Increasing Our Odds

As the new Lindley investment reflects, our mandate (i) is focused on finding attractive investments one-by-one and (ii) affords us the flexibility to invest capital only when we think an investment is truly compelling on an absolute basis. We assess individual investment opportunities based on our estimate of their expected returns and the likelihood that the underlying businesses will perform close to our expectations for them. This decision-making process is an exercise in assessing probabilities, and we are constantly trying to stack the odds for success in our favor. We believe two particular factors are most important for accurately predicting which investments will do best over the long-run:

• The first is the sustainability of a company’s moat. A sober assessment of a company’s competitive advantages and how long they will last is the key to understanding the long-term cash-generating prospects of a business, and hence, estimating its intrinsic value. Often this evaluation cannot be done effectively, and an investor should put the company into the “too-hard pile” and just move on. However, higher quality businesses do have competitive characteristics that allow an investor to project a company’s results to the right order of magnitude 10+ years into the future. Sometimes these advantages are on the supply side, but more often the best businesses have demand side advantages (pricing power, lack of suitable substitutes, no dependence on complementary products, patents, better R&D, etc.) that make future profitability more predictable.
• The second factor is a company’s current stock price. In what we consider a ‘law’ of investing, future returns from an asset are inversely related to the price paid for it. Buying a stock at a price that is a meaningful discount to its intrinsic value serves to prevent permanent capital loss – the biggest enemy of long-term outperformance – when an investor makes a mistake in his analysis while also providing for outsized returns when that analysis is correct. In other words, buying at an attractive price both decreases risk and increases potential return.

Alas, market participants usually value businesses with great moats accurately. When an investor can acquire such a business for a cheap to fair price, however, history suggests that Mr. Market will likely catch on sooner or later and reprice the business close to its intrinsic value, rewarding the patient investor in the process. We are in search of just such opportunities that offer both of these dynamics and meet our other core investment criteria.