Mecham:
-It’s really quite simple. I need to understand the business like anowner. The firm needs to have staying power; I want to be confident about thegeneral nature of the business and industry landscape on a longer term basis
-In fact, I think very little about quarterly earnings and more aboutthe barriers to entry, competitive landscape/threats, the ongoing capital needsand overall economics, and most importantly, the durability of the business
-Wealso stress test the business under various economic scenarios and look to anormalized earnings power. We passed up many seemingly attractive ideas overthe years as we would ask, “What happens under 7-10% unemployment (whenunemployment was in the 4-5% range) and 6-8% interest rates?
-“Is the business overly reliant on loose credit extension and frivolousspending?” Many names didn’t hold up under these stress test scenarios, so wepassed.
-We prefer cockroach-like businesses — very hardyand almost impossible to kill!
-Oftentimes a key cog of valueis in a form that’s difficult to measure — brands, mindshare/loyal customers,exclusive distribution rights, locations, management, etc. Sometimes it’s thelocation of assets that can be hugely valuable. Waste Management [WM] andUSG [USG] both have assets that are uniquely located and almost impossible toduplicate, which provides a low-cost advantage in certain geographies.
-Any time you arepaying a price today that’s dependent on heroics tomorrow — fantastic growthfar into the future, favorable macro environment, R&D breakthroughs, patentapproval, synergies/restructurings, dramatic margin improvements, large payofffrom capex, etc. — you run the risk of inviting pesky over-optimism(psychologists have shown overconfidence tends to infect most of us), whichcan result in skewed probabilities and payoffs. We want to see a return todayand not base our thesis on optimistic projections about the future. Investments based on projections that are disconnected from any historicalrecord make us leery. Investments dependent upon a continued frothy macroenvironment (housing, loose credit) are prone to over-optimism as well — howmany housing-related/consumer credit companies were trading at 6x multiplesgrowing 15%+ inviting IV estimates 5x the current quote?
-How do you generate investment ideas?
-Wealso stress test the business under various economic scenarios and look to anormalized earnings power. We passed up many seemingly attractive ideas overthe years as we would ask, “What happens under 7-10% unemployment (whenunemployment was in the 4-5% range) and 6-8% interest rates?
-“Is the business overly reliant on loose credit extension and frivolousspending?” Many names didn’t hold up under these stress test scenarios, so wepassed.
-We prefer cockroach-like businesses — very hardyand almost impossible to kill!
-Oftentimes a key cog of valueis in a form that’s difficult to measure — brands, mindshare/loyal customers,exclusive distribution rights, locations, management, etc. Sometimes it’s thelocation of assets that can be hugely valuable. Waste Management [WM] andUSG [USG] both have assets that are uniquely located and almost impossible toduplicate, which provides a low-cost advantage in certain geographies.
-Any time you arepaying a price today that’s dependent on heroics tomorrow — fantastic growthfar into the future, favorable macro environment, R&D breakthroughs, patentapproval, synergies/restructurings, dramatic margin improvements, large payofffrom capex, etc. — you run the risk of inviting pesky over-optimism(psychologists have shown overconfidence tends to infect most of us), whichcan result in skewed probabilities and payoffs. We want to see a return todayand not base our thesis on optimistic projections about the future. Investments based on projections that are disconnected from any historicalrecord make us leery. Investments dependent upon a continued frothy macroenvironment (housing, loose credit) are prone to over-optimism as well — howmany housing-related/consumer credit companies were trading at 6x multiplesgrowing 15%+ inviting IV estimates 5x the current quote?
-How do you generate investment ideas?
Mecham: Mainly by reading a lot. I don’t have a scientific model to generateideas. I’m weary of most screens. The one screen I’ve done in the past was bymarket cap, then I started alphabetically. Companies and industries that are outof favor tend to attract my interest. Over the past 13+ years, I’ve built up a baseof companies that I understand well and would like to own at the right price. Wetend to stay within this small circle of companies, owning the same namesmultiple times
-That’s the beauty of the public markets: If you can be patient, there’s a goodchance the volatility of the marketplace will give you the chance to owncompanies on your watch list. The average stock price fluctuates by roughly80% annually (when comparing 52-week high to 52-week low). Certainly, theunderlying value of a business doesn’t fluctuate that much on an annual basis, sothe public markets are a fantastic arena to buy businesses if you can sit stillwithout growing tired of sitting still
-We try andstick with companies we understand, where we have a high degree of confidencein the staying power of the firm. We spend considerable effort thinking criticallyabout competitive threats (Porter’s five forces, etc). We really stress long-termstaying power and management teams with proven track records that are focusedon building long-term value. Then we always “stress test” the thesis againstdifficult economic environments.
-If the financialcrisis taught nothing else, it showed how elegant financial models that calculaterisk to decimal point precision act like a sedative towards critical thinking andeven common sense
-Most investors are their own worst enemies — buying and sellingtoo often, ignoring the boundaries of their mental horsepower. I think ifinvestors adopted an ethos of not fooling themselves, and focused on reducingunforced errors as opposed to hitting the next home run, returns would improvedramatically
-That’s the beauty of the public markets: If you can be patient, there’s a goodchance the volatility of the marketplace will give you the chance to owncompanies on your watch list. The average stock price fluctuates by roughly80% annually (when comparing 52-week high to 52-week low). Certainly, theunderlying value of a business doesn’t fluctuate that much on an annual basis, sothe public markets are a fantastic arena to buy businesses if you can sit stillwithout growing tired of sitting still
-We try andstick with companies we understand, where we have a high degree of confidencein the staying power of the firm. We spend considerable effort thinking criticallyabout competitive threats (Porter’s five forces, etc). We really stress long-termstaying power and management teams with proven track records that are focusedon building long-term value. Then we always “stress test” the thesis againstdifficult economic environments.
-If the financialcrisis taught nothing else, it showed how elegant financial models that calculaterisk to decimal point precision act like a sedative towards critical thinking andeven common sense
-Most investors are their own worst enemies — buying and sellingtoo often, ignoring the boundaries of their mental horsepower. I think ifinvestors adopted an ethos of not fooling themselves, and focused on reducingunforced errors as opposed to hitting the next home run, returns would improvedramatically
