This week, I listened to an enlightening podcast from MicroCap Conference, featuring John Huber, who writes the blog ‘Base Hit Investing’, and is a portfolio manager at Saber Capital. He shared his investing style and discussed about companies that he calls ‘compounding machines’.
Let me share with you what I learned from him. I strongly encourage you to listen to the podcast as well.
John categorizes his investments into two:
- Compounding machines – businesses that grow and generate significant wealth for shareholders for long periods of time
- Special situations and bargains – those which arise due to undervaluation
John is an advocate of reaping gains from the extreme volatility of stock prices. He does not favor buy-and-hold strategy. The stock prices fluctuate wildly even for the large caps, which gives us an opportunity to buy low and sell high:
The average gap between the yearly high and low price is nearly 50% for these ten mega-cap companies, or an average yearly change in market value of $130 billion. – John Huges
He believes that this dynamic exists to much higher degree in small caps. Much more such opportunities are available, than trying to find the next big compounding machine! Interesting departure from Buffett-style!
John opines that buy-and-hold strategy has one disadvantage: there are only very few businesses that can compound at, say 30%, for long time. He makes a big case for reaping the gains, taking advantage of the market volatility, even for the compounding machines that you discover.
However, I should make a point which John did not expressly say – that this strategy may not be easy to do for large stakes. In such cases, you need to slowly exit, selling bit by bit every day, taking into account the daily trading volume for that stock.
John, over his many years of experience, has steadily built a database on quality companies which he understands. He then waits for market to provide opportunities to buy or sell these stocks. He says, there will always be something happening among those 100 companies, providing either short-term or long-term opportunities.
John’s style of building up a database of companies/ businesses he knows is similar to many other investors featured in a blog post in Latticework blog (link at the bottom of this page).
John strongly believes that much of the investment mistakes happen due to choosing the wrong business, rather than going wrong on valuation of a good business.
In the first case (buying wrong business), you could lose money, while in the second case (error in valuing the good business) you might end up with mediocre returns. Mediocre returns are better than losing money. This is the margin of safety offered by the compounding machines.
Many of us believe that cash is a drag on returns. John has a different point of view: being fully invested (that is, having no cash balance) can sometimes be an opportunity cost. We might lose good opportunities when we are short of cash.
John is comfortable with having no catalyst for the stock price to appreciate. A reason to invest in a stock could be just under-valuation, rather than expectation of a catalyst.
He discusses two of his key investments:
Markel Corporation – an insurance company – was trading at 1.2x book value, which was cheap on historical basis as well as on fundamental basis. He believes that the company’s major quality is that it does not underwrite for the sake of receiving premium or gaining market share – it is more concerned about profitable underwriting. Markel also has a good investment team which deploys the float. Further, the management owns significant stake, and has their interests aligned with shareholders. Markel has been a compounding machine for a long time. John sold this stake later after the price appreciated.
Bank of Utica – is a bank in New York with only one branch, but with US$ 1 billion in total assets. John bought the stock because of its undervaluation – it was trading at 0.6x book value, which is much lower than historical average multiples, despite consistent growth in book value. John points out that the bank is very under-leveraged, with equity to total assets at 20%, and has paid out dividends every year since founding in 1929.
John is a big fan of looking at track records – especially how the companies performed during recessions.
We all have heard about moats – a term popularized by Warren Buffett. Again, John has a different point of view here. He believes that almost every company faces competitive pressure. John points out that Warren Buffett bought Coca Cola, and not Pepsi – despite that both are strong companies competing against each other. It is tough to find monopolies.
Source of featured image: Pixabay