Good Investing Talks - What is a good Investment process? A talk with the Value Investor Rob Vinall

Episode Date: January 25, 2021

In this conversation, Rob Vinall of RV Capital outlines his investment process and what he is looking for in companies.

Rob, welcome back to our interview. In this episode we want to talk about process. Okay, like from the beginning from idea generation to invest or sell at a certain point. Let's start with idea generation. Where did you get your ideas from? Yeah, I think that's a great question because if you think about it, there's 10,000 plus public companies out there. So probably the biggest single factor of what you end up ultimately investing in is what you actually, which of those 10,000 and you actually start looking at because you know they have to make it to the top of the

filter if they're going to make it to the bottom of the filter at some point and um my opinion on on how to you know where to start with an idea has changed quite a lot over over the years so you know when i started investing i was very much sort of enamored by ben grim and he was a very took a very quantitative outlook of you know he he was famous for the so-called net nets you know companies trading at a discount to the tangible assets they had on their balance sheet and you know some I, too, would typically do screens looking for companies which are trading at, you know, discount to their book value, very low P or a 52-week low share price, so this type of stuff. And then over time, I realized that this was actually really the wrong way to go about things

because, you know, on average, not always, but on average, companies which are trading on big discounts to their tangible book value or other types of low metric are, you know, kind of below average companies because, you know, the market is not completely stupid. If it's saying something is worth only four times earnings, then on average, that's going to be a pretty crappy company. And, you know, as a long-term investor, I don't want to be spending my time analyzing the crappy companies in the hope that every now and again one crops up, which isn't, you know, I want to be looking at really great companies. You know, so I, you know, stopped screening many years ago. And, you know, I was thinking about, you know, what is the

single most important thing that gets me excited about an investment and in my particular case I'm sure for other people it's different but my particular case it's a you know it's a very passionate aligned entrepreneur running a business so given that that's sort of the main thing I'm looking for you know I thought well probably makes sense to use that as a as a starting point on which ideas to look at you know so now what I'll you know for me to get sufficiently excited to start reading the annual report for a company or trying to learn about what it does. What I like is to find that there's a sort of a passionate entrepreneur who's somehow connected to the business, either as a major shareholder or ideally as the CEO of the company

as well. So, you know, how do you find out about that? It can be through a referral. You know, someone else points out to you or, you know, there's this great entrepreneur running the company, you should check it out or, you know, maybe you read an article in a newspaper. So there's different ways you can come across it but that's really the trigger for me to now to actually start analyzing a company like maybe talk a bit also about filters you said the great management filter is important for you is there in another filters to say no maybe like yeah if you say i don't invest in certain countries for instance yeah no so um so what we're talking about now is like literally the first sort of five minutes of uh of an investment sort of analysis so where you're

literally somebody throws a name of a company at you, you've never heard of it before, you've no idea of what it does. So the first filter would be, like I just said, you know, is there someone running the business that I have the potential to trust? But there's other filters as well, such as, you know, the most important one is just on a brief look at the business. Do I think this is a business where I have the potential to understand it? So is the business of a nature where, you know, I think it's going to be within my capacity to kind of build up an understanding of what it does, what the risks are going to be and stuff.

So if it's a sort of a, you know, biotech company, which has got an early stage cure for cancer, then realistically, as a non-biologist, I'm never going to be able to answer that question. So I'll kill the idea very, very quickly. But you mentioned countries. That's one thing that I'm very indifferent to. I'm not bothered about which country a company is based in or which sector or whether it's a big company or a small company. All those things which a lot of people use as themes or for their funds, that's not something that particularly interests me. I'm perfectly happy to look at and indeed invest in a company, whether it's from South Africa or Germany or anywhere or so that matter.

So you don't say I don't invest in certain countries? Well, you know, obviously there has to be the rule of law and has to be upheld and, you know, property rights have to be properly protected in a country. So, you know, there's certain countries that for sure I wouldn't invest in, but they tend to have such small capital markets anyway that, you know, there's plenty of other opportunities out there. Maybe let's try to invert a bit. What makes the company perfectly uninvestable for you? perfectly uninvestable you know so you know if the CEO has changed you know three times in the last two years you know because I need a track record of a CEO to be able to judge if that's going to be a good person or not you know typically if there's no major shareholder because

I think it's important companies have have owners if it's a business that I don't understand or think is going to change a lot in the coming years you know there's a business. are the type of things that would make a company and investable right from the get-go. And debt for instance? Yeah, thank you. Yeah, that's a good one as well. Yeah, so debt is something I'm quite allergic to. If it's an industrial or a kind of service type company, it would typically have zero debt and most likely a net cash balance for me to be interested in it. And if it's a financial company like a bank or a lending business, then of course it would have debt, but

its equity ratio would be multiples higher than comparable companies in the field, you know, so that if there is a crisis in the industry, that, you know, this would be the company, which is the last man standing. Cyclical companies, has there? You know, I've absolutely nothing against a cyclical company. From a purely personal perspective, I find them sometimes difficult to value. If a company earns, you know, kind of 100, one year. 50 the next, then 75 the year after that, then it's quite difficult to form an opinion on what it's

really worth. So I struggle a little bit with cyclical companies for that reason, but as a matter of principle, I'm perfectly happy to invest in a cyclical company. So company goes through the next step after the five minutes. You're taking your time to look at it. What are the important numbers or metrics you're screening for yeah so well I don't really screen for numbers or metrics and what do you look first at the company what so what so if I so if so if a company passes that five-minute test and I'll typically start to read about it and so that would most normally mean sort of downloading the annual report my favorite situation is if the CEO writes a long thoughtful letter

about the business because then you really get a sense of the essence of the company, but also the way the manager thinks, which are two very important factors for me. So that's an ideal scenario. And then, you know, and in the back of my mind as I'm reading about the company, I guess there's, you know, the hypothesis of any investment that I make is that, you know, this is a wonderful business which is going to grow and flourish over the next 10 years. And by being an owner of the business, I'm going to participate in that value creation. And, of course, that's a very rare for that hypothesis to really play out. So as I read through the annual report, I'm sort of looking for, you know, for disconfirming information, which would

sort of, you know, invalidate that hypothesis. So maybe there's a market where the growth is about to be, or the growth opportunity is about to be exhausted or where there's a very obvious competitive threat which is going to impair the business's ability to make money. And so I'm basically looking for this disconfirming information. And as soon as I find that disconfirming information, then I'll simply stop the analysis and move on to a different opportunity. And if I don't find disconfirming information, I'll keep reading, keep learning about it at a later point in the process, I'll visit the company. And if at the end, right at the end of the process, I still haven't found any reasons why that hypothesis

shouldn't play out, then I'll probably end up in investing it. Maybe a question about numbers, what do numbers play in, what role do the numbers play in the whole process for you? How do you? Yeah. Well, the numbers in isolation really don't mean anything. You know, what's important is to understand what a business really does, you know, how it sells, how it makes money, what the value it creates for its customers. And then, you know,

the numbers or the, you know, the figures that it produces should then reflect that, obviously. But, you know, the context of what brings the numbers about is infinitely more important than, you know, just what the numbers are. So you take numbers as a way to understand to play the companies in or the field companies and how it's performing this matter. Yeah, I guess the numbers are a bit like the scoreboard so um so you know if you're if you're watching a if you're watching a soccer match then obviously what you're interested in is how well the players play you know whether they're they seem better than the opponents whether they're well organized whether they're motivated where the teams working together and all that kind of stuff these are the

things you would look at and then of course the output is then the score you know maybe the team wins or loses or whatever. But really what you're what will you focus on as a as a as a fan of a football game would be actually what's happening on the field and not not what's happening on the scoreboard and for me it's the same with companies. What are you preferred sources to get knowledge about a company besides the CEO letter? Yeah so what I my my preferred source is primary information so direct facts about the business on the basis of which I can then form my own opinion on what its long-term perspectives look like. You know, so the annual report is a great source of primary information, you know, feedback

from customers or suppliers or employees are great sources of primary information. That's really what I'm looking for. And then based on that, I kind of start to form an opinion. What I'm less interested in is other people's opinion. But do you get the primary information from? Do you go to fares? do you look at portals where employees vote about the company or yeah i mean um it depends on the type of the business it is um you know if it's a consumer business then you know i'm myself a customer

so that's a great source of input or speaking to people like yourself whereas if it's more of a kind of a b-to-be type company then to get that primary information you need to speak to the the businesses customers so it really depends on on the type of opportunity but a big part as well is just sort of building out a network so increasingly when I visit you know if I visit company X because I'm interested in company X most likely that company X will also be a supplier of or a customer of lots of other companies that I've visited with over over the years in which case is a great opportunity to not just analyze company X but also analyze company Y and Z. How long has the research process for?

where you usually take before you invest. Yeah, so in an ideal situation, and of course, investments don't always work out in an ideal way, but ideally the way a process should work is that I, you know, get to know a company on day one, obviously, start to analyze it, build up hopefully quite a decent amount of knowledge about it and then follow the company over a number of years and only after a few years actually end up making an investment when you know something happens that makes it attractive you know maybe the share price falls or have an inside of the company could be much more valuable than I initially thought but I think time is is an amazing way to kind of find out the flaws in a high

in an investment hypothesis so no matter how diligent you are if you just spend a month looking at a company, there's almost certainly going to be risks and elements of the business which you simply overlook or don't find them. Whereas if you follow a company maybe from a distance, but over a number of years, then you tend to learn a lot more about it and build up a lot higher conviction in the business. So, you know, ideally I would follow a company for a number of years before actually making the investment. So let's go from ideal to example. What was the fastest time period for you to invest and what is the longest where you're still looking maybe at a company? Yeah, so, you know, a case where the process worked really well was, for example, a Grinkle leasing, which was a company had on day one of the fund and even today is still one of the largest positions.

You know, so I first met with Mr. Grinker, who's the founder of Grinker leasing, I think in 2005. And at the time, this was a few years after the company had IPOed, and the valuation was incredibly high because rightly the market was very optimistic about the prospects of the business. And at the time, I'd never seen a financial company before. I was super impressed by Mr. Grinker. He really sat down with me at a table like this and explained the business to me and how they could grow. and I was super impressed but the valuation I thought was too high

but I meant it mental note to myself that if ever this company were to get cheap then I would like to buy it and if you kind of fast forward three years to 2008 the middle of the financial crisis

everybody was panic selling all companies with any connection to financial services you know that's when I just use the opportunity to buy Grinker so that was really

sort of an ideal sort of situation so a number of years passed where I was able to continue to follow the company to learn about it and then when an opportunity presented itself I was able to you know make the investment so that would be kind of like a typical scenario you know a shorter scenario would be something like you know I think for example Trupanion which is a pet insurance company I think I first started studying it in the spring of either 2014 or 2015. I can't remember which. And I made the initial investment sort of around sort of the autumn of the same year.

So there's probably about six months that went between when I first started sort of looking at it and then ended up making investment. So I think six months is probably the absolute minimum. I wouldn't invest in something in less than that. And actually it's difficult, in any case, just from a purely logistical perspective to do it in less than six months because, you know, you start off by doing those sort of the desk research, reading through all the annual reports, building a model, that kind of stuff. And that typically takes kind of a few weeks. Then you sort of schedule a call with the company, and normally the call gets scheduled then, you know, a week or two in advance. And then to the extent the call goes well, then you try to figure out an opportunity to go visit the company. and especially if the company is in a different continent

and normally it takes at least a month to plan that. So I think it would be very difficult to invest in something with less than six months time period. But of course not all of those six months are spent analyzing just that company that's times when you're doing other things, obviously. In your research process, do you have a rough number, how many companies you visit per year?

Well, I do, but I don't think it's a very meaningful number. So especially if I'm new to a country, what I'll typically do is trying to attend a conference there where, you know, organized by a broker or the stock exchange, whoever it is. And typically a conference is set up that, you know, it takes three or four days and you get to see, you know, five or six companies a day. So, you know, kind of five companies times five days. you're seeing 25 companies in a week or whatever. So if I'm doing that, obviously, there would potentially be hundreds of companies that I'm seeing a year. But I found, especially once I get to know countries and industries well, that type of, you know, scattergun approach is in a very efficient use of my time. And what I much prefer to do is have one or two companies that I'm super interested in and then spend, you know, one, two or even three days just at that one company.

And so if I look at today, in the course of a year, I'm seeing much, much fewer companies than I was, say, five years ago, but, you know, that's simply because I'm spending much more time at the companies I'm interested in rather than, you know, seeing five companies a day. How much detail is important for you? Yeah, so detail is really absolutely crucial because, you know, I have a very concentrated fund. There's only 10 companies in my portfolio. And that's not 10 times 10%. You know, some of the larger ones are 20, even more than 20% of the portfolio. Obviously, the smaller ones are more around the 5% mark. So I have a very concentrated portfolio. So that means I can't

afford to make too many mistakes. I really need to know the companies very well before I make an investment. And also what I found is the most successful investments are made when you buy a company when everyone else is sort of very pessimistic about it and potentially even panicking. And obviously to have the courage to buy something when everyone else is effectively saying they think it's worthless is very difficult intellectually but above all emotionally. And the only way I find I'm able to do that is if I really feel I know the company better than everyone else, even if some of those things I know aren't necessarily particularly relevant to the investment, it's still super important to have that knowledge.

in order to then have the confidence to make the investment. How do you see the relation between details and key drivers and mechanisms? Yeah, so it tends to be the case that, you know, there's hundreds of different things that can seem important at a company. There's lots of metrics you can track and calculate and follow. And all of those have some kind of value. course, if you're following hundreds of metrics, then it become one blows into the other, and you quickly lose sight of where you are. So what I tend to find is that every investment tends to come down to just a kind of handful of factors or metrics, and sometimes even just

one. And so the really important thing is to, A, figure out what that metric is, and then, and then, of course, B, to follow it closely. So, yeah, I think. a big part of any analytical process is sort of taking all that complexity and then distilling it into you know into simplicity and simplicity means you know kind of one or two key drivers for an investment. Can you maybe name the example for the one key driver? Yeah I mean it it really depends on the company you're talking about. You know one of my favorite investments is a company called credit acceptance. which does subprime lending for cars in the USR.

And so credit acceptance, his founder, Don Foss, had this amazing idea when he started the business that you could lend much more effectively to people if the dealer, so the person selling the car, participates in the riskiness of the loan. And it's kind of counterintuitive because you think, well, how enough does a dealer know whether someone is going to repay or not? And actually, the dealer has quite a big influence,

because the dealer knows the quality of the car. And if the car is gonna fall to pieces a few months after it leaves the garage, then the person is not gonna be able to get to their work to go to their job. And if they can't go to their job, they're not gonna be able to earn money. And if they can't earn money,

they're not gonna be able to repay the loan. So this was a genius insight that he had. But he wasn't a mathematician. And although this insight served the company very well over many decades, there came a point where it suddenly reached the situation where in no log in you whether the loans it was making were profitable or not. And so it was the influence of the now CEO Brett Roberts who really introduced the tools

to figure out, okay, is the loan profitable or not? And the way he describes it is, you know, it's difficult to know if you're winning, if you don't know what the scoreboard is. So he created the scoreboard. And the scoreboard for credit acceptance is what they term the kind of the economic value added. So what is the profitability of you? loan after allowing for, you know, the capital cost of that loan. And they're very, very rational if they think a loan, well, their capital is scarce. So they allocate first to the most profitable loans and then to the less one, less profitable ones. And the ones which don't reach their profitability targets, then they leave out completely. So, but for them, it's the economic

value I did, which is the key driver. When do you sell underway? Well, by far the most important, reason to sell is actually when you realize you're wrong. So like I mentioned, my investment hypothesis at the start of an investment is, you know, this is a wonderful business run by a wonderful person and it's going to become much more valuable over time. And of course, that situation is very rare. So quite frequently, the hypothesis proves to be wrong. You know, maybe the growth opportunity is less than I expected or the manager is less engaged than I hoped or whatever it might be. And whenever I realize that that hypothesis is wrong, it's very important I react quickly and sell the company. And whenever I've done that in the past, I've never

regretted it. I think another reason obviously to sell is if you think something has become too expensive. And in my experience where everything else about an investment has been 100% what I'm looking for, but where I've felt the price has got too expensive. And And then I've sold this oftentimes turned out to be a mistake because kind of unexpected things happen and in great businesses the unexpected things tend to be very positive as opposed to the bad businesses where they tend to be negative the surprises. And so oftentimes I've sold things and later regretted it if it was purely because of my assessment of the value.

So we have to deal with this now? Well just by, you know, the way I've learned to invest and the way I can continue to learn to invest is by looking at past investments, figuring out which ones did well, which did less well, and the reasons for that, and then iterating to obviously do more of the positive things in the future and less of the negative things. And, you know, like I just described where an investment was otherwise perfect, but I was just concerned about the price that's been a source of mistake. So on a forward-looking basis, maybe I'm a little bit, you know, I weight my opinion on the sort of the price element of things a little bit less because it's proved

to be less reliable and then overweight, you know, these other elements such as the quality of the business as the people to hopefully correct for that bias. How do you track the companies you've sold? Yeah, so, you know, sometimes I sell a company but fundamentally remain interested in potentially investing again, in which case I'll continue to follow it quite closely or continue to visit the company from time to time, read the quarterly reports. kind of stuff. And then other companies, I've discovered something in it as a result of which I've sold and decided it's never going to be an investment again. So in that case, I tend

not to follow it that closely in the future. But I do kind of keep an eye on them and like to make sure that they continue to do reasonably well. You know, I would consider it a poor reflection on my ability as an investor if every time I sold a company, the company was a few months later going to go down to zero then on the one hand it would be nice to have sold but on the other hand i would wonder you know how good an analyst am i if i'm buying companies and they end up going to zero so um i do like to see that companies do reasonably well after i've sold and i think generally even for the companies that i've sold they've most of them have continued to do reasonably well afterwards and how many companies are on your watch list um yeah so it's it's it moves around

a little bit. As, you know, hopefully companies coming in as I discover new good companies and then sometimes others going out as I discover a reason why they no longer suit me as potential investments. But I would guess that it's generally around, you know, somewhere between, you know, kind of 70 to 100 companies on my watch list. Thank you very much for the great insights on this interview. Thank you. It's a pleasure. Thank you.