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Grahamites
Grahamites
Articles (274) 

My Early Inspirations

What I learned from Tom Russo, Chuck Akre and Rob Vinall

February 12, 2018

For the past few articles I wrote about how my research process has evolved over time. Someone asked me what the inspirations were for me to make those changes. As I reflected back on my journey, I think there are a few important turning points which I’ll detail below.

It was in May 2013 that I attended the Value Investor Conference in Omaha right before the Berkshire meeting. It was very expensive for me back then and it was the first value investing conference I ever attended. I was still in the very early stage of value investing and more attracted to the "cigar-butt" companies (those will little business value left). The conference lasted for two days with most of the speakers scheduled on the second day. One of the speakers was Tom Russo (Trades, Portfolio), who spoke on the first day before dinner. And Russo said something that completely changed my way of thinking. In 2013, Berkshire Hathaway and 3G partnered up to buy Heinz (now part of Kraft Heinz). When commenting on this transaction, Russo said the following: “Obviously the margin of safety did not come from price; it came from the competitive advantages of the business.”

You may say, well, that’s pretty obvious. But back then, I’ve only viewed margin of safety from a price point of view in the cigar-butt world. I’d always thought margin of safety meant getting a big discount on a cigar-butt company. Russo enlightened me with the insight that there’s another type of margin of safety, which comes from the competitive advantage of a business. Even though today it’s perfectly obvious that margin of safety based on competitive advantage is at least equally, if not better than one based on price, back then it was a profound insight.

The second turning point also happened in Omaha and again through the Value Investor Conference. This time it was the 2014 Value Investor Conference and the speaker that inspired me the most was Chuck Akre (Trades, Portfolio). Throughout his speech, Akre asked these two questions many times: Why is that? How do you judge that? And then he walked us through why some companies have above-average margins and can compound at above average rates. Those are the companies which he called compounding machines. Akre used the “three-legged stool” approach, which can be found on Akre Fund’s website:

Business:

“We begin with the premise that our return on an investment2 has the ability to approximate the company’s growth in book value over time. As a result, we look for businesses that have historically compounded book value3 or shareholders’ equity per share at very high rates. These businesses, in our opinion, also have a high likelihood of producing such returns for the foreseeable future. High barriers to entry and significant pricing power tend to characterize these businesses.”

Management:

“The businesses in which we typically invest are run by highly skilled managers who have a demonstrable history of treating shareholders as though they were partners. Great managers possess equal parts of integrity and skill. One without the other is insufficient.”

Reinvestment:

“We strive to invest in businesses that, because of the integrity and skill of their management, can reinvest their free cash flow in a manner that continues to earn above-average returns. This reinvestment acumen generates compelling compounded growth in economic value per share.”

It was the third-leg -- reinvestment opportunities -- that struck me the most because before Akre’s speech, capital allocation and especially reinvestment opportunities had never made it to my thinking. I had a "eureka!" moment when hearing Akre talking about why he wanted to find businesses that could reinvest their free cash flows in a manner that could generate above-average returns.

Another speaker of the 2014 Value Investor Conference, Rob Vinall from RV Capital, also greatly inspired me with his presentation. The talk was titled “Mistakes of Omission.” During the speech, Vinall walked through some common mistakes of omission but highlighted one that really resonated with me personally – fear of paying a high multiple. Vinall showed us mathematically why it’s much better to pay a high multiple for a great business than to pay a fair price for an average business. And the lessons he gave at the end of the presentation were wonderful. They were:

  • Focus on the multiple relative to the business and not the absolute multiple.
  • At nearly all times, the great business will trade on a higher multiple than the value business.
  • For the truly long-term investor, the great business (properly analyzed) beats all other businesses at almost any price.
  • There is a time horizon arbitrage in great businesses trading at high multiples.
  • It is perfectly valid to invest in non-great businesses, but be sure to pay a lower relative multiple.
  • Longevity of growth is far more important than the rate of growth.

Conclusion

So those are my early inspirations. Russo taught me margin of safety can come from competitive advantage of a business. Akre said that if you find a great business with great management that can reinvest the cash flow at above-average returns, you’ll find compounding machines. And Vinall showed it’s better to focus on the multiple relative to the business and not the absolute multiple.

If you put them together, that’s how I evolved from stage II to stage III in my research process as outlined in my previous articles. No doubt that I owe a tremendous amount of debt to Russo, Akre and Vinall. They are truly great minds in investing and I encourage all readers to learn more from them.

About the author:

Grahamites
A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.

Rating: 5.0/5 (14 votes)

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Comments

snowballbuilder
Snowballbuilder - 3 months ago    Report SPAM
Hi Grahamites interesting article and great investors to look at

I think Chuck Akre (Trades, Portfolio)'s talk at google is one of the best speech about long term focused investing

https://www.youtube.com/watch?v=O38I7QIc_eQ

Best Snow

DrakeMcHugh
DrakeMcHugh - 3 months ago    Report SPAM

Agreed. Nice article. Yes all three are inspirational. They make successful investing look easy.

ciba
Ciba - 3 months ago    Report SPAM

Another top article from Grahamites. That´s why i´m here. Thank you for that!

zyl41
Zyl41 premium member - 2 months ago

Great artile and really enlightening!

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