“When you analyze what happened, the big money’s been made in high-quality businesses.” (Charlie Munger)
Let me kick off 2024 with another behind-the-scenes piece to show you how our analysts aim to identify new EVA Monster candidates every year. Before delving into the details, it is worth noting that our global EVA Monster database is the heart and soul of the FALCON Method service. The list of these exceptional quality-growth companies doesn’t change too often, as data reveals that good businesses seldom become bad businesses or vice versa.
As mentioned in the previous issues, our analysts seclude themselves in a rural guesthouse for several days every year to avoid distractions during this work. They comb through the raw results of our EVA-based quant screening and the ideas from select podcasts (such as Business Breakdowns), industry-specific books (like The Curious Economics of Luxury Fashion), or portfolios of other quality-growth investors worth following. In our experience, this process demands at least 40 working hours, while analyzing the new names takes roughly the same 40 hours per company. If you do the math, the newsletter’s price pales in comparison to the value provided, and we owe this to your continued support and the substantial size of the FALCON Family.
With most (if not all) of the unquestionable, high-conviction EVA Monsters already covered, we made some changes to our process. New candidates don’t automatically qualify and appear on our list but must undergo our thorough analysis first. We want to avoid situations where new names are presented in our raw data spreadsheet (published along with the newsletter) and overenthusiastic investors jump on them before our in-depth analysis could reveal possible qualitative red flags. This means our team will most likely do plenty of work without visible results (killing ideas before presenting them), but we’re fine with this as long as the FALCON service keeps improving.
Entering Uncharted Waters
As a result of our latest “rural guesthouse efforts,” seven new EVA Monster candidates appear very worthy of analyzing, with favorable odds to pass with flying colors and thus land on our global quality-growth shortlist. Additionally, more than twenty other companies made it to our “B-list” of exciting businesses that we plan to address after achieving full coverage of the higher-conviction names.
Next, let me share some of our underlying thoughts behind expanding our investable universe. One aspect influencing our decisions was the desire to broaden our circle of competence by diving deep into new industries and megatrends. For example, while Fortinet seems to be one of the best players in the cybersecurity field, we must deepen our understanding of its industry before determining the company’s EVA Monster status.
We are eager to capitalize on the growth of the experience economy, yet we have only identified two preferred business models within the tourism industry. The first is the Online Travel Agency model, with Booking and Airbnb at its forefront. These are highly scalable, dominant platform businesses, epitomizing the capital-light compounder theme with the network effect serving as their primary moat source. The second is Hilton’s scalable and capital-light franchise model, further aided by the premiumization tailwind.
Elsewhere, playing the cloud megatrend from the hardware side also sounds reasonable, so Cisco’s fierce competitor, Arista Networks, looks absolutely worthy of our ~40-hour analysis. The numbers suggest that this firm may have carved out a unique market position, becoming indispensable for cloud data center expansion through its leadership in high-speed switching for enterprise networking. Additionally, getting to know the cloud market from a different perspective may bolster our existing investment theses of affected players like Amazon, Alphabet, Microsoft, Tencent, and Alibaba, to name a few.
The second aspect influencing our decisions was the desire to explore the competitors of already covered EVA Monsters, offering dual benefits. Besides possibly giving us new investment targets, we could also gain a more in-depth knowledge of the industry and see previously analyzed firms from a different angle. For example, Adyen is the direct competitor of PayPal’s Braintree leg, and by familiarizing ourselves with the merchant acquirer role, we get a more complete picture of the highly sophisticated payment ecosystem. While this is a challenging undertaking, Adyen’s financials speak for themselves. It is a focused, pure-play business in the field that is expected to play a more significant role at PayPal, as the competitive position of the latter’s core checkout segment seems to be weakening. Overall, the time spent analyzing Adyen may well be worth it for numerous reasons.
As for additional competitor names, Porsche came up as Ferrari’s rival. Although the level of exclusivity, average selling price, and margins do show meaningful differences, Porsche still distinguishes itself from traditional car manufacturers with its exceptional financials and ~100-year heritage. The expansion of the HNWI customer base is a nice tailwind (supporting many of our EVA Monster theses); moreover, Volkswagen’s spinoff decision made this pure-play target available and worthy of analysis. Researching Porsche may give us further insights into how the consumption attitude of the aspirational middle class differs from that of the HNWI group. It would be interesting to see whether a clear distinction could be made between Ferrari and Porsche along this line, akin to comparing Kering’s Yves Saint Laurent brand with Hermès. Either way, the efforts going into our Porsche analysis could potentially yield multiple benefits.
Quality Above All Else
To conclude, I’d like to reinforce your belief that quality investing is the way to go for the long run. Vitaliy Katsenelson says, “Whenever you look at your portfolio, think of Microsoft and GoPro.” The former is a wonderful company, while the latter was an overhyped fad stock with no protective moat around the underlying business. “The performance of your stocks in the short run tells you absolutely nothing about what you own or about the quality of your decisions. You may own a portfolio of Microsofts, and its value is going down because at this juncture the market doesn’t care about Microsofts. Or maybe you stuffed your retirement fund with overpriced fads that may not be around a year from now.” There’s no question about which route I’m willing to take with my money. To round off this piece, let me quote Charlie Munger’s 1994 USC Business School Speech: “We’ve really made the money out of high-quality businesses. In some cases, we bought the whole business. And in some cases, we just bought a big block of stock. But when you analyze what happened, the big money’s been made in high-quality businesses. And most of the other people who’ve made a lot of money have done so in high-quality businesses.”
Want to learn more about our stock ranking methodology and evidence-based investment approach? Start with this blog post!
Or read more like this in the Beyond Dividends book.