In his now legendary podcast series, Patrick interviews Chuck Akre, “a now widely famous investor who founded Akre Capital Management in 1989, which now manages approximately $10B dollars.” The interview is structured around Chuck’s mental model of a 3-legged stool which happens to be very similar to Marcellus’ 3-fold criteria for investing i.e. clean management, good capital allocation and high entry barriers.
Here are some of our key learnings from this entertaining 47 minute podcast:
- If you are a person who likes to work in a peaceful environment, you are better off moving to a small town and cutting yourself off from the noise & the distractions of a big city. That’s what Chuck has done – he lives on a farm in Virginia.
- Chuck spends a lot of time reading and that allows him to ideate fruitfully (others in the team do the detailed fundamental research). Chuck studied English in university. Chuck says that reading business biographies is very useful because it helps you understand people’s behaviour in the world of business. Chuck said that aspiring investors should “read like crazy” because it allows you to relate the real world to investing. Reading also helps you understand “pricing power” in deeper, more subtle ways.
- Intelligence per se is the not the key requirement for success in investing. Imagination and curiosity are central to success for investing – they help Chuck identify new businesses worth researching. Imagination and curiosity are very distinct from intelligence.
- Chuck is famous for his ‘3 legged stool’ mental construct. Chuck hit upon the idea upon seeing a milking stool with 3 legs (which he had inherited from his dad) and Chuck realised that 3 legs are stronger than 4. That gave Chuck a mental construct around which he has built his investing style. The rest of the interview is an elaboration of this style.
- The first leg of Chuck’s stool is that the return on an asset will approximate to the ROE of that asset even as valuations jag around. So if you want to have above average returns, you need to find businesses with above average ROE. Chuck returns to this point about the centrality of ROE or ROCE again and again in the interview.
- Over and above ROE, Chuck looks for businesses where the management treats shareholders with integrity. This is the second leg of Chuck’s stool. Once Chuck finds a business owner to be corrupt, Chuck never ever invests in any business set up by that guy because he reckons the fellow will steal again.
- The third leg of Chuck’s stool is management’s track record of reinvesting surplus capital. Chucks explains in the interview how he assesses capital allocation skills of the management.
- The “Art of Not Selling” is one of Chuck’s team’s great assets. If an asset has the 3 legs described above Chuck just sits on it for many, many years.
- Chuck discusses his investment in a tyre business called Bandag and how this firm which retreads truck and bus tyres fitted the 3-stool framework. Bandag’s competitive advantage was that its distribution was only through independent dealers (whereas other tyre companies had company owned dealerships). Bandag would redistribute some of its profits to its independent dealers and the dealers would use those distributions to reinvest in their stores. In addition, because Bandag did not own the dealerships, it was a high ROE, high Free Cashflow generation business. Chuck owned Bandag for a long time and only sold when Bandag entered some European markets which it didn’t know very well.
- In the last 10-15 years the ROEs of all businesses in the USA have gone down because of the lower level of interest rates.
- Chuck has not invested in any of the FAANGs but he has still generated above average returns. He says that he did not understand the FAANGs but is now trying to understand them. Chuck has invested in Mastercard because he says that Mastercard and Visa have extraordinary ROEs which even if you cut by three-fourths, you still have an above average business.
- Chuck says that conventional Wall Street analysts do NOT focus on ROE because Wall Street’s business model is to create transactions by creating false expectations around earnings. This messed up Wall Street business model creates opportunities for Chuck because he focuses on ROE and not earnings expectations (or earnings beats/misses).
- Chuck likes to make everything as simple as possible: the bottomline of all investing is great return. That is Chuck’s key tool to look at everything. Chuck says that this can applied to even the most modern tech firm.
- One of the most common thing of high quality management teams is that they don’t have TV screens showing the stockmarket or screens showing the share price ticker. Managements which focus on the share price are focusing on the wrong thing. They are to be avoided. Also to be avoided are companies which call up and ask “why are you selling our stock”. Chuck says that when he asks CEOs “how do you measure whether you are being successful in running this business?”, it is rare to find a CEO who understands that the real measure of success is compounding the cashflows of the business.
- Chuck owns a company called O’Reilly Automotive which is part of an oligopolistic setup. O’Reilly acquired a company called CSK Autoparts in 2007 because the 2 firms had complementary footprints. O’Reilly did a superb job of integrating the two firms. O’Reilly had very little debt on its balance sheet. The acquisition worked out nicely and the company started throwing off lots of cashflow. Using that cash O’Reilly has bought back 40% of shares outstanding at very reasonable prices. Chuck is a big fan of company’s that allocate capital wisely and hence continues to be a shareholder in O’Reilly.
- Chuck then describes companies which earn the cash first and book the revenue later i.e. negative debtor days. These sorts of companies Chuck believes are underappreciated by the market. The “float” that these companies earn is very valuable and these companies typically end up understating profits.
- Chuck believes that the telecom tower companies are being undervalued by the market because the market doesn’t appreciate how much more dense the tower networks will have to become as we – the customers – demand faster communication. The towers will keep collecting higher and higher tolls for many many years. However, Chuck does not like data centres because the data centres do not have the pricing power i.e. the ability to collect tolls the tower companies do.
- Sometimes great businesses like American Tower come wrapped in bad balance sheet. You as the investor then look through the bad balance sheet and understand that wrapped in the bad balance sheet is a cash machine. The CEO of American Tower laid out a clear deleveraging plan and Chuck invested because he could see that the deleveraging plan would work. Chuck then kept buying more stock over the course of the next 10 years.
- You only need to be right with investment decisions only once or twice in your career! The challenge is to know which investments will give you that long term, multidecadal compounding.
- What causes Chuck to sell – when one of the legs of the stools is found to be defective.
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Note: The above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. The information provided is intended for educational purposes only. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India (SEBI) and is also an FME (Non-Retail) with the International Financial Services Centres Authority (IFSCA) as a provider of Portfolio Management Services. Additionally, Marcellus is also registered with US Securities and Exchange Commission (“US SEC”) as an Investment Advisor.
