Great Stocks vs. Great Businesses
When I look around the market these days, it seems that a sense of panic is finally in the air. I asked one of the smartest guys I know — someone who I would happily trade my bank accounts with — what he sees on the horizon. He surprised me with his lack of conviction and confidence. When the smartest guys in the room are uneasy, I figure you must also keep your eyes on the eject button.
So I want to make two points.
First, at the 100x Club, we’re about finding great businesses with long runways of growth. The macro — what economies and currencies are doing — doesn’t change that one bit. As my good friend Todd Harrison constantly reminds me: “Look back at the Great Depression as a construct of optimism, whether it’s Disney or Texas Instruments or Hewlett-Packard or Tyson Foods or Continental Airlines, The Washington Post… [Look at the] franchises that were born out of crisis, out of that era, that period.”
It’s a wonderful thing to remember. The hunt never ends.
Second, when people become uneasy, they tend to sell where they have profits. They prefer to raise cash by taking gains instead of pruning unfit companies from the portfolio. But this is not what we do at 100x — and I want to make clear that this is not a strategy we find agreeable.
Instead, we’re reminded of a lengthy interview Forbes conducted with Buffett and Munger many years ago. Forbes concluded: “They both believe you should never sell those great businesses as long as they stay great, almost regardless of how high the stock price gets. What would be the point? You would have to reinvest the money in something less great.” Exactly.
I’ve developed a framework recently that has helped me sharpen my pencil and focus on only the highest-quality ideas. The ones we would never want to sell. Most people settle for a great business or a great stock. But we are greedy here. We need to be pigs.
As Stanley Druckenmiller, who might have compiled the best track record of the last 40 years, likes to say: “The first thing I heard when I got in the business… was bulls make money, bears make money and pigs get slaughtered. I’m here to tell you I was a pig. And I strongly believe the only way to make long-term returns in our business that are superior is by being a pig.”
A great stock is one for which the market will pay an increasing value for each dollar of earnings. What characteristics make a great stock?:
- Good industry backdrop — growing, not in decline.
- Strong earnings and/or revenue growth (i.e., double digit).
A great business generates lots of high-margin cash, so that you can win with an analysis that is approximately right — a margin of safety, of sorts. What makes a great business?
- High returns on capital — for example, a business that invests $100 and earns $20 enjoys a 20% return on capital. That’s a good, high number.
- Minimal cash needs.
- Sound management.
I’ve made plenty of mistakes in my day settling for one or the other so that you don’t have to make these same mistakes. As Buffett told Forbes in that aforementioned article, “Charlie [Munger] made me focus on the merits of a great business with tremendously growing earnings power” (emphasis mine).
Let me be your Charlie!
Unfortunately, with our stringent requirement, Chris and I don’t have a new stock pick for you. But I wanted to highlight a name that has the potential to one day hit most of our checklist.
Sprott Inc. (SPOXF), familiar to longtime readers, is a Canada-based asset manager that for many years focused on the resource markets, with an emphasis on gold. But at last count, just 40% of their funds were precious metals-focused. That hasn’t stopped the stock from tracking precious metals. Since its IPO in 2008, Sprott is down about 60% while the gold miners index (GDX) is down around 65%.
Now, asset management is a great business.
It checks all our boxes, although we plan to watch management more closely. But it looks better than most think. Many in the U.S. still think of the Sprott’s eccentric chairman when they think Sprott, but I don’t mind what I see.
Eric Sprott gave up the CEO role in 2010 and stopped managing funds earlier this year, even allowing his CFO to tell news outlets that “by the end of next year, he’ll be relegated to ‘chief cheerleader duties.” The new team has rolled out successful products and earned advisory business with sovereign wealth funds. They are even making a very intelligent hostile bid for some products currently managed by others.
This is a good business. It generates plenty of cash and needs little of it. In fact, they currently pay a 5%-plus dividend, which many Americans can collect tax-free if placed in their IRA (please check with your tax adviser) due to a USD-CAD treaty signed years ago.
Management believes assets under management (AUM) can double without having to touch operating expenses. We love that. And a doubling of AUM can be much more meaningful to EPS due to incentive fee structures at many of the funds they manage.
This is an opportunity to own a great business that pays you handsomely to wait possibly at the bottom of its cycle. History doesn’t repeat, but it often rhymes. In that spirit, here is an example of a well-positioned asset manager coming out of the last cycle bottom (see chart above).
It was good for better than a 50x return!
Druckenmiller reported that he purchased $300 million of gold personally in Q2 2015. If he’s right, we may get the revenue and EPS growth we so desire. Oink, oink!