INTERVIEW EXCERPTS OF PAT DORSEY, TOM RUSSO, CHARLES DE VAULX, THOMAS S. GAYNER ON THEIR INVESTING STYLE

Following are the excerpts of Interview with Great Value Investors done by MOI Global Community at Latticework 2017 Summit:

PAT DORSEY (President of Sanibel Captiva Investment Advisers and ex-Director of Equity Research at Morningstar)

Smart managers can build moats; they can enhance moats; they can destroy moats, but they are not moats themselves because management comes and goes.

But if the brand doesn’t change my behavior one of those two ways, I would argue it’s not worth a dime. Think of the Sony [SNE] brand. The Sony brand is incredibly well known. It’s one of the top 20 most valuable brands in the world; according to the big annual Interbrand survey. But would anyone reading this interview now pay 20% more for a Sony DVD player relative to one from Philips [PHG] or Panasonic [PC]? I doubt it. So, there you have a company with mindshare. Sony has mindshare. We’ve all heard of it; we know Sony well, but it doesn’t change our behavior. So what good is the brand?

I think of big pharma almost as a distribution platform more than anything else. Part of their value is, to some extent, those giant R&D labs, but so much of the innovation is happening in large molecule drugs and in biologics right now. You hear the big pharma companies buying the more innovative smaller businesses and that the value a big pharma company generates is in having this massive distribution platform, trusted relationships with tens of thousands of practitioners around the globe, and that’s going to be very hard to replicate, much more so than having a new innovative molecule.

Think about LVMH [Paris: MC] and their focus on exclusivity. They’ll actually destroy unsold bags. They’ll take a $2,000 bag and just shred it to keep that scarcity out there.

Everything Amazon does is about making the customer experience better, and that’s why people use it. I’ve probably given 50 talks on moats around the world, and I always ask the audience how many people have bought something off Amazon without checking the price anywhere else. Usually over three-quarters of hands go up, which is an amazing statement when you think about the ease of checking the price somewhere else. So focus matters, not diversifying.

There’s a lot of opportunity to reinvest capital at a high incremental rate of return, and that moat and that ability to reinvest for ten years before someone really wanted to steal your competitive lunch are incredibly valuable.

Whereas the moat for a business that has reinvestment opportunities is very, very valuable. That’s often how I think about the “when do I want to pay up for a moat” question, is whether that moat is actually going to allow the company to reinvest a lot of capital at a high rate of return, or does it just add stability and predictability.

JOSH TARASOFF (General partner of Greenlea Lane Capital) and TOM RUSSO (managing member of Gardner Russo & Gardner)

JOSH TARASOFF Mr. Russo looks for companies with strong free cash flow characteristics, who produce high rates of return on their assets and have strong balance sheets. These have typically included branded food and beverage companies, tobacco companies, and advertising-supported media. In particular, he commits capital to leading global consumer products companies whose brands enjoy growing market shares in parts of the world undergoing economic growth and enjoying increasing political stability.

TOM RUSSO: I try to ground my investments in habits and preferences that are longstanding and I look for businesses where the rate of dislocation is intentionally slow. Generally we found that to be the case. It’s generally slow in the parts of the world where we inhabit, all of us. Gillette’s flattened in North America. Many of the businesses that are anemic in their operations here are sold, but where you’re specialized, you can find those that are blessed within international fields, in which they can plow and farm for future opportunities, and that’s been our big benefit. Our businesses have done a good job along the way harnessing the power of technology. The one business we have today that may be at risk, technology change is also confronting secular issues as it relates to the demand of their product, would be JCDecaux.

CHARLES DE VAULX (Chief investment officer at International Value Advisers)

There are several things I want to mention, but if there was one overriding theme, it’s the clarity with which he conveyed to me the obvious if one is mathematically inclined: if you can minimize drawdowns, and if you can minimize losses one stock at a time in your portfolio, that is mathematically one of the surest and best ways to compound wealth. This is opposed to shooting for the moon, betting the farm and trying to find stocks that may go up ten times – the ten baggers.

It’s important to note that diversification is okay as long as it has nothing to do with the benchmark, as long as you’re willing to make big negative bets and as long as you know your companies well enough to have accurate intrinsic value estimates. We define intrinsic value as the price a knowledgeable investor would pay in cash to own the entire business.

Marty Whitman coined a while back, which is that it’s not enough for a stock to be cheap, it also has to be safe – “safe and cheap”. Safety starts with the balance sheet.

The more leverage there is, because leverage magnifies everything, you should ask for a bigger discount. You may also, depending on the leverage, want to size your position accordingly.

When you have very low interest rates as we have now, it becomes a lot harder for stocks to become dirt cheap.

Over time, in terms of how do we improve the process and the judgment, I would mention two improvements. One, for many years, we typically only calculated one core intrinsic value estimate for a company, and typically we did not do discounted cash flow (DCF). We did not try to guess what the future earnings of a company would be. We would typically rely on merger and acquisition multiples, private market value, that sort of thing, but the one thing we started doing a few years ago is we computed a worst-case intrinsic value. We make much harsher assumptions regarding revenues. We make much harsher assumptions regarding operating margins. We try to better understand what costs are fixed, what costs are variable, and when we run these worst-case scenarios, it gives us, of course, worst-case intrinsic values that can help us identify some good entry points into stocks.

THOMAS S. GAYNER (Chief Investment Officer of Markel Corporation)

One of the great investors I’ve tried to learn from is Shelby Davis. Shelby said that you almost never come across frauds at companies with little or no debt. If you think about it, that statement makes perfect sense. If a bad person is going to try and steal some money, they will logically want to steal as much as possible. Typically, that means they will have as much debt on the books as possible in addition to equity in order to increase the size of the haul. Staying away from excessive leverage cures a lot of ills.

My main worry right now is the possibility of inflation due to the actions of the government. Inflation is part of how the world is trying to get out from under the excess level of leverage that exists.

The most important real protection is to own businesses which can reprice their products faster than their costs rise. That is a lot easier to say and describe than it is to actually find.

Natural resource stocks would probably go up as that environment manifested itself but I’m not sure that those are really good businesses in the long run. Every time an oil company pumps out a barrel of oil, it needs to replace that to keep going next year. The costs of finding new supplies tend to go up just as much if not more than the sales prices. The accounting lags reality since the costs of goods sold reflect historical rather than future costs, which creates an illusory accounting profit that isn’t real in an economic sense

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