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Ironman is the fancy name of long-distance triathlon that consists of a 2.4-mile (3.8 km) swim, a 112-mile (180 km) bicycle ride, and a 26.22-mile (42.2 km) marathon run, in that order and without a break. By completing two Ironmans, I have gained some valuable insights along the way into how the characteristics required for success in long-distance endurance sports and long-term investing are strikingly similar.

I bet most of you didn’t know that reputable value investor Peter Cundill could run a marathon in under 3 hours, even past his young years. Also, did you notice anything special about Warren Buffett’s 2012 letter to shareholders? That’s the one in which he highlights that Berkshire has a lot of home-grown talent when it comes to sports: Ted Weschler, one of the younger investment managers, has run the marathon in 3:01, while his colleague Todd Combs specializes in triathlon. I believe it is not pure happenstance that some well-known investors are involved in endurance sports, so I’d like to share some parallels and revelations that came to me during those 20-hour training weeks.

Let’s start with the hidden element. Do you think that triathlon consists of only three parts: swim, bike, and run? Wrong. It’s humanly impossible to cross the finish line of an Ironman without following a good race nutrition protocol. This is the hidden element that the more spectacular parts cannot work without, and this field is much more complex than you might imagine. We also have such a crucially important invisible factor in investing: psychology. Anyone can crunch the numbers and do some kind of valuation, but most investors let their inborn biases sabotage their success. Psychology may not sound too exciting, but it still makes up about 90% of the success equation when it comes to investing.

How well can you endure monotony? Running 50+ laps on the track and cycling 90+ laps on a short flat track were part of my preparation. While my friends say they would go crazy if they had to do this, I usually have a great time during these training sessions. I can either switch off mentally and relax or direct my thoughts to something I want to delve deep into. There’s nothing fancy about an Ironman preparation like there is nothing fancy about sensible investing. You don’t change the strategy week in and week out just to get some excitement, and you must be prepared to stick with the boring stuff even when all the others seem to be having a great time. (The boring stuff refers to our hardly changing Top 10 of undervalued quality stocks in this overheated market.) Enduring monotony is essential to becoming a successful investor; chasing fads is detrimental to your wealth.

What about pain? In my experience, every big goal in life that is worth pursuing keeps asking along the way how bad you want it. Nothing comes easy, and the excuse to give up lurks around every corner. Let me be as straightforward as possible: you will have to endure suffering along the way to financial freedom. Neither sporting nor financial success can be achieved without pain. Only those who can keep buying the out-of-favor quality stocks when there’s blood in the streets will reach their goals. This is easier said than done; don’t say I didn’t warn you! I believe that I am mentally tougher than most people, and I often experience this at both triathlon races and stock investing. Sebastian Kienle, the 2014 Ironman World Championship winner, puts it this way: “If it’s hurting me, it’s killing them.” When it starts to really hurt me, the market has already fallen apart, and others have capitulated.

We are judged by what we finish, not what we start. Starting strong is meaningless if you cannot keep up the pace and thus end up quitting halfway through the race. Do you think it’s easy to find your own pace and stick to it no matter what the others are doing on the race track? Think again! Just like it is incredibly hard not to deviate from your investment plan when others are getting rich with seemingly ridiculous speculative bets, it also requires discipline not to follow the crowd at a race. My first competitive marathon taught me this lesson in an unforgettably painful way. Know your sustainable pace, have a plan, and stick to that plan no matter what!

You will only achieve your big goals if you learn to enjoy the way that leads to them. Yes, it will involve pain and suffering, but it also gives you a chance to get to know your true self. There’s a saying that “Triathlon doesn’t build character. It reveals it.” Keep monitoring your state of mind, and you can learn so much along the way that the race becomes a celebration of all your efforts and accomplishments. Your investment journey will also serve as a mirror that won’t do you any favors in the form of positive distortions. Are you prepared for what you’ll see?

No matter your goals, you must take 100% responsibility for all your actions and stop blaming circumstances outside your control. Those circumstances may affect others as well; it’s your reactions that determine your results. No excuses; you have to keep moving, “this marathon will not run itself,” as I usually say when I am unwilling to stop regardless of how I feel. Setbacks do happen; it’s up to you to make the most of them, learn the lessons, and come back stronger. If you have the determination and perseverance, you can become financially free, an Ironman, or whatever you set your sights on. It’s only a matter of time.

The key is setting the proper goals since you can have anything you want but not everything! You’ll need to prioritize, and after having your clear number one goal, it is wise to learn from someone who has already done what you are aiming for. This approach lets you proceed toward that goal on a somewhat less bumpy road at a higher-than-normal speed. This is exactly what the FALCON Method Newsletter is intended to help you with regarding your investments, and this is why I was following a training plan created by a professional triathlete with my Ironman preparation. Once you cross the finish line (achieve financial freedom, that is), you’ll realize that what you have learned and experienced along the way is much more valuable than reaching the goal itself. That knowledge is yours to keep forever, and you can share it for the benefit of your loved ones. The journey is the destination, as they say. It is time to stop wishing for that goal and start working for it.

If you liked this piece, you may also want to take a look at my Confessions of an Ironman book.

You can also find more insights and tips for your investment journey in our Blog.

Several members sent us anxious emails after learning that “superinvestor” Mohnish Pabrai had sold ~80% of his Alibaba holding during the third quarter of 2021. While monitoring the 13F filings of renowned investors may be useful, we never advocated mindless coat-tailing, so let us share the thought process that runs through our minds when we bump into news like this.

We wholeheartedly agree with Bill Nygren of Oakmark Funds, who says, “the reason people have so much trouble with the sell decision is because they didn’t have a well-defined buy decision. If you really know why you decide to buy a stock and why you own it, then the absence of those reasons becomes the reason to sell.” At the FALCON Method, we didn’t just copy Pabrai and the other “superinvestors” (in fact, we had bought Alibaba before most of them disclosed their positions); we did our homework and built the investment thesis from scratch. One should only use the 13F info as input to start their independent analysis since borrowing an idea is seldom enough to take you to the finish line; you will need conviction.

After days of in-depth analysis, our team of analysts tends to invest a couple of hours in summarizing the investment thesis, identifying the most important drivers of performance, and listing the key metrics to monitor with every company. We also put together a short and simple premortem that forces us to build out that side of the probability tree where things don’t work out. It’s important to note that the premortem process occurs before an investment decision is made. We basically assume that we are in the future and the decision we made has failed. We then provide plausible reasons for that failure. Psychologist Gary Klein’s research shows that premortems help people identify more potential problems than other techniques and encourage more open exchange because no individual or group has yet invested in a decision. Without a premortem, we don’t see as many paths to the future in which we don’t reach our goals, while in reality, that can be a pretty robust part of the probability tree.

Once we are done with this process, we know exactly what to monitor closely with each and every company we invest in. As for Alibaba, the number of active China accounts and the gross merchandise value give us valuable clues on the level of disintermediation risk, while the cloud segment’s revenue, margin expansion, and market share dynamics may show how the “Amazon
story” is playing out. We have minimum thresholds for revenue and EVA per share growth, as well as for the EVA Margin, and the violation of these levels would prompt us to revisit our thesis. That said, we don’t believe that a single quarter’s results could be enough to make us change our minds.

The first thing we tend to check when news like Pabrai’s sale hit our mailbox is whether our well-defined investment thesis is broken. All in all, the list of valid reasons to sell a stock is relatively short: (1) We were wrong, (2) the stock became overvalued, (3) or we have a much better investment idea and need to free up capital. With Alibaba, number one is too early to call. Number two seems out of the question unless we assume the imminent collapse of the firm’s fundamental business performance. As for reason number three, the bar set by Alibaba’s total return potential looks way too high to justify a sell decision at this point.

Before moving on, we’d like to remind you that widely acclaimed investors will never call you before they sell (or buy) a stock, so managing your portfolio does require independent thinking and conviction that is based on in-depth analysis. Your emails reveal that most of you think Pabrai must have some insider information that led him to reduce his Alibaba position. While he may have an even better investment idea, history proves that selling a compounder is almost always a mistake. Warren Buffett’s Disney and McDonald’s investments come to mind, but you can also think of how Carl Icahn missed out on tremendous amount of gains by selling Netflix and Apple, or how Fundsmith’s Terry Smith screwed up with his Domino’s Pizza exit. Yes, Virginia, even “superinvestors” make such costly mistakes, which shows that they seldom (if ever) have that kind of insider info you suspect to guide their decision-making. Joseph P. Kennedy, former chairman of the Securities and Exchange Commission, whose son was President of the United States, put it perfectly: “If I had all the money that has been lost on inside information, I’d really be rich.”

As for managing EVA Monster positions, Howard Marks’ thoughts come to mind: “There’s a joke going around that in the factory of the future there is one man and one dog. The dog’s job is to keep the man from touching the equipment, the man’s job is to feed the dog. Most investors, in the same way, need a dog that has the job of keeping them from putting their hands on the portfolio.” We believe that we are best served by doing nothing as long as the EVA Monster characteristics of a business remain intact. If it feels uncomfortable holding Alibaba at this point, rest assured that this is, by definition, part of successful investing. (If your sleep is ruined, you may have to revisit your position sizing, though.)

Many of you keep asking us about the evolution of the FALCON Method and whether we are abandoning the income-focused approach we employed back when this service started. We are always on a hunt for quality dividend payers that are marked down. As the years went by, however, the pricey institutional-level data clearly supported our experience that there was a strong correlation (82%, to be more exact) between where EVA (Economic Value Added) goes and the level of shareholder returns. Take a look at this picture and see some examples to alleviate your doubts.

Investing for income alone is a mistake, the price of which is a subpar total return that negatively affects one’s future purchasing power. While we love passive income, only a snake oil salesman would try to persuade you that quality dividend payers are attractively priced in today’s market. Please do yourself a favor, and relinquish your focus on the entry dividend yield parameter as long as the scarce breed of high-quality growth companies may be the last mispriced assets. (Since it is almost impossible to overprice them based on the near-term multiples that most investors are fixated on).

If you found this article helpful, be sure to check out our Blog for more insights and tips for your investment journey.

Chances are that, just like us until a couple of weeks ago, you have never heard of Giverny Capital, even though the name might sound familiar. It was inspired by one of the most breathtaking gardens in the world, created and cared for over many decades by Claude Monet, the pioneer of the Impressionist movement. François Rochon is a Canadian investor and the founder, long-term president, and portfolio manager of the Montreal-based firm. We are bringing him up because we recently came across his annual letter celebrating the 30th anniversary of his flagship fund, the Rochon Global Portfolio. Such longevity is rare among asset managers, making him one of the most seasoned investors with a quality-growth focus.

Rochon’s investment philosophy revolves around owning a small number of great companies for the long term. Emulating the dedication required to preserve Monet’s garden, his mission is to create wealth through thoroughly selected, high-quality securities. As he once noted, “Our attitude is that of a museum director: we only want to own masterpieces.” Rochon aims to hold around twenty companies in his portfolio, with an average holding period exceeding seven years. He strives to remain unfazed by the vicissitudes of the economy, geopolitics, and financial markets, remaining fully invested at all times and accepting that trying to time the market is a fool’s errand. The Rochon Global Portfolio has returned a whopping 14.8% annually over a period of 30 years, compared to 10.2% for the S&P 500. Even if we consider that these are pre-fee results (which would deduct about 1 percentage point), the outperformance gap speaks for itself.

You might start to wonder whether, with such long average holding periods, this investment performance should exhibit some correlation to the underlying fundamental results of the companies in Rochon’s portfolio. We believe the single most valuable takeaway from his annual letters is an incredibly long track record of the fundamental performance of his portfolio constituents going back almost to the fund’s inception. Since 1996, he has included a summary table in each year’s report containing the growth in the intrinsic value of his companies, using Warren Buffett’s “owner’s earnings” approach. He estimates the increase in the intrinsic value of his holdings each year by adding the growth in EPS and the average dividend yield of the portfolio. This analysis is not exactly bulletproof (we would prefer EVA-based metrics); still, it is approximately correct over multiple decades. In fact, between 1996 and 2023, Rochon’s portfolio constituents have grown their intrinsic value by 12.9% annually, matching the 12.9% annualized return their stocks have produced over this timeframe. Of course, the figures could deviate significantly in a single year due to fluctuations in valuation, but the long-term trajectory is self-evident.

We have long known that investment returns are determined by the fundamental performance of the underlying companies in a buy-and-hold portfolio. Seeing such quantitative evidence in a real-world setting was nevertheless reassuring. The longer the holding period, the closer your returns will match the underlying companies’ fundamental return, but this is by no means a green light to be valuation-agnostic, as you can be right about the success of a business without necessarily achieving a good return on your investment when you lack caution regarding the price paid.

No wonder Rochon’s analysis made us curious about how the EVA Monsters within our investable universe fare in a similar backtest. We chose a timeframe of ten years, as it seemed like a fair compromise between a long enough period and sufficient company data, given that a substantial number of names have barely longer track records as public entities. We compiled a hypothetical equal-weighted portfolio in 2014 (investing $1,000 in each company) and computed the look-through EVA for the group. We repeated this exercise for today as well, keeping the same number of shares from each company and letting them “run freely” over the period. Note that the look-through EVA contains the impact of share repurchases as well, as it is computed using the aggregate EVA per share figures of the portfolio constituents at both points in time. We also added our estimate of the average dividend yield of the companies as the best proxy to model the contribution of dividend payments. The results were staggering: our EVA Monster universe delivered an annualized total return of ~23%, of which ~21% can be attributed to the fundamental return component. For reference, the S&P 500 has delivered a ~12% annualized total return over this timeframe, out of which the fundamental return explains ~9%.

Two major takeaways to note from this comparison: (1) the fundamental return of the EVA Monster universe has been head and shoulders above the market’s average. One could argue that there is survivorship bias (since we composed our universe based on exceptional backward-looking fundamental performance), but we contend that these companies also have excellent prospects going forward, even though the gap will likely narrow to the S&P 500. (2) The impact of valuation is quite similar in both groups (2 percentage points tailwind for the EVA Monster universe and 3 for the S&P 500). Its contribution is rather modest in both cases, and it would likely diminish over multiple decades, as shown by Rochon’s analysis.

It’s crucial to understand that two equal total return potentials could vastly differ in composition. We are talking about two completely different investment scenarios depending on whether the fundamental return or the change in the valuation multiples is the key contributor. On the one hand, we deem our EVA Monsters capable of delivering double-digit fundamental returns for years to come. These firms are best suited for true buy-and-hold investing, which requires judging the sustainability of above-average fundamental performance and trying to avoid overpaying. On the other hand, the typical Fallen Angel investment thesis is about an expected recovery in valuation multiples, leading to an attractive total return potential despite the (more often than not) subpar fundamental performance outlook. Remember, though, that a valuation rebound is a one-trick pony. In either case, the longer you hold onto these names, the higher the chance that your performance will converge to the underlying fundamental performance of your holdings.

If you found this article helpful, be sure to check out our Blog for more insights and tips for your investment journey.

Our goal with exceptional quality-growth businesses is to become long-term owners. This essentially means that we are entrusting the custody of our capital to the right people, preferably at the right price. As Fundsmith’s Terry Smith notes, “When you choose to invest with us on behalf of your clients, you’re subcontracting their capital to us to look after. The reality of this process is that we subcontract it to the management of companies.” In the long run, our investment performance will depend heavily on whether these management teams are exceptional stewards of shareholders’ capital or squander opportunities for the sake of short-termism and pleasing Wall Street.

We believe that founding families having a substantial ownership stake tilts the odds in our favor by aligning incentives, and the numbers prove us right. Extensive research conducted by Bain & Company compared founder-led firms with the rest of the S&P 500 and discovered that the former group outperformed the latter nearly threefold between 1990 and 2014. Similarly, using its proprietary database of 1,000+ publicly listed family or founder-owned businesses, Credit Suisse found that between 2006 and 2020, this universe outperformed non-family-owned companies by an annual average of 370 basis points. As a side note, although the latter study found that those with the largest family ownership stakes (over 70%) achieved the highest returns, researchers do not believe that a linear relationship between the two variables can be identified. This suggests that the simple notion of family involvement appears to be the decisive factor in the outperformance of these businesses.

We can find a clear underlying distinction in how these companies allocate capital, which is essential for long-term shareholder value creation. Multiple studies have shown that if the founder or the founding family is involved, substantially more money is spent on both intangible assets and traditional capital expenditures. Note that the difference seems most staggering in the R&D category, which we think can partly be explained by the accounting treatment of these expenditures. As a reminder, research costs (along with marketing dollars) get directly expensed instead of capitalized and amortized over time (like investments in physical infrastructure), a problem the EVA framework rightfully remedies. Outside management teams are less inclined to report lower profits (even temporarily) despite the risk of underinvesting and eroding the moat. Additionally, it is no wonder that founder-involved businesses tend to have ~30% more patents than their peers, which is evidence of their propensity for taking calculated risks to foster innovation.

We believe that an owner’s mindset is not only evident in the capital allocation policy of these companies, but it also infuses them with a profound sense of purpose and drive, prioritizing sensible risk-taking and a culture of personal responsibility. As opposed to a typical public company focusing on meeting quarterly earnings guidance, a founding family’s personal net worth is tied to the business, leading to a virtuous cycle of long-term value creation. A hired CEO expecting to spend just a few years at the helm is unlikely to act in the same way as an owner-manager with an oftentimes multi-generational timescale.

The quantitative evidence certainly indicates that using founder involvement as a screening criterion has its merits as a strategy. Rob Vinall, a fund manager who openly prioritizes this aspect, states: “I invest almost exclusively in companies with active and engaged owners. Very occasionally, you find managers who think and act like owners even if no owner is present, but this is the exception rather than the rule. If a restaurant has an absentee owner, over time the service quality will slip and the waiters will have their hand in the till. With large companies, it is no different.” That being said, our primary focus in EVA Monster screening remains shareholder value creation. However, we had the impression that in our investable universe, family involvement might be higher than average. After compiling the relevant data, we discovered that every second EVA Monster in our coverage meets the criteria of family ownership with a 10%+ stake and/or is led by an actively engaged founder. This ration is at least two times higher than among members of the S&P 500 index. While it is difficult to ascertain whether there is merely a correlation or even causality between shareholder value creation and family involvement, this revelation nevertheless astonished us.

Investing in founder-led firms doesn’t guarantee success. However, the overarching idea is that, all else being equal, founders tend to exhibit higher levels of determination, discipline, resourcefulness, and self-accountability, translating to durable and oftentimes more dynamic EVA growth over the long run. Our view is unchanged in the sense that we look for the combination of a strong secular growth theme and great business strengths first and only then judge management quality or founder involvement, not the other way around. As long as there is a CEO who is a good capital allocator and business operator at the same time, their ownership background is rather irrelevant. This is a rare breed indeed, even though excellent managers such as Microsoft’s Satya Nadella are here to remind us that they do exist.

If you found this article helpful, be sure to check out our Blog for more insights and tips for your investment journey.

This blog post is dedicated to providing a behind-the-scenes look at how subjective considerations can influence the compilation of the monthly Top 10 for the newsletter, with a particular focus on our EVA Monster candidates. While the backbone of the underlying process will always be the quantitative ranking of our investable universe constituents based on their total return potentials, we argue that a more nuanced approach produces a better outcome. This, in fact, reflects the thought process behind how our analysts manage their own money, which has to be consistent with the newsletter, as this is a pillar of our integrity.

The problem with a purely quantitative ranking is that a mere total return potential figure does not fully reflect the range of possible outcomes. As a quick recap, a good rule of thumb is that we expect our typical EVA Monster to deliver an annualized fundamental return of 10-15%, comprising the firm’s EVA growth potential, share buybacks, and dividend yield. Since we derive our total return estimates by incorporating the impact of valuation, it’s unsurprising that when the total return potential significantly exceeds 10-15%, betting on a valuation rebound will likely play a pronounced role for an investment candidate.

A common theme in those situations is a rather pessimistic market perception, requiring a case-by-case evaluation with a contrarian mindset. “The best thing that happens to us is when a great company gets into temporary trouble. We want to buy them when they’re on the operating table.” The intent from this classic Buffett adage is easier said than done, as these stocks often turn out to be difficult to hold amid periods of turbulence. We reckon that when a company of EVA Monster caliber (head and shoulders above the typical S&P 500 member in quality and growth terms) gets into a dire situation, there is a good chance it will recover, much like an elite athlete having better odds on the operating table compared to a chain-smoker. Suppose an EVA Monster trades with close to zero or a negative Future Growth Reliance ratio (implying that its EVA could stagnate or shrink from the current level). In that case, it is usually a “heads I win, tails I don’t lose much” scenario. Sometimes, the market will be right, and the competitive position may have suffered damage beyond repair, serving as a bitter reminder that even though probability is on our side, this does not mean certainty. While these investment situations could offer favorable risk-reward ratios, we must also acknowledge that not all of us have the same tolerance for bearing the inherent volatility that almost always accompanies such cases.

Let’s now consider the concept of “hitting the sweet spot”. We refer to a select group of companies as “crème de la crème,” highlighting their superiority even within our elite EVA Monster universe. The common thread among them is the combination of an unassailable competitive position, exceptional reinvestment opportunities, and, more often than not, a high degree of revenue stream diversification. Microsoft, Amazon, Alphabet, LVMH, L’Oréal, and Hermès serve as prime examples of this class, although it’s important to note that this labeling represents more of a spectrum than a clear-cut categorization.

Occasionally, some of these top-tier companies come close to reaching the upper echelons of our coverage in terms of their respective total return potentials, albeit this isn’t sufficient to qualify them for the Top 10 on a quantitative basis. While our sample size is somewhat limited, we have numerous examples where companies like Microsoft, Hermès, or LVMH briefly traded at levels offering double-digit total return potentials, only to swiftly reverse their share price trajectory and perform remarkably well in subsequent periods. Hindsight is 20/20, but we argue that seizing such opportunities and including these juggernauts in the FALCON Portfolio would have been the right decision. Quoting Buffett again: “The biggest mistakes I’ve made by far are mistakes of omission and not commission. I mean, it’s the things I knew enough to do. They were within my circle of competence, and I was sucking my thumb… Those are the ones that hurt.” In these specific cases, the mistake of omission was caused by the intention to avoid compromising on the prospective return, thereby missing out on rare opportunities to become an owner of these world-class businesses.

When crunching the numbers, we must draw the line of “enough” for the total return potential somewhere, so we’ve set the goal to achieve a comfortable double-digit annualized investment return on a portfolio level. Generally, our standard approach is to pull the trigger midway between our “accumulation” and “full position” price thresholds. In practice, this means including a stock in the FALCON Portfolio when our modeled total return potential hits ~18%. This serves as a built-in margin of safety, as even if we are not entirely correct, achieving the targeted 12% total return still seems within reach.

However, there is an important distinction: the more confident we are in our modeling and the narrower the range of outcomes, the lower margin of safety should be demanded in total return terms. We argue that it is worthwhile to consider building a position in the top-notch companies even if their total return potentials “only” reach 12%, reflecting our stronger conviction that they can deliver on their modeled EVA growth trajectory. For these EVA Monsters, we would contemplate subjectively catapulting their stock into the newsletter’s Top 10, possibly coupled with inclusion in our FALCON Portfolio if they are not already members. As luck would have it, a subsequent collapse in share price can happen anytime, so buckle up for that as well. Taking advantage of those situations is the straightest path to long-term wealth building.

One thing is for sure: no matter how outstanding a business may be, its stock can always be too expensive, so we are not willing to compromise beyond a certain point. Therefore, if our model shows a single-digit total return potential, a company will never be subjectively promoted to the Top 10, let alone become a Top Pick. In such cases, we have high conviction that the valuation component could act as a headwind over the long term, likely leading to subpar investment returns. While we might be wrong at times, it is worth keeping the good old process-outcome matrix in mind to systematically judge the results of our decision-making framework. Now let’s see what the FALCON spots this time!