The Best Stocks Hiding In Plain Sight w/Shawn O’Malley (MI380)
Summary
Hidden Compounders: The guest focuses on identifying underappreciated, durable businesses—often boring—that compound capital over long periods.
Old Dominion Freight Line (ODFL): Positioned as a standout LTL carrier with an “invisible moat,” superior ROIC, disciplined operations, and culture-driven advantages enabling decades of outperformance.
Murphy USA (MUSA): Highlighted for its gas station/convenience model tied to Walmart proximity, high volumes, and tobacco-driven retail margins supporting strong ROIC and multi-year compounding.
Serial Acquirers Theme: Emphasis on firms like Teqnion (TEQ) and Berkshire Hathaway (BRK.B) that buy high-quality niche businesses, leverage decentralized structures, and build culture-based moats.
Chipotle (CMG): Used as a case study of a young company with a “moat under construction,” illustrating early recognition of scalable, durable unit economics.
Moats and Risks: Discussion covers intangible moats, Lindy effect resilience, avoidance of flashy sectors, and pitfalls like value-destructive M&A and fading franchises.
Transcript
(00:00) the holy Grill of investing is finding Compounders that most people don't even realize are Compounders I really love this framework because it is simple but also true in my years of studying stocks I have continuously been surprised that there are so many wonderful companies to be found out there that are not only great Compounders but also largely hidden in part these Compounders may be hidden because their Moes aren't easily recognizable but what are we to make of companies that based on their track record clearly have some competitive (00:26) Advantage though it's not easy to Define what that is [Music] hello before we dive into the video be sure to click that subscribe button so you never miss an episode show us some love by giving a thumbs up and sharing your thoughts in the comments your support really means everything to us hey guys today we'll be talking about hidden Compounders and finding the best companies that are hiding in plain sight there is nothing sexy about the companies I'll discuss today but as an investor that really shouldn't matter to (00:58) you sometimes the most plain and simple businesses are the most profitable the great investor Peter Lynch is probably the most famous for talking about investing in boring businesses his book went up on Wall Street discusses at length how individual investors can get advantage in markets by investing in companies they know well through personal experience as well as businesses that are uninteresting he writes quote a company that does boring things is almost as good as a company that has a boring name and both together (01:23) is terrific Peter Lynch is best known for running the Fidelity mellin Fund where he racked up one of the most impressive careers in Wall Street history in just 13 years Lynch takes a Bottoms Up approach to investing aiming to thoroughly understand a company its prospects its competitive environment whether the stock can be purchased at a reasonable price rather than having some formula or screen that enables him to quickly pick stocks he chooses to instead investigate them one by one to assess what story can be told about (01:50) their future you can probably imagine the types of things he looks for like earnings gross and low price earnings ratios but what's interesting to me and relevant to this episode on hiden Compounders is that he specifically makes a point of emphasizing his interest in companies that are particularly unappetizing that is companies that operate in a boring field or even do something that is disagreeable or depressing this could be anything from a company that operates funeral home to one that does waste disposal on the flip (02:16) side he finds hot stocks and exciting Industries unattractive since they're likely to Garner a disproportionate amount of attention from Wall Street so to reiterate what I find interesting is not only trying to find companies that are Compounders which are essentially stocks you can Buy and Hold for several decades with such profitable businesses and attractive growth opportunities that they can single-handedly and reliably generate market gting returns but also companies like this that are hidden in plain sight they're secret Compounders (02:43) as Manish pu calls them on our we study Billionaire's podcast back in May 2020 Manish told listeners that one of his biggest career mistakes has been not appreciating the power of Compounders let's listen for most of my investing career I always focused on finding 50 centar bills and basically the idea was invest at 50 cents sell at 90 cents hopefully the transition from 50 to 90 happens in 2 or 3 years and that's a great anualy rate return well there are two three problems with that number one is taxes because you end up with (03:16) significant tax bill and the second is that you have to continue to be right so if I invest in a company for three years and I double my money I now have to find a second investment for three years and I have to keep finding these two three year BS and I have to always keep being right and so it's not that easy to continuously be right like that fast forwarding a bit Manish goes on to add the following let's listen again there are three kinds of businesses businesses that are cheap but not necessarily great Compounders they (03:55) just cheap on current earnings and what they'll make in the future but who knows where they are 10 years from now right then the second is that there are Compounders which are well known and Visa Mastercard Coke and AMX and so on and Costco and they've got huge runways ahead of them those businesses which are known Compounders probably rightfully trade at high multiples then there's the third class of businesses which I would say are the hidden Compounders so the hidden Compounders is where I have put all my (04:30) efforts now okay because that's the holy grail for me may not be F the investor I couldn't put it any better the holy Grill of investing is finding Compounders that most people don't even realize are Compounders I really love this framework because it is simple but also true in my years of studying stocks I have continuously been surprised that there are so many wonderful companies to be found out there that are not only great Compounders but also largely hidden in part these Compounders may be hidden because their Moes aren't easily (04:59) recognizable it's pretty easy to explain why meta has modes the company has billions of users across Facebook Instagram and WhatsApp and that reinforces Network effects that keep people engaged with those platforms since those are the apps everyone else is using and that success helps the company attract the best engineers and programmers and all those advantages compound in the company's favor but what are we to make of companies that based on their track record clearly have some competitive Advantage though it's not (05:25) easy to Define what that is it's a question that Chris Mayer of woodlock house capital explored in his 2020 blog post called invisible Moes and economic remote refers to in the words of Morning Star How likely a company is to keep competitors at Bay for an extended period a successful note allows High Returns on Capital to persist one of my favorite Parts about researching companies is trying to determine what note there is if any and debating that with friends Old Dominion Freight Lines one of mayor's portfolio companies is (05:55) right for controversy on that front as I've alluded to this is a company with no discernable mode at least not one that is easy to sum up in 30 seconds or less for context Old Dominion is the third largest trucking company in the US that specializes in being what's known as a less than truckload carrier these are essentially companies that combine multiple smaller shipments from different customers into a single truck as opposed to loading a truck with inventories from only one customer because they carry cargo for multiple (06:23) customers at the same time the logistics for less than truckload carriers or LTL as they're known can be much more complicated though for those looking to ship cargo LTL can be a great option because they only pay for their portion of truck space and don't pay for any empty trailer space supporting its LTL carrier business Old Dominion has around 235 service centers and 9200 trailers and it has earned a reputation for being one of the most disciplined and efficient trucking companies in the industry its profitability in Returns on Capital are (06:54) Head and Shoulders above its peers through 2019 including dividends shareholders earned more than 30% per year over 3E and 10e time periods and in the past 5 years the stock has continued that impressive Streak by growing over 27% which translates to a compound annual growth rate of 29% per year in short the company has been a wonderful compounder yet it competes in an industry that is seemingly commoditized truck space is truck space and it's not immediately clear why a trucking company should have competitive advantages that (07:26) extend across decades if it were solely due to organization and efficiency those are surely factors that could Fade Away over time or be copied by competitors but that hasn't happened as Matthew young of Morning Star puts it quote in our view even the best operators like Old Dominion struggle to carve out a sustainable Competitive Edge via the key economic Moe sources cost Advantage intangible assets switching costs and network effect young continues by arguing that economies a scale and trucking have largely proved (07:55) insufficient as a competitive Advantage given that the trucking Behemoth YRC world wide was pushed to the brink of bankruptcy during the 2009 recession so despite old Dominion's track record of high and Rising Returns on invested Capital with correspondingly high returns to shareholders there was not a simple story to be told about why this is happening working in Old Dominion's favor is that its drivers aren't unionized as compared with IRC which certainly helps and Old Dominion has relatively little debt too still as (08:24) Chris Mayer writes quote I admit Old Dominion doesn't seem to have a traditional Mo that fits in one of those bu buets instead it seems to have pieces of the different buckets somehow the whole adds up to a strong competitor versus just looking at the Parts Old Dominion does own about $ 1.5 billion worth of service centers which isn't easy to replicate and run efficiently even if you had $1. (08:47) 5 billion lying around but there isn't much keeping competitors from entering the market at least for full truckload shipping all that's needed are a truck and a trailer insurance and Licensing and a driver with those parts in place a truck driving startup simply needs to win a shipping contract to begin earning revenues however the challenge that new startups and many existing trucking companies face is that there is very high turnover for truck drivers because the job is so demanding and may require driving across the country in a few days (09:13) with little rest a subtle advantage that Old Dominion has is that as an LTL carrier they primarily do a series of shorter trips rather than long CrossCountry deliveries which helps with driver retention another Advantage for LTL carriers is that while rail isn't an OP for short deliveries it is an option for longer deliveries so not only do full truckload carriers have to deal with higher driver turnover but they're also competing more directly with Railways which tend to be cheaper so there are some less obvious advantages (09:42) supporting a company like Old Dominion that operates as a less than truckload carrier and LTL carriers need to win many contracts to operate profitably since they're carrying loads for a handful of customers at any one time and importantly they need to have consolidation centers that can load and unload caros mid route as a result the LTL Market tends to be much more Consolidated than the full load tracking market with the top 10 LTL carriers holding about 55% of the market share on top of that mayor points out that Old (10:10) Dominion has an ownership culture that gives it advantages as well the kden family has continuously run the company since Old Dominion founding in 1934 retaining a board and management presence over the company while also holding a combined 13% ownership State more impressive is that old Dominion's employees not only are loyal to the company but want to invest in it too over 20% of old Dominion's employees 401K assets are invested in Old Dominion stock and with an employee turnover rate of just 10% it's about as low as it gets (10:39) in the trucking business in ownership culture where the company is heavily owned by both its founding family and employees plus the efficiency and discipline it is shown in the LTL carrier business really makes for some kind of Mo right a company doesn't compound at 30% per year for 15 years without any kind of Moes protecting it as Chris May puts it UL minion has something of an invisible moat the company is a hidden compounder not only because its business model is unglamorous but also because many who have looked into the company can't (11:09) understand what competitive Advantage it has to support the business going forward so they just assume that competition will erode it's above average returns in the future as we've mentioned Old Dominion seems to benefit from a range of factors that in total form a Moote while each part in its own is arguably not a full Mo to me the fact that there's so much room for debate about old Minion's competitive positioning is exactly what makes it a hidden compounder if everyone agreed that old minion was a dominant player (11:36) and its market and competition was unlikely to change that then the stock would be bit up so much that it would be harder for new investors in the company to earn market beaing returns yet the uncertainty around old dominions Moes in addition to the company itself not being particularly exciting to the average investor I think contributes to the fact that the stock has been able to compound reliably at such incredible rates obviously what underlies that too is the invisible MO supporting the company's High Returns on Capital in an interview (12:03) with gu spear who runs the aquam Marine fund Manish PAB suggests that another great way to find hidden modes is to look for younger companies that haven't operated long enough for their advantages to be appreciated by the market he used as the example of having discovered Chipotle when it had just a few restaurant locations open if you had stumbled upon one of these early Chipotle locations you might have come away thinking that Not only was the food tasty affordable and reasonably healthy but that the company had the chance to (12:29) revolutionize the fast casual dining industry as he puts it you likely would have had a sense that this business could appeal to a large number of people in contrast to having a fully formed but hidden moat like Old Dominion this is more akin to a moat that is in construction Chipotle was in the process of building its moat and anyone who recognized that would have been rewarded generously to be perfectly candid with you I hesitate to share these examples because I do think they make everything sound much easier than it is there have (12:57) been a ton of fast casual chains you might have had similar convictions in that flopped while Chipotle didn't whenever looking at case studies on Compounders we have to be mindful of survivorship bias for every company that has found multi-decade success in compounding returns for shareholders at Market beating rates there are probably dozens of companies that went out of business underperformed or simply delivered average results as with everything in life there's an element of Randomness to it all that as stock (13:23) investors I think we have to be honest with ourselves about if you found Chipotle early on it was probably due to luck either having having a location open near you having someone recommend it to you or whether you came across some article on the company was a huge element of Randomness involved there's even luck on Chipotle's side too where you could imagine a number of things could have gone wrong early on that sidetracked the company's success being lucky though doesn't make you a good investor that said to be a bit cliche (13:50) what does distinguish great investors is not letting those sorts of opportunities pass them by to me it's about always keeping your eyes open to investment opportunities that might be sitting right in front of you whether that's where you're eating lunch or thinking about the company that delivers s for you by truck there are great Compounders hidden all around us keeping one's eyes open as I say and having the conviction to act is what translates luck into success I want to keep going here to show some more examples of what you (14:17) might call Hidden Compounders Murphy USA is a gas station company that operates convenience stores across 1800 locations mainly in the southwestern Southeastern and Midwestern regions of the United States despite that very basic business model Murphy's has averaged an excellent return on invested capital of 18% per year for the Last 5 Years while its stock has grown at a compound annual growth rate of 25% per year over the past decade if you've ever driven through the regions it operates in you'd see the company's locations labeled as (14:47) either just Murphy or quick check interestingly the company aims to differentiate Itself by maintaining a strategic proximity to Walmart with many of its locations and by selling gasoline at relatively discounted prices the company does have a formal relationship with Walmart 2 where Walmart plus customers get special discounts at Murphy's but on top of that Murphy's is clearly trying to appeal to the types of price sensitive Shoppers who frequent Walmart as a result their margins on gas are very thin but they make up for that (15:15) with higher sales volumes and with sales of retail products particularly tobacco products Murphy's is essentially an industry leader in per stor cigarette sales among gas stations driven primarily by its proximity to Walmart as well as its rewards programs on tobacco products with Murphy's there's probably five or six factors that work in their favor and I've already mentioned a few but like Old Dominion there's no obvious single wide Moe to point to the company's advantages aren't neatly categorized yet its track record speaks for itself and (15:44) implies some form of durable modes I haven't done enough research on Murphy specifically to argue strongly that it's a hdden compounder but I think it's at least a strong Contender it operates in an unglamorous business model that most people take for granted in their daily lives it lacks the type of obvious note that some of the best known Compounders possess and still it is both incredibly profitable and running a way that has created a tremendous amount of wealth for shareholders that last Point may seem obvious where profitable companies earn (16:11) strong returns for shareholders but you'd be surprised at how many companies operate profitably but find a way to destroy value for investors from paying dividends when that cash would be better reinvested to making frivolous and expensive Acquisitions of other companies and issuing so much stock to employees and Executives that despite total profits increasing profits per share remain flat or even decline as crazy as it may sound there are profitable companies that are terrible Investments and my point here is to say (16:38) that a potential hidden compounder like Murphy says both a strong financial track record in terms of profits earned from its operating business and a strong track record of ensuring shareholders reap the benefits of that operating success another example of a hidden compounder I'll spend a little more time on is a company my colleagues on our we study billionaires podcast have talked about in past episodes techon I'll link to the full discussion in the show notes but techon is what's known as a serial acquirer so rather (17:07) than operating a hidden compounder themselves they manage a holding company that buys up stakes in these sorts of companies in other words they find the hidden Compounders for you and in doing so become a hidden compounder themselves techon operates in a very narrow Niche targeting small Swedish B2B industrial companies suffice to say investing in companies that invest in boring yet profitable businesses can also be quite rewarding serial acquirers like techon are hitting Compounders in their own way because Acquisitions have such a (17:36) Negative perception in the financial World these types of companies are often ridden off by mainstream investors correspondingly there's no shortage of literature documenting how mergers and Acquisitions have destroyed value for shareholders historically in part that's because a premium must be paid typically to acquire a company leading acquirers to overpay and also on top of that those deals usually involve large amounts of debt to finance everything while this is true I believe there's precedent for overseeing Value creating serial (18:03) acquisition it's just rare there are examples though of Serial acquirers with exceptional track records and delivering returns for shareholders the most famous example is of course birkshire hathway led by Warren Buffett birkshire is very much a Serial acquirer and for a long time you could argue that the company was a hidden compounder before buff and Munger gained a cult following birkshire is the vehicle for making these Acquisitions as it buys up majority or minority stakes and great business and holds them indefinitely until something (18:31) materially changes about the target company's business model or evaluation serial acquirers like techon and early birkshire can be undervalued and dismissed turning them into hidden Compounders not just because of the stigma around conglomerate Acquisitions but also because of the messy system behind how they report earnings since 2018 companies like Berkshire have been required by Accounting Standards to report changes in the market value of their portfolio companies and their own net earnings meaning with a 2% stake in (18:58) app rather than reporting 2% of Apple's $100 billion in net income in the last 12 months as its profit birkshire would have to adjust its earnings to reflect unrealized gains and losses from swings in Apple stock price as Warren Buffett wrote in 2017 in anticipation of the accounting rule change quote the new rule says that the net change in unrealized investment gains in losses and stocks we hold must be included in all net income figures we report for you that requirement will produce some truly Wild and capricious swings in our Gap (19:30) bottom line birkshire owns $170 billion of marketable stocks and the value of these Holdings can easily swing by $10 billion or more within a quarterly reporting period including gations of that magnitude in our reported net income will swamp the truly important numbers that describe our operating performance for analytical purposes berkshire's bottom line will be useless with techon the situation is different because techon is listed in Sweden and therefore doesn't adhere to the same accounting standards it also primarily (20:01) invests in private companies that aren't listed on stock exchanges but still the point remains that serial acquirers could be great Compounders in their own right while also being hidden to an extent because valuing a company like techon or Berkshire is really a valuation of dozens of other companies that they own stakes in which can get messy quickly as Chris May explains as the name suggests a large part of a serial acquirers growth comes from acquiring many smaller companies serial acquirers are typically decentralized (20:28) with the acquired companies enjoying quite a bit of autonomy the free cash flow of these daughter companies is funneled to the Mother Ship where it is deployed in new acquisitions dividends or whatever typically serial acquires look to hold companies forever looking at techon the company has done this to an impressive extent even though it's just getting started after being founded in 2006 since going public in 2019 techon has delivered compounded annual returns of well over 30% per year on average for shareholders (20:58) like br sh and other successful serial acquirers I think techon has a hidden Mo in theory there's no reason a Serial acquirer should have any Moote and be able to generate these types of returns over time as we know with Stock Investing very few people can consistently beat the market averages and serial acquisition is the same idea on a different scale seemingly anyone could come in and copy The Playbook that someone like Warren Buffett has used and with all that competition it would become difficult for a company focused (21:26) on seral acquisition to find enough attractive opportunities for them to compound returns at above average rates Buy Low sell High Buy Low sell high it's a simple concept but not necessarily an easy concept right now High interest rates have crushed the real estate market prices are falling and properties are available at a discount which means fundrise believes now is the time to expand the fundrise flagship funds billion doll real estate portfolio you can add the fundrise flagship fund to your portfolio in minutes by visiting (22:00) fundrise.com Millennial that's f n d r i.com Millennial carefully consider the investment objectives risks charges and expenses of the fundrise flagship fund before investing this and other information can be found in the funds prospectus at fundrise.com Flagship this is a paid advertisement while there is some evidence that after 60 years birkshire is brushing up against this problem due to Simply how large it has gotten leaving it with fewer and fewer meaningful acquisition targets smaller serial acquires like technion appear to (22:37) have a secret sauce that like Old Dominion is both powerful and hard to Define it seems as though techon is in the process of building its moat an invisible moat that also like Old Dominion may have a lot to do with culture while serial acquisition seems as simple as just buying and holding companies and then using their earnings to buy more businesses there's a lot that can go catastrophically wrong with this model one concentrated bet that blows up is more than enough to derail a Serial acquirer doing serial acquisition (23:08) well in a way that is both sustainable and accretive to shareholders requires discipline I'll read you a list of a few of the things they look for in making an acquisition techon wants to buy companies that operate in Niche markets with strong competitive advantages built up over the years additionally they want their target companies to be profitable Market Leaders with operating margins above 9% generally these will also be companies that can be acquired for between $2 and $10 million where the initial investment (23:35) can be recouped within 5 years with a 15% annual return and last but not least techon only wants to acquire companies that have good and honest management teams with the founders or family ideally being still involved in the company while this formula does give some criteria that shape their Capital allocation decisions it's not as simple as following this formula and finding success because as I've said anyone could theoretically do this and compete with him though that hasn't happened to a meaningful extent at least not yet in (24:05) part I think that's because much of what they're doing is so personalized which has also been a Tailwind for Buffett and Munger in their careers from leaning into treating people well and building lasting relationships that in its own way is the moat techon is buying family businesses like Burkshire did in its early days with C candy and Nebraska Furniture Market and when you're selling the business you spent a Lifetime Building or your employees are your friends and neighbors you care a great deal about who you sell it to rather (24:32) than being some soulless private Equity Firm that's planning on buying the company and getting it techon provides an alternative for business owners who are looking to cash out all or part of their sake in the company they built but they still probably care a lot about what happens to the company and that's where the team at techon thrives being Swedish and focusing on acquiring Swedish companies being honest and trustworthy and promising to leave their acquired companies intact with a hands-off ownership approach helps build (24:58) the relationship that enables these deals to happen at all and as they've acquired companies and sellers have been more than satisfied by how they were treated that news spreads by word of mouth and I'm sure that it's helped techon find more Founders willing to sell their businesses to the right buyer in some academic setting I would probably be unable to describe this competitive Advantage because it's an invisible mode in theory it probably shouldn't exist but I think it does at least in my opinion trust relationships (25:24) and reputation are not things you can quantify easily but in the real world they do exist and can be quite powerful Tech neon's financial results and shareholder returns like Old Dominion are a testament to it after having met both techon CEO and chief Acquisitions officer myself at the Burkshire shareholder meeting in 2023 I like Chris Mayer am inclined to say that I see the invisible Mo in action here their modesty and reverence for Warren Buffett and Charlie Munger combined with their track record signals to mean that they (25:53) are very likely spearheading a culture at techon that is the explanatory Factor behind their success Beyond how well any single investment has worked out for them techon is a hidden compounder not only because it is a small company based in a small European market but also as I've mentioned because it is a Serial acquirer where the returns it's compounding are happening behind the scenes at its portfolio of private companies which do not have the same transparency as the types of publicly traded companies that a large serial (26:22) acquire like Burkshire has to invest in nothing about Burkshire is hidden these days it's probably the most well studied company on Earth it is arguably still a compounder but not like what it was in the past and as I said it's not hidden for reference I'll go ahead and just read off a few more companies that are candidates for being what we might call Hidden Compounders due to very simple boring businesses excellent returns and a lack of easy to define mode Rollins ticker rool is a pest extermination company with an average (26:52) annual return on invested capital of 18% per year in The Last 5 Years and a compounded annual growth rate in its stock price of almost 20% per year over the last two decades another candidate for hidden compounder status is transan group ticker tdg which operates in the exceedingly boring business of Airline components yet has delivered an average annual return on invested capital of 15% per year for the last 15 years while compounding its stock at more than 22% over the last decade and one more for a good measure is Sherwin Williams a (27:25) company that simply sells paint with an average return on invested capital of 28% in the last 10 years a simple manufacturer and distributor of paint products has earned returns at rival Google's parent company alphabet which has an roic in recent years of 29% to shareholders in this wonderful company's Delight Sheran Williams stock pric has earned compounded returns of 18% per year in the last decade so as I've said some of the most boring businesses you can imagine quite literally compound profits and returns (27:54) for shareholders at rates you'd expect only from the best known big tech companies to me this is the epitome of being a hidden compounder of course there are degrees of hiddenness and whether a company's considered a hidden compounder is definitely subjective techon is clearly much more quote unquote hidden than cherin Williams which despite being a boring business is at least a household name across the United States so again there's some subjectivity to this and I really hope that your takeaway is the essence behind (28:22) the idea of hitting Compounders rather than fixating too much on an explicit definition for it and I'll add as well that that there's clearly some companies where it's easier to Define their Moes than others just because there's room for debate on a company's Moe doesn't make it a hitting compounder though you may decide on a different definition for hitting Compounders but at its core the idea is to find companies with impressive track records and compounding returns that for one reason or another are not appreciated by markets to the (28:48) full extent they should be evidently I've talked a good deal about so-called boring businesses because I do think these Compounders with boring business models are more likely to be overlooked than some that's doing something really exciting at the Forefront of the latest hyped up fad and markets whether that be Gene editing 3D printing or more recently AI relatedly boring companies in particular are likely to have what Chris M calls invisible modes where their competitive advantages may not be as clear-cut as a leading tech company that (29:17) has some Network effect or Advanced software working in its favor yet based on their abnormal profits clearly has some combination of less visible modes collaborating to their benefit there's nothing wrong with focusing on Compounders with flash emotes it's just a different game to play and one that's more competitive and where the companies probably don't slip to attractive valuations as frequently another Point worth mentioning here in today's conversation on boring businesses and hitting Compounders is a concept known as the (29:45) Lindy effect that is to say all businesses have a shelf life eventually all competitive advantages will erode and economies will grow and contract but the Lindy effect argues simply that certain things like ideas or books actually get more durable over time for example the odds are higher that Shakespeare will still be read in a thousand years from now than the chances are that any of today's best sellers will be we can probably learn more from Timeless Classics because their lasting Legacy has meant that they added value (30:12) to generations of people rather than finding fleeting popularity before Fading Into Obscurity I think the same principle holds for companies too I'd rather bet on a company to survive another decade that has operated profitably for four decades than I would on a hot new company that's only a few years old the windy effect essentially suggests that the longer something has been around and weathered storm after storm the greater the likelihood is it'll continue to endure generally I think that companies and boring old-fashioned (30:40) businesses tend to be the most lendy firms in fast-paced Industries are exposed to much greater threats of disruptive innovation which is why there's so much turnover in Market leaders on The Cutting Edge of Technology it comes as little surprise then that Warren Buffett who is the master of finding hidden Compounders and great boring business to own avoids rapidly evolving high-tech Industries as much as possible much of what Buffett has looked for his entire career is implicitly based on this Lindy effect by (31:09) trying to identify which business models are best positioned to stand the test of time in that vein Koke is one of his all-time favorite Investments since people's thirst for sugary carbonated and caffeinated drinks isn't going away anytime soon same with Geico which is a leader in car insurance for many decades car insurance has been a boring yet profitable business hardly threatened by disruptive innovations that would fundamentally displace their operations the only threat of this nature on the horizon for a company like Geico is if (31:36) we all switch to self-driving cars but even that doesn't really seem to be on the horizon anytime soon birkshire Hathway's Investments over time are in some way the ultimate compilation of boring businesses that are great but often overlooked Compounders I'll just read you a handful of them in case you aren't familiar berkshire's roster of past and current boring businesses include names like craft Foods Chevron American Express Kroger duracel batteries Clayton Holmes Dairy Queen hellberg Diamonds the NSF railroad (32:06) company and dozens more you'll notice that none of these companies are particularly flashy instead they're intensely practical companies rooted deeply in businesses that are changing very slowly grocery stores catering to the middle class Diamond companies home builders and railroads aren't going away anytime soon by Nature these companies reflect the Lindy effect from both their long track records of success as as well as through the simply ad durable Industries they operate in boring businesses make up the fabric of our (32:33) society providing us with what we need while almost on purpose proving forgettable along the way as the last topic today to pull the thread a little bit further I want to share some of my takeaways from a 2016 report from Morgan Stanley on Compounders and the value of compounding in an uncertain world eight years later reading the paper in its cautious nature warning about an uncertain world with serious geopolitical risks it's a reminder to me that that rarely do markets ever look quote unquote normal and periods of (33:01) Tranquility are fleeting at best as uncertain as the world looks today it looked equally so back then too the world always feels crazy and that's just a challenge we face as investors if the world were safe and predictable we wouldn't deserve to earn the risk premium and higher returns that stocks offer the uncertainty is by definition what makes Stock Investing potentially more rewarding than just putting your money in a savings account still the Morgan Stanley paper isn't interesting because the authors discuss how (33:30) Compounders can offer protection and stability in an otherwise unstable world the team writes quote our research shows that these Compounders which exhibit characteristics such as strong franchise durability High cash flow generation low Capital intensity and minimal financial leverage have generated Superior risk adjusted returns across the economic cycle correspondingly they recommend that long-term investors quote adopt a Back to Basics approach to portfolio management that generate Superior return regardless of what's happening in (33:59) markets more broadly over a 15-year period they found that the top 25% of stocks in terms of the Returns on invested Capital considerably outperform the rest so their research isn't focused on hidden Compounders per se but I find it useful to better understand generally what Compounders look like as the authors right quote in our experience relatively few companies have been able to consistently compound shareholder wealth at Superior rates of return over the long term instead we have found that most companies are erratic or inferior (34:29) creators of long-term wealth some of the most durable advantages they found among Compounders tended to be intangible assets like Customer Loyalty Innovation and brand recognition which I think plays into this idea of invisible Moes as we've discussed intangible assets are well intangible meaning we can't directly observe them per se but that doesn't make them any less real than tangible assets in fact over time intangible assets have become increasingly important to the modern economy and you can definitely make a (34:58) case that some of these more abstract assets and competitive advantages resemble the type of invisible modes that Chris Mayer described when examining Old Dominion Freight Lines as the researchers that Morgan Stanley put it quote in contrast dominant assets that are physical are more easily replicated and often lead to price competition and erosion of a company's Returns on Capital so I'm sure you can see how these comments play into what we've discussed in this episode the advantages that companies like Old (35:24) Dominion and techon have are very much intangible when people think of intangible assets they typically think of things like patents and software which you might expect big tech companies to have and that's certainly true but even boring businesses can have intangible advantages too as we've learned today even better is that they found that Compounders especially ones operating in more Dole areas of the economy tended to have less cyclical profits due to the non-discretionary nature of their services and of course (35:51) that makes sense a company like Murphy's isn't going to see a huge decline in a recession because people are still going to need gas and are going to want cigarettes the same is true even for a trucking company like Old Dominion where revenues only fell 2% in 2020 during the pandemic even when the world is seemingly at a standstill there's still a lot of cargo being shipped around and Old Dominion clearly has some advantages that position it to Fair better in a downturn than others in the trucking business and despite that modest (36:18) downturn revenues jumped 20% in 2021 that is just classic hidden compounder Behavior things are less bad in the bad times and really good in the good times this line from Morgan Stanley also validates the approach that techon has taken in finding boring companies that are industry leaders they write the following when seeking Compounders we believe that the relative strength of a company within its industry is more important than market capitalization in terms of Industry structure we typically find that Compounders enjoy High (36:49) relative market share in monopolistic or oligopolistic markets these companies generally enjoy High barriers to entry usually as a result of the tangible assets they possess and their ability to continually innovate the researchers actually set their own example of what you might call a boring or hitting compounder and a Swedish coffee and chocolate company that through thick and thin hasn't seen negative sales growth in 23 years while growing earnings per share fivefold in that period thanks largely to managing their intangible (37:17) brand assets so well organ Stanley provides some warnings to for investors on the hunt for hitting Compounders they write quote when searching for Compounders investors must avoid traps in the form of fading companies or acquisitive companies by fading companies we mean those where patents or licenses are soon to expire where new technology or a change in fashion or new regulation can disrupt the franchise companies that are overly dependent on a single brand or product are more vulnerable to disruption adding to that they suggest (37:48) that poor or greedy management can similarly derail Compounders over time while Acquisitions can be especially damaging imagine for example a company earning 30% Returns on invested Capital that acquires a business earning just 5 to 10% Returns on Capital while this acquisition would artificially boost profits it would destroy value for shareholders over time because Returns on invested Capital are what matter most and this acquisition would obviously be reducing that average Roi so those are the biggest highlights (38:16) from the paper which as always I'll link to in the show notes in case you'd like to read it for yourself to wrap things up today I want to reiterate the old saying that sound investing should be like watching paint dry unless Among The Rare Breed that finds reading financial statements of practical businesses exciting which is a great thing then you really shouldn't find too much about it investing exciting Beyond thinking about how your returns will compound over time if they're invested in durable well-run (38:41) businesses that is to say if you're fixated on the hottest most Innovative companies in markets you're probably going to get burned eventually for a few different reasons ranging from bursting bubbles to simply not having the technical expertise to determine whether say one Cutting Edge computer chip maker has a sustainable advant manage over another as Wall Street Legend George Soros puts it quote if investing is entertaining if you're having fun you're probably not making money good investing is boring and really I couldn't have put (39:10) it any better myself good investing takes patience it involves finding hidden Compounders and holding them for long periods of time letting them simply do their thing and it requires very little action from you if you can have just one or two great ideas a year for companies to invest in over a lifetime you'll do quite well a value investor I had no idea what direction to go in there's just so much to try and wrap your head around but it's never too late to get smarter about Stock Investing from the ground up after spending years interviewing and studying the best stock investors as a company at the investors podcast Network I've worked to distill those learnings into a simple course for you why did I do that (40:08) so I can help you master the principles of excellent lifelong investing I was a fan of the investors podcast for years before I joined the team and I always wanted a course that broke down the most important insights from a decade of interviews with leading investors the course is great for both beginners and pros from studying what the legends actually due to small practical ways to build your wealth over time I'll take you through 10 different sections covering the basics of what a stock actually is and how stock markets work (40:38) to strategies to optimize your retirement savings picking great companies what to look for in ETFs how much you should invest and how to monitor your Investments plus so much more by the time you're done you'll be ready to invest in the stock market learning plenty of tricks from the pros along the way to access the course and begin learning how to invest like the Legends just visit thein podcast. (41:01) com SLG getstarted with stocks that's thinest podcast.com slet started with stocks and for a limited time you can use code mi15 for a 15% discount at checkout that's mi15 when checking out as Buffett once said I want to have my cake and eat it too I like quality businesses I like great Capital allocation I like high Returns on Capital but I demand value I great Compounders over time is namely a question of correctly identifying business quality and price can be used as a hedge against whether you're able to do that correctly if you buy a (41:37) company you think is a highquality compounder based both on its track record and opportunities looking forward and you can buy it near its trift twoe low you're probably going to come out okay on the investment even if its Returns on Capital going forward are considerably lower than expected you may or may not earn a market beating profit on it but you'll at least have a decent company and you'll probably have paid a very reent able price for it few people have gone broke doing that as they say shoot for the moon because even if you (42:03) miss you'll land Among the Stars
The Best Stocks Hiding In Plain Sight w/Shawn O’Malley (MI380)
Summary
Transcript
(00:00) the holy Grill of investing is finding Compounders that most people don't even realize are Compounders I really love this framework because it is simple but also true in my years of studying stocks I have continuously been surprised that there are so many wonderful companies to be found out there that are not only great Compounders but also largely hidden in part these Compounders may be hidden because their Moes aren't easily recognizable but what are we to make of companies that based on their track record clearly have some competitive (00:26) Advantage though it's not easy to Define what that is [Music] hello before we dive into the video be sure to click that subscribe button so you never miss an episode show us some love by giving a thumbs up and sharing your thoughts in the comments your support really means everything to us hey guys today we'll be talking about hidden Compounders and finding the best companies that are hiding in plain sight there is nothing sexy about the companies I'll discuss today but as an investor that really shouldn't matter to (00:58) you sometimes the most plain and simple businesses are the most profitable the great investor Peter Lynch is probably the most famous for talking about investing in boring businesses his book went up on Wall Street discusses at length how individual investors can get advantage in markets by investing in companies they know well through personal experience as well as businesses that are uninteresting he writes quote a company that does boring things is almost as good as a company that has a boring name and both together (01:23) is terrific Peter Lynch is best known for running the Fidelity mellin Fund where he racked up one of the most impressive careers in Wall Street history in just 13 years Lynch takes a Bottoms Up approach to investing aiming to thoroughly understand a company its prospects its competitive environment whether the stock can be purchased at a reasonable price rather than having some formula or screen that enables him to quickly pick stocks he chooses to instead investigate them one by one to assess what story can be told about (01:50) their future you can probably imagine the types of things he looks for like earnings gross and low price earnings ratios but what's interesting to me and relevant to this episode on hiden Compounders is that he specifically makes a point of emphasizing his interest in companies that are particularly unappetizing that is companies that operate in a boring field or even do something that is disagreeable or depressing this could be anything from a company that operates funeral home to one that does waste disposal on the flip (02:16) side he finds hot stocks and exciting Industries unattractive since they're likely to Garner a disproportionate amount of attention from Wall Street so to reiterate what I find interesting is not only trying to find companies that are Compounders which are essentially stocks you can Buy and Hold for several decades with such profitable businesses and attractive growth opportunities that they can single-handedly and reliably generate market gting returns but also companies like this that are hidden in plain sight they're secret Compounders (02:43) as Manish pu calls them on our we study Billionaire's podcast back in May 2020 Manish told listeners that one of his biggest career mistakes has been not appreciating the power of Compounders let's listen for most of my investing career I always focused on finding 50 centar bills and basically the idea was invest at 50 cents sell at 90 cents hopefully the transition from 50 to 90 happens in 2 or 3 years and that's a great anualy rate return well there are two three problems with that number one is taxes because you end up with (03:16) significant tax bill and the second is that you have to continue to be right so if I invest in a company for three years and I double my money I now have to find a second investment for three years and I have to keep finding these two three year BS and I have to always keep being right and so it's not that easy to continuously be right like that fast forwarding a bit Manish goes on to add the following let's listen again there are three kinds of businesses businesses that are cheap but not necessarily great Compounders they (03:55) just cheap on current earnings and what they'll make in the future but who knows where they are 10 years from now right then the second is that there are Compounders which are well known and Visa Mastercard Coke and AMX and so on and Costco and they've got huge runways ahead of them those businesses which are known Compounders probably rightfully trade at high multiples then there's the third class of businesses which I would say are the hidden Compounders so the hidden Compounders is where I have put all my (04:30) efforts now okay because that's the holy grail for me may not be F the investor I couldn't put it any better the holy Grill of investing is finding Compounders that most people don't even realize are Compounders I really love this framework because it is simple but also true in my years of studying stocks I have continuously been surprised that there are so many wonderful companies to be found out there that are not only great Compounders but also largely hidden in part these Compounders may be hidden because their Moes aren't easily (04:59) recognizable it's pretty easy to explain why meta has modes the company has billions of users across Facebook Instagram and WhatsApp and that reinforces Network effects that keep people engaged with those platforms since those are the apps everyone else is using and that success helps the company attract the best engineers and programmers and all those advantages compound in the company's favor but what are we to make of companies that based on their track record clearly have some competitive Advantage though it's not (05:25) easy to Define what that is it's a question that Chris Mayer of woodlock house capital explored in his 2020 blog post called invisible Moes and economic remote refers to in the words of Morning Star How likely a company is to keep competitors at Bay for an extended period a successful note allows High Returns on Capital to persist one of my favorite Parts about researching companies is trying to determine what note there is if any and debating that with friends Old Dominion Freight Lines one of mayor's portfolio companies is (05:55) right for controversy on that front as I've alluded to this is a company with no discernable mode at least not one that is easy to sum up in 30 seconds or less for context Old Dominion is the third largest trucking company in the US that specializes in being what's known as a less than truckload carrier these are essentially companies that combine multiple smaller shipments from different customers into a single truck as opposed to loading a truck with inventories from only one customer because they carry cargo for multiple (06:23) customers at the same time the logistics for less than truckload carriers or LTL as they're known can be much more complicated though for those looking to ship cargo LTL can be a great option because they only pay for their portion of truck space and don't pay for any empty trailer space supporting its LTL carrier business Old Dominion has around 235 service centers and 9200 trailers and it has earned a reputation for being one of the most disciplined and efficient trucking companies in the industry its profitability in Returns on Capital are (06:54) Head and Shoulders above its peers through 2019 including dividends shareholders earned more than 30% per year over 3E and 10e time periods and in the past 5 years the stock has continued that impressive Streak by growing over 27% which translates to a compound annual growth rate of 29% per year in short the company has been a wonderful compounder yet it competes in an industry that is seemingly commoditized truck space is truck space and it's not immediately clear why a trucking company should have competitive advantages that (07:26) extend across decades if it were solely due to organization and efficiency those are surely factors that could Fade Away over time or be copied by competitors but that hasn't happened as Matthew young of Morning Star puts it quote in our view even the best operators like Old Dominion struggle to carve out a sustainable Competitive Edge via the key economic Moe sources cost Advantage intangible assets switching costs and network effect young continues by arguing that economies a scale and trucking have largely proved (07:55) insufficient as a competitive Advantage given that the trucking Behemoth YRC world wide was pushed to the brink of bankruptcy during the 2009 recession so despite old Dominion's track record of high and Rising Returns on invested Capital with correspondingly high returns to shareholders there was not a simple story to be told about why this is happening working in Old Dominion's favor is that its drivers aren't unionized as compared with IRC which certainly helps and Old Dominion has relatively little debt too still as (08:24) Chris Mayer writes quote I admit Old Dominion doesn't seem to have a traditional Mo that fits in one of those bu buets instead it seems to have pieces of the different buckets somehow the whole adds up to a strong competitor versus just looking at the Parts Old Dominion does own about $ 1.5 billion worth of service centers which isn't easy to replicate and run efficiently even if you had $1. (08:47) 5 billion lying around but there isn't much keeping competitors from entering the market at least for full truckload shipping all that's needed are a truck and a trailer insurance and Licensing and a driver with those parts in place a truck driving startup simply needs to win a shipping contract to begin earning revenues however the challenge that new startups and many existing trucking companies face is that there is very high turnover for truck drivers because the job is so demanding and may require driving across the country in a few days (09:13) with little rest a subtle advantage that Old Dominion has is that as an LTL carrier they primarily do a series of shorter trips rather than long CrossCountry deliveries which helps with driver retention another Advantage for LTL carriers is that while rail isn't an OP for short deliveries it is an option for longer deliveries so not only do full truckload carriers have to deal with higher driver turnover but they're also competing more directly with Railways which tend to be cheaper so there are some less obvious advantages (09:42) supporting a company like Old Dominion that operates as a less than truckload carrier and LTL carriers need to win many contracts to operate profitably since they're carrying loads for a handful of customers at any one time and importantly they need to have consolidation centers that can load and unload caros mid route as a result the LTL Market tends to be much more Consolidated than the full load tracking market with the top 10 LTL carriers holding about 55% of the market share on top of that mayor points out that Old (10:10) Dominion has an ownership culture that gives it advantages as well the kden family has continuously run the company since Old Dominion founding in 1934 retaining a board and management presence over the company while also holding a combined 13% ownership State more impressive is that old Dominion's employees not only are loyal to the company but want to invest in it too over 20% of old Dominion's employees 401K assets are invested in Old Dominion stock and with an employee turnover rate of just 10% it's about as low as it gets (10:39) in the trucking business in ownership culture where the company is heavily owned by both its founding family and employees plus the efficiency and discipline it is shown in the LTL carrier business really makes for some kind of Mo right a company doesn't compound at 30% per year for 15 years without any kind of Moes protecting it as Chris May puts it UL minion has something of an invisible moat the company is a hidden compounder not only because its business model is unglamorous but also because many who have looked into the company can't (11:09) understand what competitive Advantage it has to support the business going forward so they just assume that competition will erode it's above average returns in the future as we've mentioned Old Dominion seems to benefit from a range of factors that in total form a Moote while each part in its own is arguably not a full Mo to me the fact that there's so much room for debate about old Minion's competitive positioning is exactly what makes it a hidden compounder if everyone agreed that old minion was a dominant player (11:36) and its market and competition was unlikely to change that then the stock would be bit up so much that it would be harder for new investors in the company to earn market beaing returns yet the uncertainty around old dominions Moes in addition to the company itself not being particularly exciting to the average investor I think contributes to the fact that the stock has been able to compound reliably at such incredible rates obviously what underlies that too is the invisible MO supporting the company's High Returns on Capital in an interview (12:03) with gu spear who runs the aquam Marine fund Manish PAB suggests that another great way to find hidden modes is to look for younger companies that haven't operated long enough for their advantages to be appreciated by the market he used as the example of having discovered Chipotle when it had just a few restaurant locations open if you had stumbled upon one of these early Chipotle locations you might have come away thinking that Not only was the food tasty affordable and reasonably healthy but that the company had the chance to (12:29) revolutionize the fast casual dining industry as he puts it you likely would have had a sense that this business could appeal to a large number of people in contrast to having a fully formed but hidden moat like Old Dominion this is more akin to a moat that is in construction Chipotle was in the process of building its moat and anyone who recognized that would have been rewarded generously to be perfectly candid with you I hesitate to share these examples because I do think they make everything sound much easier than it is there have (12:57) been a ton of fast casual chains you might have had similar convictions in that flopped while Chipotle didn't whenever looking at case studies on Compounders we have to be mindful of survivorship bias for every company that has found multi-decade success in compounding returns for shareholders at Market beating rates there are probably dozens of companies that went out of business underperformed or simply delivered average results as with everything in life there's an element of Randomness to it all that as stock (13:23) investors I think we have to be honest with ourselves about if you found Chipotle early on it was probably due to luck either having having a location open near you having someone recommend it to you or whether you came across some article on the company was a huge element of Randomness involved there's even luck on Chipotle's side too where you could imagine a number of things could have gone wrong early on that sidetracked the company's success being lucky though doesn't make you a good investor that said to be a bit cliche (13:50) what does distinguish great investors is not letting those sorts of opportunities pass them by to me it's about always keeping your eyes open to investment opportunities that might be sitting right in front of you whether that's where you're eating lunch or thinking about the company that delivers s for you by truck there are great Compounders hidden all around us keeping one's eyes open as I say and having the conviction to act is what translates luck into success I want to keep going here to show some more examples of what you (14:17) might call Hidden Compounders Murphy USA is a gas station company that operates convenience stores across 1800 locations mainly in the southwestern Southeastern and Midwestern regions of the United States despite that very basic business model Murphy's has averaged an excellent return on invested capital of 18% per year for the Last 5 Years while its stock has grown at a compound annual growth rate of 25% per year over the past decade if you've ever driven through the regions it operates in you'd see the company's locations labeled as (14:47) either just Murphy or quick check interestingly the company aims to differentiate Itself by maintaining a strategic proximity to Walmart with many of its locations and by selling gasoline at relatively discounted prices the company does have a formal relationship with Walmart 2 where Walmart plus customers get special discounts at Murphy's but on top of that Murphy's is clearly trying to appeal to the types of price sensitive Shoppers who frequent Walmart as a result their margins on gas are very thin but they make up for that (15:15) with higher sales volumes and with sales of retail products particularly tobacco products Murphy's is essentially an industry leader in per stor cigarette sales among gas stations driven primarily by its proximity to Walmart as well as its rewards programs on tobacco products with Murphy's there's probably five or six factors that work in their favor and I've already mentioned a few but like Old Dominion there's no obvious single wide Moe to point to the company's advantages aren't neatly categorized yet its track record speaks for itself and (15:44) implies some form of durable modes I haven't done enough research on Murphy specifically to argue strongly that it's a hdden compounder but I think it's at least a strong Contender it operates in an unglamorous business model that most people take for granted in their daily lives it lacks the type of obvious note that some of the best known Compounders possess and still it is both incredibly profitable and running a way that has created a tremendous amount of wealth for shareholders that last Point may seem obvious where profitable companies earn (16:11) strong returns for shareholders but you'd be surprised at how many companies operate profitably but find a way to destroy value for investors from paying dividends when that cash would be better reinvested to making frivolous and expensive Acquisitions of other companies and issuing so much stock to employees and Executives that despite total profits increasing profits per share remain flat or even decline as crazy as it may sound there are profitable companies that are terrible Investments and my point here is to say (16:38) that a potential hidden compounder like Murphy says both a strong financial track record in terms of profits earned from its operating business and a strong track record of ensuring shareholders reap the benefits of that operating success another example of a hidden compounder I'll spend a little more time on is a company my colleagues on our we study billionaires podcast have talked about in past episodes techon I'll link to the full discussion in the show notes but techon is what's known as a serial acquirer so rather (17:07) than operating a hidden compounder themselves they manage a holding company that buys up stakes in these sorts of companies in other words they find the hidden Compounders for you and in doing so become a hidden compounder themselves techon operates in a very narrow Niche targeting small Swedish B2B industrial companies suffice to say investing in companies that invest in boring yet profitable businesses can also be quite rewarding serial acquirers like techon are hitting Compounders in their own way because Acquisitions have such a (17:36) Negative perception in the financial World these types of companies are often ridden off by mainstream investors correspondingly there's no shortage of literature documenting how mergers and Acquisitions have destroyed value for shareholders historically in part that's because a premium must be paid typically to acquire a company leading acquirers to overpay and also on top of that those deals usually involve large amounts of debt to finance everything while this is true I believe there's precedent for overseeing Value creating serial (18:03) acquisition it's just rare there are examples though of Serial acquirers with exceptional track records and delivering returns for shareholders the most famous example is of course birkshire hathway led by Warren Buffett birkshire is very much a Serial acquirer and for a long time you could argue that the company was a hidden compounder before buff and Munger gained a cult following birkshire is the vehicle for making these Acquisitions as it buys up majority or minority stakes and great business and holds them indefinitely until something (18:31) materially changes about the target company's business model or evaluation serial acquirers like techon and early birkshire can be undervalued and dismissed turning them into hidden Compounders not just because of the stigma around conglomerate Acquisitions but also because of the messy system behind how they report earnings since 2018 companies like Berkshire have been required by Accounting Standards to report changes in the market value of their portfolio companies and their own net earnings meaning with a 2% stake in (18:58) app rather than reporting 2% of Apple's $100 billion in net income in the last 12 months as its profit birkshire would have to adjust its earnings to reflect unrealized gains and losses from swings in Apple stock price as Warren Buffett wrote in 2017 in anticipation of the accounting rule change quote the new rule says that the net change in unrealized investment gains in losses and stocks we hold must be included in all net income figures we report for you that requirement will produce some truly Wild and capricious swings in our Gap (19:30) bottom line birkshire owns $170 billion of marketable stocks and the value of these Holdings can easily swing by $10 billion or more within a quarterly reporting period including gations of that magnitude in our reported net income will swamp the truly important numbers that describe our operating performance for analytical purposes berkshire's bottom line will be useless with techon the situation is different because techon is listed in Sweden and therefore doesn't adhere to the same accounting standards it also primarily (20:01) invests in private companies that aren't listed on stock exchanges but still the point remains that serial acquirers could be great Compounders in their own right while also being hidden to an extent because valuing a company like techon or Berkshire is really a valuation of dozens of other companies that they own stakes in which can get messy quickly as Chris May explains as the name suggests a large part of a serial acquirers growth comes from acquiring many smaller companies serial acquirers are typically decentralized (20:28) with the acquired companies enjoying quite a bit of autonomy the free cash flow of these daughter companies is funneled to the Mother Ship where it is deployed in new acquisitions dividends or whatever typically serial acquires look to hold companies forever looking at techon the company has done this to an impressive extent even though it's just getting started after being founded in 2006 since going public in 2019 techon has delivered compounded annual returns of well over 30% per year on average for shareholders (20:58) like br sh and other successful serial acquirers I think techon has a hidden Mo in theory there's no reason a Serial acquirer should have any Moote and be able to generate these types of returns over time as we know with Stock Investing very few people can consistently beat the market averages and serial acquisition is the same idea on a different scale seemingly anyone could come in and copy The Playbook that someone like Warren Buffett has used and with all that competition it would become difficult for a company focused (21:26) on seral acquisition to find enough attractive opportunities for them to compound returns at above average rates Buy Low sell High Buy Low sell high it's a simple concept but not necessarily an easy concept right now High interest rates have crushed the real estate market prices are falling and properties are available at a discount which means fundrise believes now is the time to expand the fundrise flagship funds billion doll real estate portfolio you can add the fundrise flagship fund to your portfolio in minutes by visiting (22:00) fundrise.com Millennial that's f n d r i.com Millennial carefully consider the investment objectives risks charges and expenses of the fundrise flagship fund before investing this and other information can be found in the funds prospectus at fundrise.com Flagship this is a paid advertisement while there is some evidence that after 60 years birkshire is brushing up against this problem due to Simply how large it has gotten leaving it with fewer and fewer meaningful acquisition targets smaller serial acquires like technion appear to (22:37) have a secret sauce that like Old Dominion is both powerful and hard to Define it seems as though techon is in the process of building its moat an invisible moat that also like Old Dominion may have a lot to do with culture while serial acquisition seems as simple as just buying and holding companies and then using their earnings to buy more businesses there's a lot that can go catastrophically wrong with this model one concentrated bet that blows up is more than enough to derail a Serial acquirer doing serial acquisition (23:08) well in a way that is both sustainable and accretive to shareholders requires discipline I'll read you a list of a few of the things they look for in making an acquisition techon wants to buy companies that operate in Niche markets with strong competitive advantages built up over the years additionally they want their target companies to be profitable Market Leaders with operating margins above 9% generally these will also be companies that can be acquired for between $2 and $10 million where the initial investment (23:35) can be recouped within 5 years with a 15% annual return and last but not least techon only wants to acquire companies that have good and honest management teams with the founders or family ideally being still involved in the company while this formula does give some criteria that shape their Capital allocation decisions it's not as simple as following this formula and finding success because as I've said anyone could theoretically do this and compete with him though that hasn't happened to a meaningful extent at least not yet in (24:05) part I think that's because much of what they're doing is so personalized which has also been a Tailwind for Buffett and Munger in their careers from leaning into treating people well and building lasting relationships that in its own way is the moat techon is buying family businesses like Burkshire did in its early days with C candy and Nebraska Furniture Market and when you're selling the business you spent a Lifetime Building or your employees are your friends and neighbors you care a great deal about who you sell it to rather (24:32) than being some soulless private Equity Firm that's planning on buying the company and getting it techon provides an alternative for business owners who are looking to cash out all or part of their sake in the company they built but they still probably care a lot about what happens to the company and that's where the team at techon thrives being Swedish and focusing on acquiring Swedish companies being honest and trustworthy and promising to leave their acquired companies intact with a hands-off ownership approach helps build (24:58) the relationship that enables these deals to happen at all and as they've acquired companies and sellers have been more than satisfied by how they were treated that news spreads by word of mouth and I'm sure that it's helped techon find more Founders willing to sell their businesses to the right buyer in some academic setting I would probably be unable to describe this competitive Advantage because it's an invisible mode in theory it probably shouldn't exist but I think it does at least in my opinion trust relationships (25:24) and reputation are not things you can quantify easily but in the real world they do exist and can be quite powerful Tech neon's financial results and shareholder returns like Old Dominion are a testament to it after having met both techon CEO and chief Acquisitions officer myself at the Burkshire shareholder meeting in 2023 I like Chris Mayer am inclined to say that I see the invisible Mo in action here their modesty and reverence for Warren Buffett and Charlie Munger combined with their track record signals to mean that they (25:53) are very likely spearheading a culture at techon that is the explanatory Factor behind their success Beyond how well any single investment has worked out for them techon is a hidden compounder not only because it is a small company based in a small European market but also as I've mentioned because it is a Serial acquirer where the returns it's compounding are happening behind the scenes at its portfolio of private companies which do not have the same transparency as the types of publicly traded companies that a large serial (26:22) acquire like Burkshire has to invest in nothing about Burkshire is hidden these days it's probably the most well studied company on Earth it is arguably still a compounder but not like what it was in the past and as I said it's not hidden for reference I'll go ahead and just read off a few more companies that are candidates for being what we might call Hidden Compounders due to very simple boring businesses excellent returns and a lack of easy to define mode Rollins ticker rool is a pest extermination company with an average (26:52) annual return on invested capital of 18% per year in The Last 5 Years and a compounded annual growth rate in its stock price of almost 20% per year over the last two decades another candidate for hidden compounder status is transan group ticker tdg which operates in the exceedingly boring business of Airline components yet has delivered an average annual return on invested capital of 15% per year for the last 15 years while compounding its stock at more than 22% over the last decade and one more for a good measure is Sherwin Williams a (27:25) company that simply sells paint with an average return on invested capital of 28% in the last 10 years a simple manufacturer and distributor of paint products has earned returns at rival Google's parent company alphabet which has an roic in recent years of 29% to shareholders in this wonderful company's Delight Sheran Williams stock pric has earned compounded returns of 18% per year in the last decade so as I've said some of the most boring businesses you can imagine quite literally compound profits and returns (27:54) for shareholders at rates you'd expect only from the best known big tech companies to me this is the epitome of being a hidden compounder of course there are degrees of hiddenness and whether a company's considered a hidden compounder is definitely subjective techon is clearly much more quote unquote hidden than cherin Williams which despite being a boring business is at least a household name across the United States so again there's some subjectivity to this and I really hope that your takeaway is the essence behind (28:22) the idea of hitting Compounders rather than fixating too much on an explicit definition for it and I'll add as well that that there's clearly some companies where it's easier to Define their Moes than others just because there's room for debate on a company's Moe doesn't make it a hitting compounder though you may decide on a different definition for hitting Compounders but at its core the idea is to find companies with impressive track records and compounding returns that for one reason or another are not appreciated by markets to the (28:48) full extent they should be evidently I've talked a good deal about so-called boring businesses because I do think these Compounders with boring business models are more likely to be overlooked than some that's doing something really exciting at the Forefront of the latest hyped up fad and markets whether that be Gene editing 3D printing or more recently AI relatedly boring companies in particular are likely to have what Chris M calls invisible modes where their competitive advantages may not be as clear-cut as a leading tech company that (29:17) has some Network effect or Advanced software working in its favor yet based on their abnormal profits clearly has some combination of less visible modes collaborating to their benefit there's nothing wrong with focusing on Compounders with flash emotes it's just a different game to play and one that's more competitive and where the companies probably don't slip to attractive valuations as frequently another Point worth mentioning here in today's conversation on boring businesses and hitting Compounders is a concept known as the (29:45) Lindy effect that is to say all businesses have a shelf life eventually all competitive advantages will erode and economies will grow and contract but the Lindy effect argues simply that certain things like ideas or books actually get more durable over time for example the odds are higher that Shakespeare will still be read in a thousand years from now than the chances are that any of today's best sellers will be we can probably learn more from Timeless Classics because their lasting Legacy has meant that they added value (30:12) to generations of people rather than finding fleeting popularity before Fading Into Obscurity I think the same principle holds for companies too I'd rather bet on a company to survive another decade that has operated profitably for four decades than I would on a hot new company that's only a few years old the windy effect essentially suggests that the longer something has been around and weathered storm after storm the greater the likelihood is it'll continue to endure generally I think that companies and boring old-fashioned (30:40) businesses tend to be the most lendy firms in fast-paced Industries are exposed to much greater threats of disruptive innovation which is why there's so much turnover in Market leaders on The Cutting Edge of Technology it comes as little surprise then that Warren Buffett who is the master of finding hidden Compounders and great boring business to own avoids rapidly evolving high-tech Industries as much as possible much of what Buffett has looked for his entire career is implicitly based on this Lindy effect by (31:09) trying to identify which business models are best positioned to stand the test of time in that vein Koke is one of his all-time favorite Investments since people's thirst for sugary carbonated and caffeinated drinks isn't going away anytime soon same with Geico which is a leader in car insurance for many decades car insurance has been a boring yet profitable business hardly threatened by disruptive innovations that would fundamentally displace their operations the only threat of this nature on the horizon for a company like Geico is if (31:36) we all switch to self-driving cars but even that doesn't really seem to be on the horizon anytime soon birkshire Hathway's Investments over time are in some way the ultimate compilation of boring businesses that are great but often overlooked Compounders I'll just read you a handful of them in case you aren't familiar berkshire's roster of past and current boring businesses include names like craft Foods Chevron American Express Kroger duracel batteries Clayton Holmes Dairy Queen hellberg Diamonds the NSF railroad (32:06) company and dozens more you'll notice that none of these companies are particularly flashy instead they're intensely practical companies rooted deeply in businesses that are changing very slowly grocery stores catering to the middle class Diamond companies home builders and railroads aren't going away anytime soon by Nature these companies reflect the Lindy effect from both their long track records of success as as well as through the simply ad durable Industries they operate in boring businesses make up the fabric of our (32:33) society providing us with what we need while almost on purpose proving forgettable along the way as the last topic today to pull the thread a little bit further I want to share some of my takeaways from a 2016 report from Morgan Stanley on Compounders and the value of compounding in an uncertain world eight years later reading the paper in its cautious nature warning about an uncertain world with serious geopolitical risks it's a reminder to me that that rarely do markets ever look quote unquote normal and periods of (33:01) Tranquility are fleeting at best as uncertain as the world looks today it looked equally so back then too the world always feels crazy and that's just a challenge we face as investors if the world were safe and predictable we wouldn't deserve to earn the risk premium and higher returns that stocks offer the uncertainty is by definition what makes Stock Investing potentially more rewarding than just putting your money in a savings account still the Morgan Stanley paper isn't interesting because the authors discuss how (33:30) Compounders can offer protection and stability in an otherwise unstable world the team writes quote our research shows that these Compounders which exhibit characteristics such as strong franchise durability High cash flow generation low Capital intensity and minimal financial leverage have generated Superior risk adjusted returns across the economic cycle correspondingly they recommend that long-term investors quote adopt a Back to Basics approach to portfolio management that generate Superior return regardless of what's happening in (33:59) markets more broadly over a 15-year period they found that the top 25% of stocks in terms of the Returns on invested Capital considerably outperform the rest so their research isn't focused on hidden Compounders per se but I find it useful to better understand generally what Compounders look like as the authors right quote in our experience relatively few companies have been able to consistently compound shareholder wealth at Superior rates of return over the long term instead we have found that most companies are erratic or inferior (34:29) creators of long-term wealth some of the most durable advantages they found among Compounders tended to be intangible assets like Customer Loyalty Innovation and brand recognition which I think plays into this idea of invisible Moes as we've discussed intangible assets are well intangible meaning we can't directly observe them per se but that doesn't make them any less real than tangible assets in fact over time intangible assets have become increasingly important to the modern economy and you can definitely make a (34:58) case that some of these more abstract assets and competitive advantages resemble the type of invisible modes that Chris Mayer described when examining Old Dominion Freight Lines as the researchers that Morgan Stanley put it quote in contrast dominant assets that are physical are more easily replicated and often lead to price competition and erosion of a company's Returns on Capital so I'm sure you can see how these comments play into what we've discussed in this episode the advantages that companies like Old (35:24) Dominion and techon have are very much intangible when people think of intangible assets they typically think of things like patents and software which you might expect big tech companies to have and that's certainly true but even boring businesses can have intangible advantages too as we've learned today even better is that they found that Compounders especially ones operating in more Dole areas of the economy tended to have less cyclical profits due to the non-discretionary nature of their services and of course (35:51) that makes sense a company like Murphy's isn't going to see a huge decline in a recession because people are still going to need gas and are going to want cigarettes the same is true even for a trucking company like Old Dominion where revenues only fell 2% in 2020 during the pandemic even when the world is seemingly at a standstill there's still a lot of cargo being shipped around and Old Dominion clearly has some advantages that position it to Fair better in a downturn than others in the trucking business and despite that modest (36:18) downturn revenues jumped 20% in 2021 that is just classic hidden compounder Behavior things are less bad in the bad times and really good in the good times this line from Morgan Stanley also validates the approach that techon has taken in finding boring companies that are industry leaders they write the following when seeking Compounders we believe that the relative strength of a company within its industry is more important than market capitalization in terms of Industry structure we typically find that Compounders enjoy High (36:49) relative market share in monopolistic or oligopolistic markets these companies generally enjoy High barriers to entry usually as a result of the tangible assets they possess and their ability to continually innovate the researchers actually set their own example of what you might call a boring or hitting compounder and a Swedish coffee and chocolate company that through thick and thin hasn't seen negative sales growth in 23 years while growing earnings per share fivefold in that period thanks largely to managing their intangible (37:17) brand assets so well organ Stanley provides some warnings to for investors on the hunt for hitting Compounders they write quote when searching for Compounders investors must avoid traps in the form of fading companies or acquisitive companies by fading companies we mean those where patents or licenses are soon to expire where new technology or a change in fashion or new regulation can disrupt the franchise companies that are overly dependent on a single brand or product are more vulnerable to disruption adding to that they suggest (37:48) that poor or greedy management can similarly derail Compounders over time while Acquisitions can be especially damaging imagine for example a company earning 30% Returns on invested Capital that acquires a business earning just 5 to 10% Returns on Capital while this acquisition would artificially boost profits it would destroy value for shareholders over time because Returns on invested Capital are what matter most and this acquisition would obviously be reducing that average Roi so those are the biggest highlights (38:16) from the paper which as always I'll link to in the show notes in case you'd like to read it for yourself to wrap things up today I want to reiterate the old saying that sound investing should be like watching paint dry unless Among The Rare Breed that finds reading financial statements of practical businesses exciting which is a great thing then you really shouldn't find too much about it investing exciting Beyond thinking about how your returns will compound over time if they're invested in durable well-run (38:41) businesses that is to say if you're fixated on the hottest most Innovative companies in markets you're probably going to get burned eventually for a few different reasons ranging from bursting bubbles to simply not having the technical expertise to determine whether say one Cutting Edge computer chip maker has a sustainable advant manage over another as Wall Street Legend George Soros puts it quote if investing is entertaining if you're having fun you're probably not making money good investing is boring and really I couldn't have put (39:10) it any better myself good investing takes patience it involves finding hidden Compounders and holding them for long periods of time letting them simply do their thing and it requires very little action from you if you can have just one or two great ideas a year for companies to invest in over a lifetime you'll do quite well a value investor I had no idea what direction to go in there's just so much to try and wrap your head around but it's never too late to get smarter about Stock Investing from the ground up after spending years interviewing and studying the best stock investors as a company at the investors podcast Network I've worked to distill those learnings into a simple course for you why did I do that (40:08) so I can help you master the principles of excellent lifelong investing I was a fan of the investors podcast for years before I joined the team and I always wanted a course that broke down the most important insights from a decade of interviews with leading investors the course is great for both beginners and pros from studying what the legends actually due to small practical ways to build your wealth over time I'll take you through 10 different sections covering the basics of what a stock actually is and how stock markets work (40:38) to strategies to optimize your retirement savings picking great companies what to look for in ETFs how 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(41:01) com SLG getstarted with stocks that's thinest podcast.com slet started with stocks and for a limited time you can use code mi15 for a 15% discount at checkout that's mi15 when checking out as Buffett once said I want to have my cake and eat it too I like quality businesses I like great Capital allocation I like high Returns on Capital but I demand value I great Compounders over time is namely a question of correctly identifying business quality and price can be used as a hedge against whether you're able to do that correctly if you buy a (41:37) company you think is a highquality compounder based both on its track record and opportunities looking forward and you can buy it near its trift twoe low you're probably going to come out okay on the investment even if its Returns on Capital going forward are considerably lower than expected you may or may not earn a market beating profit on it but you'll at least have a decent company and you'll probably have paid a very reent able price for it few people have gone broke doing that as they say shoot for the moon because even if you (42:03) miss you'll land Among the Stars