Good Investing Talks - Felix Gode, how to compound with over 15% p.a. in German stocks?

Episode Date: May 19, 2021

Felix Gode is a good investor with a focus on small and mid-caps from German-speaking countries. We had the pleasure to discuss his strategy and two investments.

Hello, Felix. It's great to have you on. How are you doing? Thank you. Hi, Timan. Thank you for having me today. I'm very excited to be on your show, on your podcast today. It's my first interview or my first talk in English at all. So I'm really excited and how is it going to happen. I'm looking forward to it and to learn more from you about the German stock market. You're really an expert there. And I especially bought a cup for you. It's a fun fact about Germany. I hope you can read it. Fun facts about Germany.

No fun in Germany. Go back to work. Is this true? Are we Germans so focused on work? No, I don't think that's a stereotype. I don't think that's, you can't generalize that. I don't think so. No.

I got this cup from Toby from Shopify. he founded this company in Canada and I saw it on Twitter and had to get it as well it's quite nice as in every video also here is the disclaimer you can find a link to the disclaimer

below in the show notes the disclaimer says always do your own work what we're doing here is no recommendation and no advice so please always do your own work thank you very much you're investing how much fun is it to invest

in German-speaking countries? Well, for me, it's a hell of a lot of fun. I mean, I'm doing this for 18 years now. So I've never done anything else in my life, in my career, but focusing on the German-speaking stock market, and especially the small, mid-cap market. And for me, this is as much fun today as it was 18 years ago. So this is a field which is never getting boring. There's so much to learn,

so much to experience, so much new things to learn. I mean, after 18 years focusing on this segment, you might think that there's nothing new to come, but there is a lot of things that are new every day, every week. So it's not getting boring at all. new things are you learning in 2020 and 21? I mean, this is certainly time or if you look at the stock markets, the economy and all the things that happens around COVID, certainly nobody of us has ever experienced that and something like that before. And more things like that or comparable to that in the outcome will happen in the future. but we can't sell today. So we have to be curious and have to see what future we'll bring.

But what I actually mean is not by the market itself, but if you're analyzing balance sheets or stocks in general or companies, at some point of time, you might think, okay, I've seen everything. I know the, I know how to analyze the balance sheets. I know how to read them. I know how the accounting standards, but there's always something new that comes up that you can discover. And then you think about it and you can incorporate it in all your or in the analysis process. And that changes a little bit. And over time, this sums up. And so the way of analyzing companies emerges and evolves.

And, yeah, so the way we are looking at company companies today is much different than like five years ago or ten years ago. It's a constant process that is developing over time. So what did change in your process over the last five or ten years? Oh, there are so many things. This would be a video on its own actually. But just to mention a few things, or let me think about a couple of things that we are doing differently than like five years or ten years ago. What over time has developed quite significantly is the metrics we are looking at. So, like 10 years ago, in the quite early stage of our company, I was very, let's say that,

valuation-driven. So I'm coming from that, from that deep value cigar butt approach, we've been looking for cheap companies in terms of low price-to-book values, low price earnings ratios and stuff like that, good balance, it's all that stuff. Over time, I've adopted this approach a little bit. So today, I'm saying a company's valuation is not measurable by a certain number, for example, price of earnings ratio, but it's dependent on the quality of the company. So the higher the quality of the company, the higher the ratios may be or the valuations are just justified in a higher range. So this is one example.

But there are many, many others. So in the soft fact surrounding the way we look at competitive advantages, all these things changed over time. It's just in the process of learning and getting experience by looking on companies, by MLAs and companies, so this adds up slowly all the time. And you can't even say this is like there's one point in time when we change this and then happen that. So it's a process and fluid. That's interesting. Looking back on your history, you had, I think, um, two phases before funding the fund and after funding the fund. Maybe you can explain like the two phases a bit.

Yeah, sure. Well, the whole thing started when I was in an exchange semester in the university. Of course, in my third semester. And I've been in the USA in California and I had a roommate in the place where I've living. He was also from Germany. And he was, or he realized I'm doing all these private transactions. So at night in California at night was the time when in Germany stock market opened. So I watched my private portfolio. And he said, okay, you're so keen on that. You're so behind this topic. Isn't it possible for you to manage some money of mine as well? So this was the initial

moment where I started to think about money management. This was the first time. So, and over the weeks and months, these ideas emerged. I had no money at that time, or at least not very much. I had no access to investors. So there was no chance for me at all to start a mutual fund or any other vehicle. So the only option was, and this was quite a good option in the time, or at that time, we started an investment club. My brother and I, back in Germany, started an investment club, mainly funded by family and friends, so with really low money in the beginning. And this was the time when we started to track obviously our track record. And this was more like a hobby, what we've done, but from the start from the beginning, we realized quite good returns.

What kind of returns do you have history in the history? When we are just looking at the investment club from 2006 to 2014, there was an average return of around about 16%. So after feeds, after costs, and investment clubs are even higher costs than mutual funds are. So this was quite good always, but we did not do any active selling or we had no marketing, no sales. But in 2014, we decided to do it more professionally and switch that vehicle the investment club into a mutual fund. And since then we are in a, yeah, let's say, a professional framework. And from that point on, we developed, we developed sales, we developed marketing further. But so we grew over time, obviously, in assets under management, as well as professionality regarding sales and all these topics.

What never changed is our focus on what we are investing in. So German small midcap or German speaking, smaller midcaps has ever been the topic. And this is definitely a constant in this long process over the meanwhile. In your fund, you have this idea of the investment club somehow embedded. So you're not a classical mutual fund. You have different principles, how you're building your fund. what principles are this well from the structure this is a classic mutual fund so but our

way of thinking our our way of communicating to our clients or to investors that's a little bit different i guess to many other other funds so from the beginning on our or we said our differentiation and the competition clearly are other mutual funds also in the very beginning when we still were in investment club. So we said, okay, there must be some differentiation and this was in our point of view transparency because transparency still today is a major issue. Investors don't know what happened in the fund, what the fund manager does and why. And this is what we wanted to address.

So from the very beginning, we for example, showed the whole portfolio on our website, we still do. I think we are the only Mitchell Fund in Germany who does it. I don't know any other. Additionally, we put a lot of effort in a whole in communication. So we have a monthly client newsletter or magazine, so where we share a little bit about the way we're thinking, the way we're investing, we share insights to our portfolio companies and all the things and yeah I think this is it's an important

topic on an important issue investors who know what's happening and what the fund management is doing and I have a feeling or that gives them a feeling of security the feeling of being involved and this especially in difficult times is a major advantage. That's what we have experienced also in 2008, for example, in 2020, when the corona pandemic came over us. We experienced very little outflows of our fund. And I guess, or it's our thesis, one topic or one point is that our communication strategy keeps people involved and keeps them people on board yeah so you build a kind of club that gives you also kind of patient capital for your investors giving in as they are committed to the strategy

yeah definitely also it is this this um thought of being a club this is still alive with us yeah so over the time of course the client structure changes it's not only retail private investors anymore, like in the very beginning of the investment club. Of course, over the time professional investors came on board as well, like asset managers and banks, for example, or family offices. But we all share the same information with every client. And so nobody is, everybody who wants to get informed about what we're doing is able to get this I think this is an advantage for every kind of investor. It's not only preferable for client or private private investors, but for everybody.

It's a good approach and quite interesting approach. How much? Actually, maybe I can add some one more sentence about that. I actually don't understand why not more money managers or fund managers or funds are communicating more openly because it's known that people are withdrawing money, especially when crisis has come up, when people get afraid of what is happening. And a constant communication helps be or helps clients or investors being sticky and for understanding that this will go over and this the better times will come again so this is

I'm quite curious about why others are not doing it how much skin in the game do you have in the funds me personally I'm with 100% of my private capital invested in our both funds and our team members also are all invested with major parts of their private capital in our funds. So we have a lot of skill in the game. That's good to hear. And also your friends and family are also fully, a lot of invested. So you have to be careful.

So otherwise, Mama will be angry. Well, I would always want that in my manager, I'm giving my money to invest in the same strategy as well. I mean, this aligns the interests of both parties. parties and I guess that's the best thing you can have or you can achieve sure it is you have two strategies what are these strategies and what was the first strategy and what is the second strategy well the these strategies are not that different actually so we have two public traded or public available mutual funds it's the alpha star action form alpha star dividend form the action

Now this is our basic product or first product and the successor of the investment club. This is a fund where we just invest and reinvest the gains, capital gains. And the Alpha Star Dividendent Fund is also a mutual fund which follows the same principles concerning the companies we're choosing. But it's distributing cash in quarterly rhythm to its shareholders or to its clients. So that's the main difference. So the one is not distributing. The other one is distributing and it's this, it's doing it quarterly.

So 1% per quarter, 4% per year is what investors are getting out of this dividend funds. I also already want to show the live composition of the action for because you have it on the website, but before we go into detail, about this fund and look at certain securities. I want to discuss a bit the universe you're investing in. How would you describe the universe you're investing in in the German-speaking countries like Germany, Austria and Switzerland? Yeah. Well, it's not so easy in terms of, we are not in terms of like

terms of like industry or something like that you're not focusing on certain industries for example what i love about companies is quality yeah i mentioned this before quality is of course a broad broad range of possible meanings but what we mean by this is we prefer companies for example that grew over time organically so what i don't like companies that buy other companies over and over again, leverage this, or leverage the balance sheets. So I like proprietary technologies. I like companies that have developed something, products, software, whatever, and have developed those products over time. And this focus on a product and making this better and better over a long

period of time, this is what I like the most. Because if you have such companies, those are the companies which are most likely the ones that have barriers of entry, that have competitive advantages. Of course, they have put so much effort over a certain amount of years in being the best in that area in which they have. operate so this is in a in a broad sense what we are looking for and how big is the universe you're covering i think you want that 300 stocks or around that number no i mean in a german speaking country germany austrian switzerland taking the three countries together we have around one thousand five hundred companies and our our focus is much narrower

What we are trying to do is to invest in the 30 companies. So this is 2% out of those 1,500 companies. So the best 30 companies, this is our type. Of course, the watch list we are focusing on and we are covering is a little bit broader. It's like 50 stocks to 100 stocks. but the really narrow range the um i i always compare it a little bit with the with a football team or something like a little sports team and you have a whole team but only a certain amount of players are on the pitch and this those players in our case is the 30 ones that are in our

portfolios and 20 to 30 40 others are sitting on the on the bench and waiting and to get on the pitch at a certain time. So the reasons why they are out and not on the field is they are different to this could be because they are too expensive or the time is not right to get in this stock. Several reasons. So but what we are trying, 2% of the 1,500 stocks should be underpitched. Germans like soccer, but sometimes they are. soccer players in Germany that play big fouls we had a problem with wire card and also

allegations against krenke in the last years or last year and how do you make sure you don't you stay away from frauds well um you never can be sure um in 400% of course um but if you're focusing on high quality, the probability to get in such a trap is much lower, obviously. But for example, so we are focusing on companies, as I described with a long history, a longstanding history and a longstanding history of excellence. So those companies are characterized very often by high returns on invested capital. by high cash flows, clean balance sheets. So if you have a company with a clean balance sheet,

and no, not much specialties, not much leverage, not much intangible assets, all these things, and the accounting specialties, then like for example, it's a good example. example, it's very complex, very difficult balance sheet and difficult accounting principles that are there. You won't find such things within our portfolio. And this easiness and cleanliness in the balance sheet and the business model and this whole structure, it's also a structural things with companies that reduces the probability of failure.

a lot i guess let's go back to um the overview of your portfolio and um try to understand a bit how you are constructing um this portfolio so what are the principles that have led to this portfolio yeah so um principally or basically we want to have a quite narrow portfolio So it must be at most 20 companies. So this is what we also see today, there's only 20 companies and there won't be any more. So if we add another company, if we say we find another company, then we need to decide which one or which other company should leave. So this is, I think, important. The other thing is concerning the single companies that we have a strong focus on return on invested capital.

I think this is our main value driver. We want companies that produce high yields on their capital. So this is, yeah, the main factors, I would say. does you lead to sell a company besides that you found a better one um what are reasons to sell for you well this is the this is the most common reason yeah so companies change over time they they evolve over time so and from time to time we find a company which offers a better opportunity this is the major factor we are selling so of course there can be reasoned concerning pricing when we say companies get too expensive but this is actually not

the case very often because as I explained or as I mentioned before if you have high quality companies with a high return and investment capitals and high cash flows so it's possible to allow a lot a lot company or allow the stock to rise a little bit over a little bit too much and a higher pricing is more acceptable that because you know that this company will grow into this valuation quite soon or even even even more if that company comes down at some point of time because of high valuation you always have the opportunity without having to think about to buy new shares or additional shares.

So what we do if companies are getting too expensive or a little bit, yeah, too expensive, then we obviously reduce the weighting in the portfolio. But we almost never sell them because of high price. We don't sell the complete position. We drive down the valuation and put the weight on cheaper stocks a little bit higher. So the impact if the valuation is coming down is not that big on the portfolio. But if you have a great company, there's not really a reason to sell it completely.

With 20 stocks, you have like 5% position for every position. like in the medium like how big can your positions go like from just 1% till 10% or what is the size you're how are your sizing as we are a mutual fund we are bound to certain rules so you might be familiar with the 51040 rule which says there's one single stock is not allowed to be bigger than 5% in waiting but there are except and the exception says that a certain amount of stocks can be up to 10% in weight, but all these exceptions together cannot be more than 40%. So if you take this 51040 rule and you take also the need to have to have a quite narrow portfolio, then the consequence is you can do an overweight on like four or five stocks and all the other stocks is in our wording, regular weighting of 4%. So the we have in a portfolio of 20 stocks, we have 15 stocks at 4%, and we have 15 stocks at 4%, and we have

five stocks at seven percent so this is roughly the the decisive we are aiming at that's interesting maybe let's go into detail for some of the stocks you have in your portfolio um you have one stock that's also quite common for some of the american investors because it was one of the stocks that that was also kind of promoted internationally. It's Endor. What is Endor doing and why do you like it? Yeah, Ender is one wonderful example for the companies or for the high quality companies I mentioned before. I mean, they're doing gaming equipment.

So it's really easy to understand business model. They're doing the steering wheels, wheel bases, and the gear shifts and so on. The paddles for sim racing, so for computer games, for computer gamers. But they are focusing on the high-end segment on that. So the products they're producing are not comparable to what you buy in a toy store somewhere for your kids, but they're high-end and they're simulating like real-life real life experience. And they actually are used as well in real life. So, for example, they've made a steering wheel for a BMW. This is actually used, you can use it for gaming, but it's

actually used in the BMW. It's a GT3 racing car. So it's the same. And this company focuses only on this narrow range of products and has put all its focus over many years on getting better and better and improving quality and experience with this product. So really a niche market they are dressing, but they're the leading ones there, they have a market share of like 80% or something in that area. And that's really, really interesting. So that they are a leading company you see by all the partnerships they have. Obviously, the partnering with the console or the game console produces like Microsoft, Sony for Xbox and PS PlayStation.

But also they have corporations with the racing associations like Formula One and NASCAR, World Rally, World Rally Association or Championship. But also with the car manufacturers, like they're partnering with BMW, Porsche, and so on. So you see they are really on top of the whole gaming or whole racing, sim racing industry. And this is what makes it interesting. And that's what you see in the numbers as well. So if you look at the growth history over the last couple of years, have been growing tremendously and that with quite high margins and additionally they have slow asset business so they they have put their brain power into the

product over the last couple of years and this materializes over time yeah so this is one perfect example is those are companies we love the company is the company is founder-led I think what percentage does the founder own do you know the number of your head i don't know i don't know i had 40 50 percent something like that 40 percent is this important for your approach to have founder-led companies or not necessarily i like that this is like like we had before if the founder is involved in his own company has it has skin in the games you have the same alignment of interest like like when when i'm in my own fund yeah so this is definitely something we like but it's not a must

have another company in your portfolio there is i think it's quite long in there i see it's from you bought it 2014 is e v u what do you like about this company well the same thing here this is they are dressing in each market yeah but this market um is big enough to give this company an opportunity to grow over a long period of time. And that's what they have done. So they addressing the public transport market and the rail market with software solutions. So ERP systems, organizing systems for those public transport companies. And all this digitalization that is happening around us is, of course,

course given them tables. And also here you see it in the numbers. If you look at the growth rates over the last couple of years and the development of the margins, so the scaling of the business sets in over over the years. And actually this is one, we have this company even longer. We also, I guess we had it since 2007 or I can't even remember maybe 2009 so the first price we bought if I was at one euro so over time it's at 18 at the moment this is a real long-term I guess it's the longest engagement in any stock we have yeah it's quite interesting so that you're really a long-term shoreholder and be willing to be invested in company for the long term yeah so this is this is what we

aim for. It's not always working because of course things change. Things might happen. And as we have a very narrow portfolio, so it happens that there's a change in your portfolio. But I guess over the next couple of years, it's probably less turnover necessary than it was before in the last couple of years. Because Well, at least for the moment being, I can say I feel quite comfortable with the portfolio we have, the companies in a whole. So if you just look at 2020, those companies we own right now, have developed very good despite recession, despite Corona, because they are focusing on growing or they are active in growing markets. So I really feel comfortable right now with this portfolio. And I think there will be less turnover, actually, than in the cost.

Are you a pure bottom-up stock picker in your approach? Or are you investing around certain topics as well? It's pure bottom-up, if you want. I mean, I'm doing this for 18 years. and it's a limited amount of companies you have in the German-speaking market. So I would say I know most of them, at least, at least roughly. And if you, so additionally, it's my opinion, it's the best way to invest. So go take one stock, look at it, decide what you do, kick it out or go further.

Then take the next and the next and the next. I think that's the best way to find the best stocks. But of course, from time to time, you read something, you get an idea about a certain industry, a certain trend. And then I think about, okay, what companies do I know which could benefit from this certain trend? But then, of course, I am not buying this company blindly, but of course I do the whole process of analyzing the stock and checking if that hypothesis might be true that this company is profiting or benefiting from this certain trend. So, for example, I can say one example. We've been thinking about. the whole electric car and battery business so lately so we have been thinking about what company might be interesting for us in this environment so

but you have of course in the small-cap sector and in Germany no possibility or not not too many possibilities to invest directly and I mean far away of the of the W would have been nice investment, but it's totally out of our scope. I don't, or we don't invest in this and such large companies. But we are thinking, we are always thinking to first or second or one step further or two steps further. And have a look at the companies that might interact. benefit from such threats. So this is what you obviously have to do many times in the small cap segment because there is just no direct players. I could not invest in Tesla like stock in the small cap EV market. So by the you have to see who is delivering certain parts to certain batteries or in this special case in the batteries. Yeah. That's that's the way we approach if we do this kind of industry.

One new addition of you is called GECA software. What do you like about this company? Hey, Tillman here. I'm sure you're curious about the answer to this question. But this answer is exclusive to the members of my community Good Investing Plus. Good Investing Plus is a place where we help each other to get better as investor day by day. If you are an ambitious, long-term-oriented investor that likes to share, please apply for good investing plus just go to good minus investing dot net slash plus you can also find

this link into show notes i'm waiting for your application and without further ado let's go back to the conversation that's an interesting method and a good method i think looking out in the next five years where do you see alpha star then Yeah, interesting question. What we have done, or what we have done so far, we've talked about it the last couple of minutes, we are focused on the German-speaking market so far. But, of course, this market is limited. And for example, our funds are also, or we intentionally keep them quite small. So, for example, the action form, we closed it at a volume of $50 million just to give it to an opportunity to grow via return over the next couple of years without having to leave our focus, without having to change our strategy. This is the intention because the outcome will be that we have the potential to achieve those returns. that we have achieved in the past also for the next couple of years.

So this is the main and most important point or most important topic for us. So, but as I said, we try to invest in 2% of the best companies in the German-speaking market. So obviously the volume is limited to you can put in. So for the next five years you will see a new mutual fund we are setting up, but with a broader range in Germany. We are intending to set up a new fund, which is focus on bridges, covering the Alpha Star strategy on the European market. For that, we are setting up the sales right now.

So we're expanding in the area of sales, marketing. And of course, we are looking for new people. for fund managers for portfolio managers which can bring know-how about the european stock market about a european small mid-cap landscape into our company because we cannot cover this on our own of course do they have to work in oxburg well it's a difficult topic um preferably from my point of view today would be it's an advantage um because investing is a a lot about talking to each other and exchanging thoughts and this of course is possible nowadays via video conferencing or traditional calls but it's not the same so if you take your time

if you talk about i don't know certain topics about is a certain thing about a company a competitive advantage yes or no so if you have desk discussion it's much more effective I guess if you take your time if you talk about that and think about it quietly I have the feeling that video conferencing for example always is a little bit more how do you say that it's not that relaxed as you're sitting on the couch with a coffee in your hand and to jointly thinking about things. But of course, I would not totally exclude this as an option. I mean, the possibilities to communicate, we are there.

This is certainly certainly not a no goal, but I guess there are slight advantages on being present so if there are any investors interested to apply i will add a link below so people can find the drop offers if they are still open yeah yeah it's a good good idea um i'm really looking forward to anybody who is uh yeah interested in working with us yeah and i mean it's a it's a nice project and what we have, I mean, what we have achieved with the Alpha Star Accent font is that we are leading the rankings in Germany over a couple of years now. That's what we want to achieve in Europe with the new European Fund as well. And I mean, it's a project that is built up from the scratch. And so there's nothing there yet.

But of course, we have selling power and we have demarcating power, which we can use as soon as we start. And I think that's challenging and very, a very nice opportunity for anybody who's interested in European stock market. That's good. I'm happy to share this. Thank you. For the end of our interview, is there something you want to share? We haven't discussed that might be interesting for the viewer. Maybe one aspect that is important for us, which we have not been talking about so far, is the whole topic about management evaluation. So what you often hear if people or investors are assessed in management, quality, talking about personal things, of course, their management must be

be trustable, must be reliable, all this stuff. Of course, it's important. But the thing is that we think that we can measure the quality of the management as well. So out of the numbers. So for example, what a management team can do is to control the balance sheet. And so if you have a look at a balance sheet, you see how the management is operating, how the management is doing their business. So are they capitalizing intangible assets? For example, are they leveraging? Are they growing inorganically? Are they doing many acquisitions, all this stuff? So the quality of accounting principles or the way they address accounting principles, the way they want to shape their balance sheet, all this is an indication of how the management is thinking.

and behaving. This is maybe one thing. And the other point is, of course, the whole capital allocation topic. I mean, I said before our main driver or the main value driver is return on invested capital. And of course, this is in then the main driver for growth as well. So if a company has high return and invested capital, then the capital allocation decision is crucial for the growth. So, growth is a function of the quality of the business in terms of regional capital and the reinvestment. So it makes a difference if the management decides, for example, to make an acquisition with a certain amount of available money or if they are, for example, reinvesting the capital into their own business in terms of development of new

products or the exploration of new markets and something like that. this is of course a critical point because it's all coming back to the topic return on invested capital and growth as important value drivers in the long run yeah very interesting point for the end and thank you very much for taking the time and thank you very much to the audience as well for listening to this interview thank you for having me it was fun talking to you um as i said in the are again in my first interview in english i hope i was understandable or it was understandable i think you are yeah if there are any comments or if you want to know anything else of course you can contact me anytime and of course we can talk in german then as well so this

is better to understand thank you very much and thank you for the invite thank you Bye, bye Bye bye