
- Retail Class Shares (AKREX)
- Institutional Class Shares (AKRIX)
- Supra Institutional Class Shares (AKRSX)
The objective, according to the annual report, is to compound its investors' capital at above-average rates while taking on below-average risk. The report notes the first part of the objective is straight-forward, and one the firm has met.
The "below-average risk" component, however, is not so easy to assess, “...we do not subscribe to the widely held view that share price volatility is synonymous with risk. If share price volatility equaled risk, then investing in private companies would be nearly risk free simply by virtue of there being no active price quotation for the shares! Instead, we view the risks of any public equity investment through the same lens as we would a private equity investment: the business, the people, the reinvestment and the valuation.”
To implement its strategy, Akre and his associates think in terms of a "three-legged stool." Indeed, Akre keeps a milking stool in his office, a low stool on which a farmer could sit while milking a cow; it gets the farmer up off the barn floor, but is low enough that he or she would not be injured if they fell off it.
Akre’s investment philosophy
This is how they show the three legs of the stool on the company website:
Finding a suitable business comprises the first leg of the stool. In the Third Quarter 2016 Akre Focus Fund Commentary, Akre said, “We … focus on identifying the really outstanding businesses and add them to the portfolio when the valuation opportunity reveals itself.”
As noted, the search starts with companies that have a history of compounding value per share at very high rates. To break that down into three parts:
- A candidate company must have demonstrated it knows how to increase its intrinsic value, to generate above-average returns on the owners’ capital. Above-average means higher than the returns of the S&P 500 Index. That may or not be discerned from book value, as Akre observes in a paper posted on the company website, “Sometimes it is quite easily measured by the growth in book value per share. Other times this easy approach is altogether without value due to the oddities of accounting rules.”
- Second, a candidate company’s management must be shareholder-friendly. An Investing Daily article reports Akre looks for managers who have both skill and integrity. The article says he has three informal criteria for finding those managers: (1) they own a lot of company stock; (2) management compensation is not excessive; and/or (3) founding entrepreneurs are still involved.
- Third— Akre now considers this the single most important part—the candidate company must be able to reinvest its profits for above-average returns. In other words, he is looking for two advantages in one: a company earning above-average returns which can take those returns and reinvest them at above-average rates. For example, a fast-growing company that invests its profits in expansion or growth. This obviously rules out most dividends and share buybacks by companies flush with cash.
The third point reinforces the idea of "compounding machines," wherein a company doubly-compounds its profits, subsequently increasing its intrinsic (and perhaps book) value, which in turn should increase its share price at an accelerated rate.
Where other firms would add quantitative analysis or other sophisticated tools, Akre and his colleagues do not.
“Our approach, by contrast, stresses the importance of wisdom by subtraction. We endeavor to look past the non-essential details and tune out the often deafening noise. We want to identify the 'essence' of each business. So, for instance, what is it about MasterCard (MA, Financial) that enables them to generate after-tax margins approaching forty percent? Why have the Rales brothers been so successful buying and fixing businesses? How has Markel (MKL, Financial) managed to compound book value per share at 15% for the past 20 years despite falling interest rates and a competitive underwriting environment?”
The idea of compounding is almost as old as civilization itself, yet Akre has taken the idea to a new level, not only conceptually but also operationally. His track record tells us he also has done this successfully for enough years to prove it is not a random result.
What are the results?
The GuruFocus Score Board tells us Akre and Akre Capital Management have produced average annual returns of 11.2% over the past 10 years, and 12.7% since the company’s inception in 2000.
This table from the Annual Report shows shorter-term results:
Note these results cover just the period these two funds have been existence and, as a result, their inception date is later than the company’s inception date in 2000.
Morningstar reports the S&P 500 (SPY) has averaged 7.41% over the past 10 years, compared to the 11.2% posted by Akre Capital Management. That is a 3.8% difference, which, according to a compounding calculator at MoneyChimp, represents an additional $45,202 on a $100,000 investment over one decade:
Akre has achieved what he set out to do in generating above-average returns for his clients. Whether that has involved below-average risk is, according to him, a somewhat subjective exercise.
What is in Akre’s portfolio now?
This GuruFocus chart shows a sectoral view of Akre’s investments:
Note, this portfolio is made up of just 33 stocks, the firm’s holdings on the last day of 2016. In addition, Akre has indicated he and his colleagues do not give much weight to sectors, instead they are focused on the three criteria listed above.
These are the top 10 holdings in Akre’s current portfolio (again, the last day of 2016):
- American Tower Corp. (AMT, Financial)
- MasterCard Inc. (MA, Financial)
- Markel Corp. (MKL, Financial)
- Moody’s Corp. (MCO, Financial)
- CarMax Inc. (KMX, Financial)
- Dollar Tree Inc. (DLTR, Financial)
- Enstar Group Ltd. (ESGR, Financial)
- Roper Technologies Inc. (ROP, Financial)
- Visa Inc. (V, Financial)
- SBA Communications Corp. (SBAC, Financial)
Akre’s stake in the fund’s biggest position, American Tower, had a valuation of $708,213 on Dec. 31. GuruFocus reports his quarter-over-quarter turnover is 6%.
The list of current holdings is a somewhat eclectic collection of companies, but what they have in common is the ability to generate above-average earnings and to subsequently reinvest profits or free cash flow at above-average rates of return. Compounding, or double-compounding, in short.
Conclusion
Albert Einstein famously said, “Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it.”
Akre obviously understands it, and understands it at a depth few of us can match. By focusing on companies that are "compounding machines," he has staked a place in the investing pantheon (not to mention, fifth place among the gurus followed by GuruFocus). To outperform the S&P 500 Index by an average of more than three points a year for 16 years is an accomplishment.
For retail investors, Akre is also an interesting name because it is reasonably easy to copy his portfolio. He rarely changes the names, which means low transaction costs (also a key to maximizing returns). While today’s investors may not get into these stocks at the same low price Akre did, they can get in without worrying about paying too much; these are all long-haul stocks.
In any case, Akre is a guru worth studying; even if we do not follow his example, there is much to learn from his successful experiments in choosing companies that can compound wealth: their own and ours.
Disclosure: I do not own shares in any of the companies listed in this article, nor do I expect to buy any in the next 72 hours.
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