We Study Billionaires - The Investor’s Podcast Network - TIP529: Joel Tillinghast & Uncovering the Art of Outperformance

Starting point is 00:00:00 You're listening to TIP. Welcome to the Investors podcast. I'm your host, Clay Fink. It's great to have you, as in today's episode, I'll be covering a book by Joel Tillinghouse called Big Money Think Small. Joel Tillinghouse is an investment legend who has managed money with Fidelity for 36 years and manages $70 billion. Peter Lynch hired Joel at Fidelity, and he described him as one of the greatest, most successful stock pickers of all time. Since 1989, Joel has beaten the market by 3.7 percentage points, which is just an incredible feat. During this episode, you'll gain insights about how the future is entirely uncertain and some level of speculation is required in every

Starting point is 00:00:46 investment. What speculations are acceptable for Joel's conservative investment approach? What you need to understand about a company prior to investing? Joel's stock thoughts on why he chooses not to invest in gold, why investing in countries with the fastest GDP growth may not be the best decision, and so much more. At the end of the episode, I'll do some stock analysis on two companies that focus on acquiring businesses for their continued growth, Brown & Brown Insurance and Constellation Software. Constellation Software specifically is a very interesting case study, as Mark Leonard, who has at the helm of the company, has increased the share price of Constellation at an astounding rate of a turn of 34% annually, increasing the stock

Starting point is 00:01:31 price by over 125 times. So be sure to stick around until the end of the episode to learn more about Constellation in the brilliance of Mark Leonard. With that, let's dive right into today's episode. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now, Peter Lynch wrote the foreword to this book, and he gives Tillinghouse quite high praise. He says that there are many skilled investment professionals whose funds have beaten their benchmarks, and Joel Tillinghouse is right up there with them.

Starting point is 00:02:21 And that there are a lot of books out there that purport to help you become a better investor, but few mesh the human aspects of investing and business with the number side, and even fewer do that by drawing on the experiences of arguably one of the most successful stock pickers and active mutual fund managers over the past three decades. Lynch was actually the person that ended up hiring Tillinghouse at Fidelity in 1986. He says, I have witnessed Joel's growth as an investment professional, and I continue to be amazed by an almost unworldly ability to consume mountains of information about hundreds of companies at a time, analyze them and distill them, and use it to find long-term winners while

Starting point is 00:03:03 avoiding many of the losers. Lynch received a cold call from Tillinghoused, and Lynch was immediately blown away by the knowledge that this guy had. Immediately after he received the call, he called the head of Fidelity's investment division and said, we've got to hire this guy. He is just unbelievable. In his book, Joel argues that you cannot learn to become a great investor, but you can learn from the investment mistakes of others to be a more successful one. Things like investing patiently and rationally rather than investing emotionally and based on your gut, or the mistake of chasing fads, fast-changing industries, or commoditized businesses with a lot of debt. He breaks down five key principles for avoiding investment mishaps in the book.

Starting point is 00:03:48 Tillinghouse opens up the book by saying that this book is about succeeding in investing by avoiding mistakes. The organizing framework of this book in five parts is that we will reap pleasing investment rewards if we make decisions rationally, invest in what we know, work with honest and trustworthy managers, avoid businesses prone to obsolescence and financial ruin, and value stocks properly. With the help of this general approach, Tillinghouse has outperformed the Russell 2000 and the S&P 500 by nearly four percentage points a year. In over 27 years, $1,000 grew to $32 in the Fidelity Low Price Stock Fund, and a dollar in the index grew to $12. One of Tillinghouse keys to successful value investing is patience.

Starting point is 00:04:35 Value investing is all about buying something for less than one believes its worth, and then being patient enough and letting time be on your side. He points out that in the mutual fund industry, funds with lower turnover tend to perform better. This is counter to our natural human instinct, which tells us that we need to take action in our portfolio in order to achieve some result. His first lesson of investing rationally brings him to mention the countless bubbles of the past and how quickly large groups of people become irrational as if the bubble they're in is different than all of the bubbles in the past.

Starting point is 00:05:10 When emotions are all stirred up inside of someone and they become delusioned by narrative talking points, they lose their ability to reason and can't really separate fact from fiction. He says that crowds are impressed by spectacle, images, and myths. Misinformation and exaggeration become contagious. Prestige attaches to true believers who reaffirm shared beliefs. Crowds will chase a delusion until it is destroyed by experience. One bubble we can all learn from from the past was the South Sea bubble in Great Britain in 1711. The South Sea Company was launched as a scheme to privatize British government debt and the Crown granted South Sea exclusive rights to trade with South America. Holders of this government debt could swap that

Starting point is 00:05:56 debt for South Sea shares, and South Sea would collect interest. Interest income was South Sea's only source of earnings at the time. In just six months, shares in the South Sea company rocketed by eight times based on just purely speculation around the South American trade industry, and it really had no tangible earnings to back up the hype. Even Sir Isaac Newton lost money in the South Sea bubble as he stated, I can calculate the motion of the heavenly bodies, but not the madness of the people. In Chapter 3, Tillinghouse breaks down the major differences between speculation and investing. He says that, quote, in the public eye, it all looks like gambling, and sometimes it is. Wall Street confuses things further by calling all of their customers, investors, in quotes.

Starting point is 00:06:44 Awkwardly, every investment involves some sort of speculation about future events. More dangerously, many who believe they are investing are actually speculating. The distinctions matter because investors gather information and manage risk and uncertainly differently than speculators. Tillinghouse explains that investment is a product of thorough research that indicates that capital is broadly secure and an adequate return should be earned. Speculation, on the other hand, oftentimes gets a bad reputation in the value investing community, but it's something that is really a key part of our daily lives.

Starting point is 00:07:21 Very few decisions that are based on forecasts in the future can be made with absolute certainty. But he says, among the most treacherous speculations are on share prices, commodity prices, and crowd psychology. Since we don't want to speculate on share prices, commodity prices, and the sentiment of the crowd, well, what really is worth speculating on? Tailinghouse states that topics that are really, worth speculating on, include whether management will make the right decisions when the time comes, whether an industry is prone to failure because of commoditization, obsolescence, or financial

Starting point is 00:07:58 overreach, and what a security's value might be. Because we're anticipating responses to challenges and opportunities that have not yet presented themselves, no one really knows. However, the track records of executives and industries can provide useful indications. For example, brick and mortar retailers will have to sell on the internet or risk being destroyed by Amazon. My speculation center on which categories of merchandise will move more slowly to the internet, how the internet and end-store transactions might combine, and which chains have the systems and adaptability to serve customers in both formats. Benjamin Graham, who is the father of value investing, stated that an investment operation is one in which, upon thorough analysis, promises safe

Starting point is 00:08:46 of principle and an adequate return. An adequate return may be something greater than what you could get in the bond market. For example, in the U.S. today, you can purchase a bond for around 4% before accounting for inflation. Many value investors I've studied target of return of at least 10% or 15%, and I tend to use a 10% discount rate when I'm doing my own DCF calculations. Tillinghouse provides a four-point checklist to help guide people to better understand whether they are investing or speculating. 1. Are you thinking about the profits of the enterprise as a whole over time? 2. Have you investigated enough to feel fairly certain about your conclusions?

Starting point is 00:09:27 3. Will the business remain stable enough to say that your capital is secure? 4. Is it reasonable to expect an adequate return? Throughout the book, Tillinghouse explains some of the basics around investing, such as if you're not willing to do the research around individual stocks, then you should just stick with low-cost index funds. And then stocks are the best vehicle to build long-term wealth, and we should ensure we aren't paying excessive management fees or expense ratios. If you do decide to invest in individual stocks for yourself, Tillinghouse believes that you must stick to investing in businesses that you understand and know really well. He explains, to understand a business, you must understand

Starting point is 00:10:07 what every segment does and how they all make money. You must identify the factors that will produce its future earnings and be able to make a more or less accurate stab at forecasting them. Not all industries are equally easy to understand. Some industries such as biotech are impossible for most lay people. After a little study, you'll find that some industries are brutally competitive and unprofitable while others are consistently lucrative. Peter Lynch commonly says that you should start by researching companies that you're familiar with in your day-to-day life. But Tillinghouse points out that familiarity can also work against investors. How do you continually invested in the single largest company in the S&P 500 from 1972 through 2016? Your compounded returns were less than

Starting point is 00:10:55 4% per year, while the index earned over 10%. Sometimes investors are duped into believing that familiar names are safer investments. Familiar staples in the American economy such as Walmart and Apple may very well be safer bets, but it's good to be aware. that familiarity may lead us to be biased towards a particular company. In order to understand the company, you want to understand a number of pieces of the business. You want to understand why customers buy that particular product, why they might stop buying it or switch to a competitor. This also ties into familiarity. I've covered William Sonoma's stock in the past, and Tobias Carlisle said that during the Mastermind episode that his wife buys all of her furniture for their house from William Sonoma. So,

Starting point is 00:11:41 for many people, it's just a really good brand that customers are attached to because they know what they're going to get and they can rely on the quality. And William Sonoma has really won that trust over their customers. So that's just William Sonoma is an example for how I think about understanding the company. Other items that are worth noting around understanding a company include understanding the company's competitive advantage and what makes them different from their competition, how the business actually makes money, what causes their profitability to rise. in fall? What is the driver of the company's growth? What threats the business faces that may cause it to fail? As well as how good of an idea you have on where the business will be in roughly five years.

Starting point is 00:12:24 This all ties into the Circle of Competence concept as well. Your circle of competence contains businesses and industries you are competent in and have special skill or insights into. Some industries are going to fit much better into your circle of competence than others, and that's totally okay because, at least for me, there's no way I even want to analyze or understand all the tens of thousands of businesses that exist. I just don't have the time or the mental capacity to do so. You only need to have conviction and a strong understanding in a select few companies. I appreciated that Tellinghouse didn't just focus on stock picking like Lynch did in his books.

Starting point is 00:13:03 He talks about a wide range of topics, including the overall economy, economic forecasts, and gold. Here's an excerpt I wanted to share regarding gold specifically. The garden variety versions of failures to consider intrinsic value and take in new information are permanent bears who always expect stocks to tank and gold bugs. This isn't to say that bear markets don't occur or that gold can't be a useful store of value. Value investors are likewise intent on preserving capital, but we worry about the opportunity costs of holding such assets that produce little or no income like cash or gold. Permabairs and gold bugs often tells sagas of impending disaster, with accelerating inflation,

Starting point is 00:13:47 usually following from high and rising consumer and government debt. Every data point is reinterpreted to support their cause. It's intelligent to worry, but that doesn't mean the most worrisome analysis is the most intelligent. I have some sympathy for the permabairs, as the average PE of the S&P 500 in the quarter century between 1992 and 2016 has been higher than the quarter century before it, or just about any quarter century since the index was created. Some argue that higher multiples are justified by globalization, increasing monopoly power, and new technologies. Those who believe market valuation

Starting point is 00:14:25 metrics are nonetheless mean reverting have appeared to be permabairs. A distinction might be found in their actions during bear markets like 2009, when market multiples tumbled far below even the averages of longer histories. If they bought stocks, then, they are not permabairs. Gold may be a store of value, but how much value isn't clear. Since gold earns no income, it has no intrinsic value. But over time, it does seem to have an average value based on a basket of consumer goods with huge variance. Yet in 2001, gold traded at $270 an ounce, and in 2011, $1,900. dollars. Even making a generous adjustment for consumer price inflation, in 2011, the real price of gold was five times what it had been a decade earlier. The popularity of tales of hyperinflationary

Starting point is 00:15:15 disasters peaked coincidentally. In a weird parallel to inflationary fears, large quantities of securitized paper gold were issued. Investors with a sense of value and the ability to change their mind might have reduced their gold holdings at that time. this is a really interesting point of discussion. The traditional value investor will say that over the long run, stocks are the best performing asset class because they're productive assets and you don't have to guess whether now's the time to own gold or now's the time to own stocks. You just hold the stocks for the long run and you know you'll turn out well. Plus, value investors want to buy something for less than its worth and it's impossible to value gold, so why even

Starting point is 00:15:57 bother is their perspective. The other side of the coin for why people invest in gold, or even Bitcoin nowadays is because the debt levels are just increasing higher and higher, as Tailinghouse mentions, and that eventually reaches a point where the debt simply can't be paid back in real terms. So the gold bugs believe that high inflation is inevitable, which in theory would be beneficial to gold and not as beneficial to stocks in general. I can understand both sides and believe that everyone should come to their own conclusions. Of course, I personally chose to allocate to both gold and Bitcoin because I foresee a good chance we see a lot of asymmetric upside and at least one or the other. But that definitely doesn't

Starting point is 00:16:36 prevent me from investing in equities as well to get the long-term benefits from those. This reminds me of what Bill Miller said on William Green's richer, wise, or happier show that the purpose of investing is not to invest in productive assets. The purpose of investing is to make money. And there are a number of ways to do that. You don't have to just pick stocks. You You don't have to just pick gold, just pick Bitcoin, but some people choose to do that. Just stick with stocks or stick with gold or Bitcoin. More power to them if they decide to go that route. Gold and Bitcoin are more so macro-type bets.

Starting point is 00:17:09 They're based on this really big picture and this big macro approach. And the overall economy is just extremely complex as well, to say the least, which can make it even more difficult to decide whether a non-productive asset is a good investment or not. To counter this difficulty, Tillinghouse encourages us to think small. He says, so instead, I try to think small. There are fewer news reports on a specific company than on the economy as a whole. Analysis of stocks is less a matter of careful interpretation than analysis of the economy. It's not inside information. It's simply that most people aren't paying attention, especially if the company is small. Everyone makes mistakes in figuring out

Starting point is 00:17:53 what the future will bring. If the connections are clearer and more direct, your forecasts are more likely to be accurate. Unlike more cosmic subjects, it is easier to know what you don't know with the specific stock. Both macro investors and stock pickers must fearlessly seek the truth, but for me, smaller errors are easier to admit. Once I've committed to a theory that explains big, important things, I rarely change my mind. It's more unsettling to admit that I don't comprehend the world around me, than a small situation of narrow interest. While I make fun of investors who incessantly think that the stock market is about to implode or that gold is the only safe asset, I also have my own settled beliefs. An idea about a specific stock is just one of many,

Starting point is 00:18:40 and I know all along that a certain fraction of them will be duds. A smaller mistake is generally easier to repair. Thinking small not only reduces the severity and frequency of errors, but it also puts you in a better frame of mind to expect them and fix them. I think this is one of the common pitfalls of gold bugs or Bitcoin maximalists is that once you take a stance, because of things like groupthink and other psychological factors, I very rarely see someone revert back to being, say, a stock picker or having the opposite opinion. I like Tillinghouse Insight that we rarely change our mind on these big, broad ideas. This also relates to an idea I discussed during my episode covering Guy Spears book, The Education of a Value Investor, which was that we tie

Starting point is 00:19:27 our identity to something. It becomes extraordinarily difficult for us to revert back our opinion or viewpoint once we take that stance. To counter this, Guy Spear just doesn't talk about his stock picks for the most part, so he's much more freely to change his mind when the facts change. Let's take a quick break and hear from today's sponsors. All right, I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is.

Starting point is 00:20:05 From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year, bringing together activists, technologists, journalists, investors, and builders from all over the world, many of them operating on the front lines of history. This is where you hear firsthand stories from people using Bitcoin, to survive currency collapse, using AI to expose human rights abuses, and building technology under censorship and authoritarian pressures. These aren't abstract ideas. These are tools real people are using right now. You'll be in the room with about 2,000 extraordinary individuals, dissidents, founders, philanthropists, policymakers, the kind of people you don't just listen to,

Starting point is 00:20:45 but end up having dinner with. Over three days, you'll experience powerful mainstage talks, hands-on workshops on freedom tech and financial sovereignty, immersive art installations, and conversations that continue long after the sessions end. And it's all happening in Oslo in June. If this sounds like your kind of room, well, you're in luck because you can attend in person. Standard and patron passes are available at Osloof Freedom Forum.com with patron passes offering deep access, private events, and small group time with the speakers. The Oslo Freedom Forum isn't just a conference. It's a place where ideas meet reality and where the future is being built by people living it. If you run a business, you've probably had the same thought lately. How do we

Starting point is 00:21:30 make AI useful in the real world? Because the upside is huge, but guessing your way into it is a risky move. With NetSuite by Oracle, you can put AI to work today. NetSuite is the number one AI cloud ERP, trusted by over 43,000 businesses. It pulls your financials, inventory, commerce, HR, and CRM into one unified system. And that connected data is what makes your AI smarter. It can automate routine work, surface actionable insights, and help you cut costs while making fast, AI-powered decisions with confidence. And now with the Netsuite AI connector, you can use the AI of your choice to connect directly to your real business data. This isn't some add-on, it's AI built into the system that runs your business. And whether your company does millions or even

Starting point is 00:22:18 hundreds of millions, NetSuite helps you stay ahead. If your revenues are at least in the seven figures, get their free business guide, demystifying AI at netsuite.com slash study. The guide is free to you at net suite.com slash study. NetSuite.com slash study. When I started my own side business, It suddenly felt like I had to become 10 different people overnight wearing many different hats. Starting something from scratch can feel exciting, but also incredibly overwhelming and lonely. That's why having the right tools matters. For millions of businesses, that tool is Shopify. Shopify is the commerce platform behind millions of businesses around the world and 10% of all

Starting point is 00:23:01 ecommerce in the U.S. from brands just getting started to household names. It gives you everything you need in one place. from inventory to payments to analytics. So you're not juggling a bunch of different platforms. You can build a beautiful online store with hundreds of ready-to-use templates, and Shopify is packed with helpful AI tools that write product descriptions and even enhance your product photography. Plus, if you ever get stuck, they've got award-winning 24-7 customer support.

Starting point is 00:23:30 Start your business today with the industry's best business partner, Shopify, and start hearing... Sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show. In Chapter 8, Tillinghouse covers the considerations when investing internationally.

Starting point is 00:24:00 Investing internationally adds a whole new layer of complexity to an investment approach. You're likely dealing with a different currency, different inflation rates, different growth rates of the economy, different political situations, just to name a few. This is why I personally tend to stick to the U.S. and avoid investments such as things in China, which are becoming much more popular. Our We Study Markets newsletter team has a great article covering the risks investing in China. I'll be sure to get that linked in the show notes for those interested. The biggest advantage of investing internationally is that your opportunity set is substantially bigger, as many countries have more public companies than the U.S. Tillinghouse cautions against focusing on countries with the most

Starting point is 00:24:44 runway for growth in GDP per capita because these countries historically didn't perform the best for investors in these countries. He notes that Japan and Italy had among the highest growth in GDP per capita, but stock returns in Japan were roughly average, and Italy was comparatively low. Italy's average stock market returns were only 2% in the study, while the U.S. was on the higher end around 6.5%. Many other countries were somewhere in between. And it's also worth noting that Italy even had higher levels of GDP growth per capita than the U.S. Australia, Sweden, South Africa, the U.S., UK, and Canada had the best stock returns from the year 1900 through 2015. GDP per capita didn't grow particularly fast in these countries, but several of them

Starting point is 00:25:30 had the tailwind of high population growth. Tillinghouse prefers to invest in countries with a rule of law that are cheap on a relative basis rather than looking for countries with high growth and GDP per capita. Starting in Chapter 13, Tillinghouse explains that there are four elements of value within a company, the profitability or income, the company's lifespan, future growth and certainty. One of the most important and overlicked parts of this equation is certainty. lately I've been reading a book called The Joys of Compounding by Goddum Bade. Goddham had this brilliant insight into how Warren Buffett views investing in uncertainty. Most of our listeners are probably aware that Buffett says that he invests in what he calls

Starting point is 00:26:13 his circle of competence in businesses that he can know and understand really well and be really certain about the company's future. When he finds a business, he is certain of their future, then he evaluates whether the stock is cheap enough to buy. But if he's not certain about the company's future, then he just stops his analysis there and just doesn't even think about investing in the company, which really sounds obvious. But Buffett states that 99% of the stock ideas he comes across fall into the too hard category for him, which I believe would really surprise many people, me included. Just let that sink in, Buffett, who is known as the greatest investor in the world, admitted that he does not understand 99% of the businesses he comes across. So that's just a really good reminder that we don't need to have an opinion about the vast majority of businesses in order to be a successful investor. Goddham says that the basic idea behind the circle of competence is so simple.

Starting point is 00:27:11 It is embarrassing to say it out loud. When you are unsure and doubtful about what you want to do, do not do it. So Buffett only invests in businesses that he is highly certain on in order to make an attempt to eliminate any potential risks that may pan out in the future. Tillinghouse points out that in a rapidly changing world with companies rising and falling faster than ever, investors have fared best in industries that cater to daily needs where customers can't or won't switch. Unless Tillinghouse can be shown that customers don't view a product as a commodity, then he will assume that it is a commodity.

Starting point is 00:27:46 And commodity industries tend to have mediocre profits, as well as be very capital intensive. Alternatively, industries with no substitutes and companies with no competitors tend to, to enjoy the highest returns, survive the longest, and deliver the greatest value. He says that while he generally avoids commodity businesses, if he had to invest in one, then he would go with an oil business because of the limit on supply and the relatively inelastic demand, meaning that if the price of oil increases by a lot, then it doesn't have a huge impact on demand. This is true in my own life, for example, as the price of gas really doesn't affect my decision to go on a road trip or drive to the grocery store. I'll pay for

Starting point is 00:28:27 gas, whether it's $2 a gallon or $6 a gallon, and that's really where the term and elastic demand plays in there. He says that demand for oil continues to increase, while the Earth's resources and supply of oil is finite and global reserves are being depleted. Because of the boom-bust nature of the oil industry, Tillinghouse builds conservatism into his investment approach by assuming that oil prices in the future will be lower than today's spot price or the 10-year average. In addition to looking for companies with a low production costs that are in a politically stable country. Additionally, he wants them to be cheap on a PE basis and have little to no debt.

Starting point is 00:29:05 Trey Lockerbie released a great interview covering the oil industry and Buffett's purchase of oil companies like Chevron and Occidental with expert Josh Young back on episode 468 in August of 2022. I'll link that in the show notes as well. What really sets Tillinghouse apart from some of the other investors I've covered here on the show is he ensures that a company is really truly undervalued and he is not overpaying for the company. He has a four-part checklist he provides that he uses to help ensure that a company is undervalued. First, does the stock have a high earnings yield, which is the same as a low PE ratio after

Starting point is 00:29:41 normalizing their earnings? Second, does a company do something unique that will allow it to earn super profits on its growth opportunities, which is essentially asking, does the company have a moat? Third, is the company built to last, or is it at risk from competition, fads, obsolescence, or excessive debt? And fourth, are the company's finances stable and predictable into the extended future, or are they cyclical, volatile, and uncertain? He says, this checklist does not catch every undervalued stock, but it does call out the most common sources of disappointment.

Starting point is 00:30:16 It does not guarantee that bad things can't happen, but it does improve your odds. When I can fill my portfolio with stocks with all four qualities, I see no need to consider those with defects. Most stocks will fail this screen, but that does not mean that they are not undervalued. In those cases, you must work through a full DCF, watchful of the risk of forecast error stemming from the known point of vulnerability. Tailinghouse walks through the case study of United Healthcare, which he bought in 2010 around $30 a share, in the stock advanced to $150 by 2016.

Starting point is 00:30:50 The stock had a low PE as it traded out of just 7.3, providing a 13, almost 14% earnings yield. The company had steady growth, steady return on equity of 20%, which was above the median of the S&P 500 at 14%. In being the largest health insurer in the country, United Healthcare had a significant moat that gave them immense negotiating leverage in economies of scale. The only question mark around the company was the impact that Obamacare would have on the company, and if government regulations would be increasingly difficult for health insurers to be profitable going forward. For his fourth test of assessing certainty, the industry that United

Starting point is 00:31:31 Healthcare was in had extremely stable and predictable revenues. Insureds would sign up for coverage at premiums set a year in advance. Health insurance is a service that will always be in demand, and a lot of people stick with the same plan year after year. The overall business was definitely certain in terms of the durability before considering any of these regulatory concerns. Tailinghouse talks about a ton of different subjects in his book. He talks about bubbles, IPOs, technology, and its role in the economy, globalization, and a whole lot more that I won't be getting into during this episode. But during his final chapter, he says that two icons of investing, Warren Buffett and Jack Bogle, point in completely opposite directions.

Starting point is 00:32:12 Buffett personifies an utterly idiosyncratic style of active investing, while Bogel created the Vanguard S&P 500 Fund. Both approaches are systems for minimizing regret with your investment decisions. The indexing approach Bogel advocates for defaults your returns to the average of the market and removes any risk of getting overly emotional, assuming if you really don't know what you're doing and you're just making silly mistakes with investing. But Buffett and Bogel, don't represent the only conceivable way one can invest. He says, quote, the path you choose and sometimes must develop depends on your emotional character, knowledge, and curiosity. It's always critical to rationally examine one's own motives, the capabilities, and limitations. But it's

Starting point is 00:33:00 important to do it. Many people prefer the contentment of the easily practical to shooting for the stars and often missing. Don't torture yourself if you're not cut out for stock picking like Buffett. Not only is Tillinghouse more apt to search for cheap companies, he is also very, very diversified relative to someone like Buffett especially. He'll hold hundreds of stocks while Buffett is fine being concentrated in just a handful. I think this is a good transition point to discuss and assess a couple of different companies. Recently, I booked an interview with Chris Mayer for the We Study Billionaire Show. Chris is the author of a very popular book called 100 Baggers.

Starting point is 00:33:38 That interview is scheduled to be released on the We Study Billioner Show. podcast on April 8th, and I'm really excited to chat with Chris because his approach and philosophies to stock investing, I feel aligned fairly closely with mine of, you know, we're looking for high-quality businesses with high returns on capital that have a long runway ahead. And this is very similar to Terry Smith's approach, who I just recently covered on the show on episode 526. Chris Mayer manages a fund called Woodlock House Family Capital, and thankfully, he has shared the companies that he holds in his portfolio, a couple of which I wanted to dive into today's

Starting point is 00:34:14 episode. The first company is Brown and Brown Insurance. Chris has tweeted a few times about this company as he said that after their most recently quarterly release, they had another solid year. So I figured I'd dive in, take a look at the company, and see what I find. Founded in 1939, Brown and Brown Insurance is an insurance broker headquartered out of Daytona Beach, Florida. They focus on primarily selling property casualty insurance and employee benefits. They're the fifth largest insurance broker in the country, and they have 450 locations. Since they're a broker or intermediary that sells insurance, their primary source of revenue are commissions paid by insurance companies and to a lesser extent fees paid directly by customers. Their 2021 annual report states that their four business segments

Starting point is 00:35:01 offer a wide range of insurance solutions and services for businesses, government institutions, professional organizations, trade associations, families, and individuals. When I pull up our TIP finance tool on our website, I see that they increase their revenues from $1.2 billion in 2012 to $3.4 billion in the most recent year. Their net income and free cash flows continue to march up toward overtime. Operating margins are consistently in the mid-to-high 20% range. Their PE at the time of this recording is around 26, and their price to free cash flow is just under 19. Then, before I turn back to the annual report, the return on invested capital

Starting point is 00:35:41 is consistently 9 to 10% in recent years. That might be a question I asked Chris if we get the chance to discuss this company during our interview. The stock returned almost 16% to investors over the past 10 years, excluding dividends, while the S&P 500 delivered a return of around 10%. And they pay out a relatively small dividend, but they've increased that dividend for the past 29 years in a row, giving it the status of a dividend aristocrat. Turning back to the 2021 annual report, they grew sales that year by 10% organically and almost 17% overall. The company completed 19 acquisitions with annual revenues of about 132 million, and this contributed to their overall revenue growth. The report states that we grow our business organically and through the acquisition of like-minded

Starting point is 00:36:32 companies. Our focus on growth and profitability enables us to self-finance many of these transactions. Cultural fit remains the most important ingredient to a successful acquisition, followed by favorable financial terms. Then a bit later, our capital management strategy is based on the philosophy of investing to optimize returns and minimize debt. We strategically deploy capital to invest internally, acquire firms, and return capital to shareholders while maintaining a conservative debt profile. Chris had mentioned that Brown & Brown is really good capital allocators, and I love how they show this chart of how their cash was spent over the year. 12% of cash went towards share repurchases, 7% for capital expenditures, 16% for dividends,

Starting point is 00:37:18 and 65% went towards acquisitions. So they're really plowing a lot of money back into buying other companies. Their largest acquisition was a number. insurance broker out of Ireland named O'Leary Insurance, but a great majority of Brown and Brown's presence is in the United States. The company's CEO is Jay Powell Brown, who was the grandson of Adrian Brown, who originally started the company back in 1939 with his cousin, hence the name Brown and Brown Insurance. Jay became the CEO of the company in 2009 and has been with the company for 27 years. And get this, Jay Powell Brown, the CEO, owns 2% of outstanding shares valued at $332 million. And his dad, Jay Hyatt Brown, owns 13.3% of outstanding shares valued at $2.2 billion.

Starting point is 00:38:10 So these two combined owned 15% of the company. And then the total insider ownership is almost 17%, which is really, really good to see that we have that strong alignment of interest between managers and shareholders for Brown and Brown Insurance. In the annual report, it shows the results of operations for 2021 and then compares it to 2020. The majority of their revenue comes from commissions and fees from selling insurance at all their various brokerages. Commissions and fees were up 17% year over year, while overall revenue was up just shy of 17%. Total revenue was just over $3 billion leading to a net income of just shy of $600 million. Then the report breaks down their revenue into four business segments from largest to smallest

Starting point is 00:38:56 by revenue. They got their retail, national programs, wholesale brokerage, and services. So the business really isn't all that complicated from a high level as the majority of their revenue simply comes from commissions and fees from selling insurance. When I do an intrinsic value calculation for Brown & Brown, I looked at how much their free cash flows have grown over the years to help project those out into the future. Over the past 10 years, free cash flows have grown by around 15% annually, so I want to project some sort of growth with a little bit of conservatism as well. I went ahead and projected free

Starting point is 00:39:30 cash flows to grow at 10% for the first five years and 7% for the following five years. Then I put a terminal value on the company at 15 times free cash flow in year 10. Discounting all those cash flows back to today, I come up with an intrinsic value of around $68, while the stock today trades at $58 per share at the time of this recording. That gives us a 17% discount to intrinsic value, assuming that the business is able to achieve this decent level of growth. So if the company is able to achieve these decent results relative to what they've achieved in the past, I'd expect the stock to return somewhere in the 10 to 12% range. Of course, nothing said on this podcast is intended to be financial advice. This is all just my opinion and based

Starting point is 00:40:14 on the research I've done. What I really like about the company is their stability and their consistency in their business. They continue to grow their free cash flows despite the pressures over the past year or so. The stock has held up much better than a lot of other growth names. The results have continued to be strong throughout 2022. The company has a long history of success and they still have the family of founders in the company who own a ton of shares and based on their history, they're really good managers. So I'd expect them to continue to deliver. consistent results for the business, excluding any crazy recession that's essentially outside of their control. I think that family control companies like this do a better job of focusing on

Starting point is 00:40:54 long-term value creation, and I think that's something that Chris points out as well in his analysis. Rather than trying to play games with Wall Street and trying to hit their quarterly earnings targets, family-owned companies tend to be much more long-term oriented and not play these Wall Street games. My concerns for the company include their company's moat and how they've been, able to grow free cash flows consistently at a higher rate of return than their return on invested capital. So I'll have to tap into Chris Mayer's knowledge on the business to hear his thoughts. Part of the return on invested capital piece may be fueled by higher debt levels. Their debt-to-equity ratio, which, as of the most recent quarter, looks to be around 0.8, whereas 10 years ago, it was

Starting point is 00:41:36 0.25. I'd expect that higher interest rates might be a bit of a headwin for them in the future, if they're utilizing debt in order to make these acquisitions to help fuel that growth. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process

Starting point is 00:42:02 and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a stock two or running, an enterprise GRC program, VANTA keeps you secure and keeps your deals moving. Instead of chasing spreadsheets and screenshots, VANTA gives you continuous automation across more than 35 security and privacy frameworks. Companies like Ramp and Ryder spend 82% less time on audits with Vantta. That's not just faster compliance, it's more time for growth. If I were running a startup or scaling a team today, this is exactly the type of platform I'd want in place. Get started at Vanta.com slash billionaires. That's Vanta.com slash billionaires.

Starting point is 00:42:47 Ever wanted to explore the world of online trading, but haven't dared try? The futures market is more active now than ever before, and plus 500 futures is the perfect place to start. Plus 500 gives you access to a wide range of instruments, the S&B 500, NASDAQ, Bitcoin, gas, and much more. Explore equity indices, energy, metals, 4X, crypto, and beyond. With a simple and intuitive platform, you can trade from anywhere, right from your phone. Deposit with a minimum of $100 and experience the fast, accessible futures trading you've been waiting for. See a trading opportunity. You'll be able to trade it in just two clicks once your account is open. Not sure if you're ready, not a problem.

Starting point is 00:43:33 Plus 500 gives you an unlimited, risk-free demo account with charts and analytic tools for you to practice on. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit Plus500.com to learn more. Trading in futures involves risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500, it's trading with a plus. Billion dollar investors don't typically park their cash in high-yield savings accounts. Instead, they often use one of the premier passive income strategies for institutional investors, private credit. Now, the same passive income strategy is available to investors of all sizes, thanks to the Fundrise income fund, which has more than $600 million invested and a 7.97% distribution rate.

Starting point is 00:44:24 With traditional savings yields falling, it's no wonder private credit has grown to be a trillion dollar asset class in the last few years. Visit fundrise.com slash WSB to invest in the Fundrise income fund in just minutes. The fund's total return in 2025 was 8%, and the average annual total return since inception is 7.8%. Past performance does not guarantee future results, current distribution rate as of 1231, 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information can be found in the income funds prospectus at fundrise.com slash income. This is a paid advertisement.

Starting point is 00:45:07 All right. Back to the show. Next, let's transition to one of Chris Mayer's other picks here. The one that really piqued my interest was Constellation Software out of Canada. This is a company that was mentioned and caught my attention as well in William Green's Richer Wiser Happier Series with Francois-Rashon. He heavily focuses on quality companies. Francois said that the reason he invested in Constellation Software was because of their leader and president, Mark Leonard, who he regards as a really great human being.

Starting point is 00:45:40 Here's a clip of that episode with Franchois chatting with William about his investment in Constellation. You obviously have invested primarily in the U.S. over the years, but there's an important component of your portfolio that's Canadian companies, which is particularly interesting for the rest of us since you obviously have local not. as someone who's lived in Canada for a long time. I remember once, I think last time we spoke, I don't know if you had already picked out Constellation Software, but I'm fascinated by that company because the CEO, or I guess the president he's called, has a kind of cult following. He's sort of often viewed in the same way as a Bezos or a Buffett in certain circles of the software world, for example. Can you talk about that? Because I remember you saying at one point that really that entire investment in Constellation Software was based on the fact that you thought

Starting point is 00:46:33 Mark Leonard was this extraordinary leader? Yes. I remember as yesterday, I think there was a Christmas party in 2013. I was at some friend. And a young friend of mine, very young, he asked me if I know this company Constellation Software. And I was a little ashamed because I thought I knew all the great companies. So I said, no, I don't.

Starting point is 00:46:57 then. So I think it was almost on Christmas Eve. I read the 2000, well, probably 2012, annual report of consolation software written by Mark Leonard. And I remember when I read that, that was love at first sight. I said, this is my kind of God. I knew it because 20 years of reading out of reports, that was on the best I've read. And I, of course, did a little more research, read about the company, read the annual letters, tried to understand everything about the company, and probably a month later, I think the day after I read the annual report, I bought a few shares just to follow it, but a month later, you made a sizable investment with the company and never sold a share, so that was almost nine years ago.

Starting point is 00:47:48 And have you met how in 2014? Yes, a few times. And I think he's a great guy, is a great human being, a great businessman. and as great as you can find. What makes him stand out as a business leader? That's a good question. You know, people want some scientific approach to, you know, assessing managers what makes a great manager manager.

Starting point is 00:48:14 But I remember a friend of mine said, well, this is the kind of person you'd like him to marry your daughter. and I think that sums all the great managers, either Tom Gainer or Mark Leonard or Stanley Mott, MTFO, they're great human beings. You want them to manage your capital. I mean, if I had to go away, you know, I always use that analogy of the Gilligan Island test.

Starting point is 00:48:44 If you're stranded on that desert island for 10 years, you remember that show Aguigan Island? Yeah. Who would you entitle your capital? with. And that's one question I ask myself. Do the CEO of the company we invest? I'll be happy for him to manage our capital if I'm trending 10 years of Ireland. And I think Mark Leonard, I would sleep very well at night, this desert island, knowing that he's there in managing consolation software. Same thing with Tom Gainer at Markell or Stanley Maher at Mee Food, of course,

Starting point is 00:49:22 So Warren Buffett at Berkshire. It's a great insight. With someone like Tom Gaynor, who I know well from Markell, which you've owned, I think, for 10 years now, practically. Yeah, it's also 10 years. I mean, Tom, you would, yeah, you would just, you know, if you keeled over, you'd say, you know, before he keeled over, you'd say, Tom, can you just make sure my family is okay financially?

Starting point is 00:49:41 Like, you manage, you manage the money and make sure it's great. Yeah, it's great, really. Yeah, it's interesting. That's a great filter, actually, to think of who you want to partner with, not just as a money manager, but as a CEO. I think because most of us don't really think of our investments in such a long-term way, we underestimate the importance of that personal element, of that trust. Yeah.

Starting point is 00:50:07 And these are not easy to explain because they're kind of subjective. They're based on judgment. But, you know, as you get more experience, I think that's something that, that comes with experience, better judgment. Well, I like to think so. And that judgment helps us, you know, select great people. Because, you know, we've heard a lot, we've seen a lot, and we can see great managers because they're so rare.

Starting point is 00:50:40 And I would probably go back to the art analogy here. When you go to museums and go to and visit, you know, the best museums in the world, pretty quickly you can see which are the greatest artists. And so I always say that beauty is hard to describe, but when I see it, I know it. And I would say that if you look at a lot of art in your life, you'll be able to identify masterpieces. I think it's the same thing with companies and CEOs.

Starting point is 00:51:12 If you see a lot of them, if you read a lot of annual reports and you study a lot of companies and eat a lot of businessmen and business women over the years. years. After a while, he'll be able to identify the really great ones. So as I mentioned, Chris Mayer has this company in his fund as well. He actually wrote an article back in June 2020 all about it on his website, which I'll be sure to get linked in the show notes. Chris writes, so what if I told you about a company with great returns on invested capital, low leverage, Modi businesses, a great capital allocator at the helm, an owner-oriented culture, and a history of mouth-watering returns. Would you be interested? Since the company's IPO in 2006,

Starting point is 00:51:55 the stock is up 125x, and this is in February 2020. It's up 125 times, so it's already reached mayor's 100-bagger status since their IPO, but it wasn't until recent years did Mayor research the company to purchase it for his own fund. So Constellation is in the business of acquiring, building, and managing vertical market software businesses in Canada, the U.S., the UK, and the rest of Europe. Its industry-specific software businesses provide specialized in mission-critical software solutions. They were incorporated in 2005 and they're headquartered in Toronto, Canada. So many people in the U.S. might not know about this company because it's in Canada, since many investors like to focus on the country they're at.

Starting point is 00:52:42 Chris explains that he read through Mark Leonard's annual letters and he became really interested in the company from there, similar to what Francois was talking about in that episode. Chris says Leonard writes his letters in a way I wish all CEOs would write letters, from one business owner to another fellow owner. He focuses on things that matter, like Return on Investor Capital, and writes thoughtfully about how to think about and evaluate the business. Then there are passages that make Leonard seem like a special. character and the permanent of founder CEOs. Leonard says, I've traditionally traveled on economy

Starting point is 00:53:18 tickets and stayed at modest hotels because I wasn't happy freeloading on the shareholders, and I wanted to set a good example for the thousands of employees who travel every month. Then there are other bits that Leonard writes that speak to a good owner-centered culture. We incent managers and employees with shares escrowed for three to five years so that they are economically aligned with shareholders. In return, we need and want loyal employees. If they aren't planning to be around for five years, then they aren't going to care much about the outcome of multi-year initiatives. And they certainly aren't going to forego short-term bonuses for long-term profits. And then later, he says of his managers, we also pay them well. They are all millionaires many times

Starting point is 00:54:02 over, with much of their net worth invested in unescrowed CSI shares. Chris says these ownership attributes are hard to find in public companies, and I value them highly. Their presence alone would have me interested to learn more. Then Chris talks a little bit how Constellation is richly valued on a multiples basis because the company is just so good at performing acquisitions. And if these acquisitions of the future aren't as successful as those in the past, or those opportunities just aren't there at scale, then the stock price could definitely suffer tremendously. That's somewhat been the story over the past 10 years, yet Constellation has continue to, you know, just chug through these acquisitions and continue to outperform to a large

Starting point is 00:54:44 degree. Over the past five years, for example, the stock has delivered an average annual return of 24% annually. And if I remember right, I don't think the stock has ever declined more than 30% over its entire lifetime from 2006 through 2023, not one drawdown of 30% or more. The return on invested capital is spectacular at 27% per year, on average, over the past 5%. I think what Mark Leonard is doing at Constellation is really something special and incredible. Even looking back during the great financial crisis, you wouldn't be able to tell there was a recession. The share price just continued to chug along upwards. But of course, it was trading at a much lower multiple back then as well.

Starting point is 00:55:27 The stock chart ever since it went public is just relentless, which means that, of course, they are trading at a pretty high multiple today. I pulled together data on where the company has traded historically. back in 2012, the price to free cash flow was around 17, and then it increased to around 20 for a few years, and now it's increased to a price to free cash flow multiple of 30 over the past couple of years. If you look at the PE for Constellation, you'll find that it's nearly 80, which is very high. But this is because the net income amount is much higher than the free cash flow, because there are significant amortization write-offs that are non-cash expenses.

Starting point is 00:56:04 Essentially, a way to think about it is that accountants assume that the intangible assets that Constellation owns are declining in value. While Constellation doesn't believe this is an accurate measure of what is actually happening economically, Leonard states, internally, we think about the adjusted net income as the cash profits we generate after paying cash taxes. The most significant variation from gap net income is that we assume our intangible assets are not diminishing in economic value. This is a critical assumption that our board challenges and that you as shareholders need to monitor. The way we support the ever-expanding Intangibles Value contention with our board is by regularly forecasting the cash flows for each of our

Starting point is 00:56:51 acquired business units and then comparing them to our original acquisition costs to calculate the acquisitions IRR. Now I dug more into what Constellation actually does, and Mark Leonard is very much trying to take this Buffett-like approach of buying companies that will deliver strong returns, for consolation. Typically smaller companies, and then they incentivize the managers of those companies to allocate capital effectively, so essentially they're trying to align the incentives of the managers with those of the shareholders. They also specialize in acquiring smaller companies, and they're pretty good at avoiding debt in making these acquisitions. A lot of people say that Leonard writes like Warren Buffett, and I can understand why people say that. In February 2021,

Starting point is 00:57:35 on his most recent letter, it said, most of our competitors maximize financial leverage and flip their acquisitions within three to seven years. CSI appreciates the nuances of the VMS sector. We allow tremendous autonomy to our business unit managers. We are permanent and supportive stakeholders in the businesses that we control, even if their ultimate objective is to eventually be a publicly listed company. CSI's unique philosophy will not appeal to all sellers and management teams. But we hope it will resonate with some. In parallel with our established and growing small and mid-sized VMS practice, in our nascent large VMS practice, we are trying to develop a new circle of competence. We are seeking attractive returns, a sustainable competitive

Starting point is 00:58:22 advantage, and the ability to deploy large amounts of capital outside of VMS. That will require highly contrarian thinking and is likely to be uncomfortable in the early going. Hopefully, we have built enough credibility to warrant your patience as we explore new and underappreciated sectors, end quote. Here's another bit that I felt was too good not to share regarding having a longer-term-oriented shareholder base. Moving on to the manage the stock versus manage the company issue, I used to maintain the belief that if we concentrated on the fundamentals, that our stock price would take care of itself. I'm coming around to the belief that if our stock price stays too far, either too high or too low, from that intrinsic value, then the business may suffer.

Starting point is 00:59:09 Too low and we may end up with the barbarians at the gate. Too high and we may lose previously loyal shareholders and shareholder employees to more attractive opportunities. In previous letters, I've talked about how important long-term-oriented employees, customers, and shareholders are to both our strategy and organizational design. A long-term orientation requires a high degree of mutual trust between the company and all of its constituents. I do, of course, think there are some risks for Constellation. They're acquiring companies, which is what really anybody can do, I think. If they want to pay $5 million for a company, I'm sure there's somebody else out there that's

Starting point is 00:59:48 willing to pay a bit more. So the competition has really flooded in as Constellation has really made a killing applying the strategy, and there's no shortage of companies trying to copy what they're doing. If anything, I think Constellation is a really good case. study for what makes a great business. They have a great management team that works to be very honest and transparent with their shareholder base, and they have the track record to prove it as they've continually produced high returns on Invested Capital. So that wraps up my analysis on Constellation Software. After doing my initial research for this episode, just a bit of a spoiler,

Starting point is 01:00:21 I went ahead and read through all of Mark Leonard's letters and any other write-ups I could find on Constellation. This company, I feel, is so special that I actually ended up taking a relatively small position in the company, and I've recorded another podcast episode solely dedicated to Mark Leonard in the business of Constellation Software. The episode will be released on March 4th, so if you enjoy learning about consolation, be sure to mark your calendars for the evening US time on the 4th to tune in my deep dive covering consolation software in Mark Leonard. I promise you won't want to miss it, as this is just an incredible and unique business with a very admirable leader at the helm.

Starting point is 01:01:03 All right, that wraps up today's episode. If you enjoyed this episode, make sure you're following the show on your favorite podcast app so you can get notified of these episodes on our next release. Also, my interview with Chris Mayer is coming up soon, so feel free to tweet at me or message me on Twitter to let me know what questions you have for him. I'm really looking forward to the interview and know the audience will love it. My username is at Clay underscore Fink on Twitter, C-L-A-Y-U-S-A-Y-U-S-E-S-E- F-I-N-C-K. With that, thank you so much for tuning in, and I hope to see you again next week.

Starting point is 01:01:36 Thank you for listening to T-I-P. Make sure to subscribe to Millennial Investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any Decision Consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP529: Joel Tillinghast & Uncovering the Art of Outperformance

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.