Ben Graham Centre Interview With Josh TarasoffVW Staff
Ben Graham Centre January 25, 2017 interview with Josh Tarasoff, General Partner, Greenlea Lane Capital Partners, LP
BG: In what way does your investment strategy differ from the majority of the value investing community?
Josh Tarasoff: I’d say there’re 3 ways. The first way is that in very common value investing culture, value investors tend to be comfortable with betting on consistency, and uncomfortable with betting on change. The classic Buffet thing is: are people going to buy this product 50 years from now? Is it durable? Are people still going to drink soda, and will Coca Cola have the biggest market share? Is Geico still going to have the lowest cost? And, to bet on change is more of the growthy temptation that if you do it, you’re undisciplined, imprudent and risky. What I believe is that, certain changes can be as certain and predictable as certain constancy. It just depends on the situation. For example, in my portfolio, I think more shopping being done online overtime is as certain as many constancies that I’d be willing to bet on, like consumer brands. I think that, traditional on-premise IT moving to the cloud is certain as one needs it to be. I think that more people having pet medical insurance is as certain as one needs it to be to prudently invest in it. There are certain patterns and frameworks that when there’s a way of doing something that’s both better and cheaper simultaneously, it will happen. Online retail is that, cloud computing is that, and probably electric vehicles are that. That’s one thing.
The other one is that when there’s a new way of doing something where if you do it that way instead of the old way, it’s a win-win for every party involved and no one loses, then that’s certain to happen too. I think pet medical insurance is an example of that, where if the pet owners can’t afford to pay $5,000 to save the pet’s life, then paying $40 a month premium in order to be able to save the pet’s life benefits the pet, the pet owner, and the veterinarian who gets to do the highest-level procedure to make more money. It’s truly a win-win. Even in cloud computing, there’re losers, who are the incumbents. And there are losers in online retail, who are the incumbents. There’s literally no loser in pet medical insurance. So, there are certain situations where change is inevitable, so I’d love to invest in that. It’s a little bit different than the normal value investing mentality.
The second thing is that, most of the time, the companies that I invest in are not statistically cheap by normal rules of thumb for what statistically cheapness is. We have these rules of thumb that say 15x is a middling multiple, 10x is getting cheap, single-digit is really cheap, 20x is not cheap, and over 20x is really expensive. We have these rules of thumb for a good reason which is, on average, right. The market as a whole is an average of all businesses. If all of the companies in the market are homogeneous with respect to their future earnings growth and returns on capital, then you can apply these rules of thumb to every single company. But, in realty, companies are so ridiculously different from one and other. What I’m looking for is the outliers in the 99.9 percentile of great companies, and what is cheap for those companies is so far from these rules of thumb. I invested in Amazon in 2011, and it was trading at 200x P/E, but actually the multiple of what I thought was normalized sustainable free cash flow is in the 30-40x range. And I thought that was cheap! That’s very different from what most value investors do. This might not be accepted by many people. I’ve had phone calls with prospective investors where I actually would explain the Amazon thesis and I would say “I think it was at 30-40x free cash flow when we bought it”, and the other guy was like “13-14?”. And then I said “no, no, 30-40”. And then it’d be a weird pause, and I knew that the conversation was over. There’s a lesson in that we are getting back to one of the things I said about the advantage of not telling your investment strategy to something that you can sell to other people. I think that most people, whether they admit or not, or whether they know it consciously or not, are making compromises on what they do to make what they do salable. Whenever you do that, you’re trying to appeal to the lowest common denominator to the prospective investors, and by definition, you’re becoming a consensus investor. You can’t do that and expect to have good results. I think that there’s almost literally a direct conflict between salable as an investor and being good as an investor. That’s what it is.
The third thing is I think there’s another common belief within the value investing community that things may get cheap temporarily but then in the few years they become fairly valued and they need to be sold. And holding things that are fairly valued is not being a value investor. And there’s this presumption that every investment thesis will play out over 2, 3, 4, or 5 years. I think that’s usually the case, but not always the case. And the difference between “usually” and “always” is like night and day, just like it is within the efficiency market theory. The difference between “always efficient” and “usually efficient” is night and day, and it’s the same thing with this. Sometimes there are some companies that are systemically undervalued for decades. You can look and see what they are. Just look at Walmart, Berkshire Hathaway, Amazon, Netflix, a lot of these really amazing compounders. You could have purchased for excess returns 90% of the time in the past 20, 30, 40 years. Buffett didn’t stop getting excess returns at his Berkshire Hathaway 40 years ago when people figured out that he was really good. He still is getting excess returns. That’s just a weird thing. So, what are the reasons for that? I think the reasons for that is: number 1, the most exceptional compounders are by definition doing something idiosyncratic and weird, and people are fundamentally not super comfortable with that; number 2 is that, they usually look statistically not cheap. A lot of times it’s because people do give it some sort of premium because they understand that it’s good in some way, but sometimes it’s because the economics of the business are represented by GAAP differently than the conventional businesses. It’s true for Berkshire Hathaway and a company in my portfolio called Markel because they generate a lot of value by having unrealized gains in their stock portfolio which don’t flow through the earnings. For Markel, one-third of its value creation over time has been unrealized gains in its investment portfolio, and that has never shown up in earnings or ROE. If you just look at the accounting or its ROE, you would have ignored it because you have ignored one-third of its earnings power. Or with Amazon, which has businesses that are more mature and profitable, and businesses that are losing money. You don’t see the breakdown because they don’t want their competitors to know what they’re doing. So, it looks like they’re not making money when they are. They’re just re-investing. So, often the financials of these companies look strange, and the valuations just don’t look statistically cheap; number 3, what’s special about these companies is the long-term excess returns. It’s the returns that you’ll get from owning them for 5 years, 10 years, or 20 years, which are irrelevant to most market participants who care only about a shorter period of time. So, there are really obvious reasons why these companies can be systematically undervalued. My approach is to have a permanent attitude towards all of our investments.