One of the traits that sets the Great Investors apart is the ability to be grounded – to remain calm under pressure and sensible when things get hairy. All the Masters have it but none more so than Chuck Akre.
Grounded: Mentally and emotionally stable, admirably sensible, realistic, and unpretentious.
And ‘Grounded’ quite possibly is the perfect word to describe Chuck. If you’ve been an active reader of our blog over the last few years, I’m sure you’ll remember our post on Chuck Akre and his Three Legged Stool. Like Buffett, he prefers to work away from the noise of Wall Street. His office is based in a small Virginian town that boasts a single traffic light. His humility and expertise are synonymous with those we call Master Investors and Chuck has been kind enough to give of his time to us on a number of occasions. He is someone we follow avidly.
Chuck was recently interviewed on one of our favourite Podcast series: ‘Invest Like the Best’ with Patrick O’Shaughnessy. O’Shaughnessy typically has a great line up and as usual, he delivered big time on his recent talk with Chuck. Chuck’s explanations and investment approach are refreshing in their simplicity. Over more than fifty years of investing experience, Chuck has distilled the essence of great investing into three key criteria which he refers to as his ‘Three Legged Stool’. And while Chuck might be reluctant to disclose insights into his favourite stock positions, he does share a key insight in the Podcast which took him decades to appreciate. The podcast gets to the core of what great investing is all about. The Podcast is replete with pearls of wisdom and anecdotes, all straight from the legend’s mouth. It’s the perfect mental detox to remove the daily noise we get caught up in as investors.
Following are some of our favourite quotes from the Podcast:
“I spend a lot of time reading. That’s how ideas bubble up in my universe. Mostly it is a serendipitous, non-quantitative approach.”
“In my career I’ve literally run across thousands of people who were very very bright, but not necessarily good investors. Pure knowledge, in and of itself, is not a ticket to being a good investor. Imagination and curiosity are what’s hugely important. We’ve discovered things over the years purely by being curious and continuing to keep involved in the search process to find these exceptional businesses.”
“I find that curiosity has been useful to me in searching for investments. Relating real life experiences allows me to pursue lines of thought to find a stock that might be interesting.”
“Curiosity and imagination go hand in hand in being creative and identifying businesses.”
“I had no background whatsoever in the business world; I was an English major and I’d been a pre-med student and had no courses in business whatsoever. So I had a clean canvas and a willingness and a desire to learn and so my voyage was: ‘What makes a good investor, what makes a good investment?’”
Stocks Outperform Long Term
“I examined early on, and continue to do so, rates of return in all asset categories and made the observation that rates of return in common stocks over a long period of time was higher than anything else on an unlevered basis.”
“Thomas Phelps, wrote the book, ‘100 to 1 in the stock market’ in 1972, and to this day it remains inspirational to me and fundamental to me in terms of thinking about the issue of compound returns.”
“A return in an asset will approximate the ROE [FCF return on owners capital] given a constant valuation and given the absence of any distributions. You get that from your quantitative background. There are no constant valuations so you work hard to have a modest starting valuation.”
“If our goal is to have above average outcomes we need businesses to have above average returns.”
“We try to identify businesses that have had high returns on the owner’s capital for a long time and we spend a lot of time trying to figure out why that’s so and what caused that. What’s does the runway ahead of them look like? Is it broad and long? Do they still have the opportunity to earn above average returns on capital?”
“Rate of return is what drives us. Did I understand that implicitly thirty years ago or fifty years ago? No! Stuff that is right in front of your face sometimes doesn’t reveal itself in terms of its importance for a long time. I carry a coin in my pocket that says, ‘I am a chartered member of the slow learners’. And that’s in fact the case.”
‘Three Legged Stool’
“Leg one [of the three-legged stool approach to investing] is the quality of the business enterprise. Leg two is the quality and integrity of the people who run the business and the third leg is, what is their record of reinvestment and what is their opportunity for re-investment? Once we have those in place, we say we’re just not willing to pay very much for these businesses. Those are the three legs of the stool.”
“We try not to talk very much about the companies in our portfolio and we certainly never talk about ones that are coming in and going out.”
In March of 2010, Chuck added their first position to MasterCard. Due to regulatory concerns, MasterCard and Visa were selling at 10 or 11 times. In regards to return on capital, Chuck noted “there isn’t a word in the English language superlative enough to talk about them. You could cut the margins in half twice and you’d still be above average for an American business. So clearly something extraordinary is going on there. It also tells you there is a big target on their back; everybody wants some of that. It tells you they are probably jamming everything they can in the income statement to try to reduce how good the margin is they are showing. We think we know what causes that and we’ve quit talking about it. If you read any research from Wall Street, and we read very little, there is no-one who talks about rates of return they are earning on their capital. Because Wall Street, in general has a completely different business model than we have. Our business model is to compound our capital. Wall Street’s business model, generically, is to create transactions. What is the best way to create transactions? Create false expectations, they are earnings estimates. We call it ‘beat by a penny and miss by a penny’. That gives us opportunities periodically.”
“Everything should be made as simple as possible. Lots of very bright people can build really intriguing complicated ways to find out why something is cheap or expensive. We try to keep things as simple as possible.”
“[The managers we have owned] don’t have a screen in their office showing them the price of their stock. And lots of them do. Sometimes you find it in the lobby of a company and sometimes you find it on the CEO’s desk. That doesn’t interest us. Their focus is on the wrong thing, in our judgement.”
“We have an expression, ‘Our experience is that once a guy sticks his hand in your pocket, he’ll do it again’. So we just have no reason to go there. We constantly find people’s behaviour which is antithetical to our interests.”
“We explore, we learn and we observe; we think a lot about the businesses we have sold. Was that the right decision? We’ve concluded in a number of cases is was not. But who does it perfectly?”
Right Once or Twice + Long Runway
“Here’s an important notion: You only need to be right in your investment decisions once or twice in a career. The challenge is how do you identify that? Typically you want something that’s small.”
“A pre-med major, an English major, someone involved in the investment business – they’re all the same. They are about collecting data points and forming judgements around them. It’s all the same.”
“If we own exceptional businesses, one of the hardest things in the world is to not sell them. All businesses have hiccups in their business operations and all businesses have things occur that are unplanned for. Nothing is perfect. Not selling maybe is one of the hardest things to do. Maybe one of our greatest assets is our ability to not sell.”
“Reading business biographies you learn about people’s behaviour. Sometimes you see it through the eyes of a biographer who has a rose tint to the glasses, sometimes you see it through pure actions.”
“Follow your passion. That’s the most important thing. And read like crazy and be curious about everything. It’s relating real life experiences.”
“I’m always looking for ways to understand pricing power because pricing power is key. What is the source of their pricing power? Think about MasterCard and Visa; we have our notions and we don’t talk about it anymore. And you’ll notice the company never talks about it.”
It’s Not all Quantitative
“If this business was susceptible to purely quantitative approach, they wouldn’t need me and you would just a punch a button and it would solve for all your problems. That hasn’t happened.”
A Question for CEO’s
“One of the questions we like to ask [the CEO particularly] is, how do you measure if you’ve been a success managing this business? As you might expect some say the price of the stocks goes up, or we hit our earnings target, or we delivered on all the things the board asked of us. It’s a rare occasion that the CEO articulates an idea that shows he understands the idea of compounding the economic value per share. Why is that so? Because they’re trained to run businesses. They’re not trained to think about compounding the intrinsic value per share, which is really the single most important thing.”
Whilst Chuck has continued to out perform the Index for many years, it is interesting to note that his recent above average performance has been done entirely without any of the FAANGS. Many of the Masters cannot say the same; the likes of Google and Apple and Amazon feature in many of their portfolios. Chuck says it was simply because he ‘wasn’t smart enough or quick enough to figure them out.’ Humility indeed. But that said, it doesn’t say he’s not open to considering them.
“Everyday is a learning day and we have to figure out which of those businesses [FAANGS], if any of them are truly attractive, and not subject to rapid changes in technology or governmental intervention or retaliatory issues relating to different countries in different parts of the world.”
Curiosity and Reciprocation
Chuck tells the story of how curiosity, observation and imagination led him to a tyre company with a history of very high returns on capital, a company called ‘Bandag’, which had done well for a long period of time. Chuck arranged a meeting with the company and when he walked into the CEO’s office, the CEO had his feet up on the desk and was eating an apple … “we got a different feel right off the bat,” Chuck noted.
Bandag’s returns were three or four times the competitors. Chuck’s goal was to go meet them and figure out what business they were actually in. Bandag was a tyre company that dealt with independent tyre dealers who retreaded Bus and Truck tyres. Bandag had taken the savings generated when key input costs fell and distributed the windfall to their dealers on the basis the dealers had to use the money in their business, ‘They couldn’t buy new Cadillacs, but they could buy a new store.’
As all the Bandag stores were franchised, each was an independent dealer who worked long hours compared to the competition. In contrast, employee dealers had no share in the profits and worked shorter hours. Bandag very wisely shared the wealth with their dealers instead of passing it all onto their shareholders. As a result they built a huge loyalty network of independent dealers, who continued to use the Bandag products instead of the national tyre companies. This resulted in much higher returns on capital than other tyre companies.
Just like successful athletes develop strategies to mentally prepare for the emotional rigour of a race or big game, investors can do the same. I find setting aside some time early in the day to re-visit insights from the great investors, be it Akre, Munger, Buffett, Lynch or others, keeps me grounded and mentally prepared for when volatility strikes.
Chuck’s ‘Three Legged Stool’ criteria for identifying great investments is beautiful in its simplicity. His lessons and mental models on other aspects of business and finance are incredibly handy to have at your disposal.
You don’t have to have a major in business to succeed, nor it seems do you need to be the quickest of the mark. It’s Chuck’s innate curiosity and imagination that have allowed him to spot great companies that quite often others have missed. We’re glad to have him in our community of Master Investors and we look forward to many more inspiring lessons.
Berkshire Meeting: Omaha 2019
Further Reading: ‘Chuck’s Three Legged Stool’, Investment Masters Class.
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