0:00

You're listening to TIP. On

0:03

today's episode I'll be going over the

0:05

concept of hidden Compounders

0:07

are are, well, that have extraordinary

0:09

track records compounding earnings and returns for shareholders

0:11

over time. I covered

0:14

why long -term investors should focus on

0:16

finding high -quality compounders last week's episode, but

0:18

in short, Owning companies with deep moats, protecting

0:20

their profit margins and opportunities for growth

0:22

is a recipe for a success. So

0:25

episode will very much build on that

0:27

conversation from last week. While

0:29

there are some very well -known examples

0:31

of great compounders like Apple Amazon that might come

0:33

to mind, hidden are meant to

0:35

reference businesses with phenomenal histories of stacking up

0:37

returns are hidden in plain sight. They

0:40

might have generated some of the market's best returns in

0:42

the past decade or so and still be largely unknown. Hidden

0:45

Hidden are typically companies with boring,

0:47

unexciting business models or with invisible moats where

0:49

it's clear the company has some

0:51

advantage in its favor, but it's difficult

0:53

to pinpoint exactly what that is. When

0:56

I say hidden compounders, think of companies

0:58

that do things like waste management, trucking

1:00

or manufacturing airline components. These

1:02

are unglamorous businesses with glamorous

1:05

returns. Hidden compounders

1:07

aren't talking about AI or the metaverse

1:09

on their earnings calls. Their

1:11

businesses are established and reliable, and and they

1:13

don't need to lean into the latest trend

1:15

to try and impress investors. You

1:17

You remember my episode a few weeks back

1:20

on on Monster which has been surprisingly the best

1:22

performing stock of the past three decades. Monster

1:24

is a great example of a hidden compounder because

1:26

it's simply a beverage company, but the

1:28

wealth it has created for shareholders over

1:30

time rivals any big tech name. What

1:32

I like about hidden compounders is that because less

1:34

well known and understood They're

1:36

more likely to go through periods of undervaluation you

1:38

can snap up shares at a discounted price.

1:41

Today's best known compounders just don't have

1:44

the same upside, or at least the upside

1:46

is less asymmetric. Looking at at

1:48

Apple, for example, at a $3 .4 trillion

1:50

market capitalization, you have to consider that the

1:52

downside risks are probably beginning to outweigh

1:54

the upside potential. As in,

1:56

it's seemingly more likely that Apple would get

1:58

cut in half rather than doubling to

2:00

$7 .8 trillion. These

2:02

are big numbers, but for context,

2:04

doubling Apple's valuation would be more than

2:06

combined GDP of Germany and the

2:08

United Kingdom. So So is beginning

2:10

to bump up against the ceiling for its

2:13

valuation. where there's not a

2:15

lot of room left for to plausibly rise

2:17

much further while there's a long way stock

2:19

fall. I'm not really intending

2:21

to say whether Apple is a good investment

2:23

at these levels or not. I'm just using

2:25

it for illustrative purposes, but I'm confident there's

2:27

a number of hidden out there that have

2:29

similar returns to Apple and are just waiting to

2:31

be snapped up by long -term investors. where

2:33

a much longer runway for growth and

2:35

future returns too. With that,

2:38

let's Drive into the world of hidden compounders see

2:40

what we can find. Celebrating

2:45

10 years, you are listening

2:47

to Millennial Investing by

2:49

the Investors Podcast Network. Since 2014,

2:51

we have been value

2:53

investors go-to for studying

2:55

legendary investors, understanding timeless

2:57

books, and breaking down

2:59

great businesses. Now,

3:02

for your host, Sean O'Malley.

3:13

Today, we'll be talking about hidden compounders finding

3:15

the best companies that are hiding

3:17

in plain sight. There is nothing

3:19

sexy about the companies I'll discuss today, but

3:21

as an investor, they really shouldn't matter to you.

3:24

Sometimes Most most plain and simple businesses are

3:26

the most profitable. The

3:28

investor, Peter Lynch, is probably the most

3:30

famous for talking about investing in businesses. His

3:32

book, One Up Wall Street, discusses at how

3:35

individual investors can get an advantage in

3:37

markets by investing in companies they know

3:39

well through personal experience, as well as

3:41

businesses that are uninteresting. He

3:43

writes, quote, a company that does boring things is

3:45

almost as good as a company that has a

3:47

boring name. And both together is terrific.

3:50

Peter is best known for running the Fidelity

3:52

Magellan Fund, where he racked up one of

3:54

the most impressive careers in Wall Street

3:56

history in just years. years. Lynch

3:58

a up approach. to investing aiming to

4:00

thoroughly understand a company, its prospects,

4:03

its competitive environment, and whether stock can

4:05

be purchased at a reasonable price. Rather

4:07

than having some formula or screen that enables

4:09

him to quickly pick stocks, he chooses to

4:11

instead them one by one to assess what

4:13

story can be told about their future. You

4:16

can imagine the types of things he

4:18

looks for, like earnings gross low price earnings ratios,

4:20

but what's interesting to me and relevant

4:23

to this episode on Hinn Compounders that

4:25

he specifically makes a point of emphasizing

4:27

his interest in companies that are particularly

4:29

unappetizing. That is, companies

4:31

that operate in a boring field, or even

4:33

do something that is disagreeable or depressing. This

4:36

could be anything from a company that operates

4:38

funeral homes one that does waste disposal. On

4:41

the flip side, he finds hot stocks and exciting

4:43

industries unattractive since likely to garner

4:45

a disproportionate amount of attention from

4:47

Wall Street. So, reiterate,

4:49

what I find interesting is not only trying

4:51

to find companies that are which

4:54

are essentially stocks you can buy

4:56

and hold for several decades with such

4:58

profitable businesses and attractive growth opportunities

5:00

that they can singlehandedly and reliably generate

5:02

market beating returns. but

5:04

also companies like this that are hidden in plain

5:06

sight. They're secret compounders,

5:08

as Manish calls them. On

5:10

our We Study Billionaires podcast in May 2020,

5:12

Manish told listeners that one of his

5:14

biggest career mistakes has been not

5:17

appreciating the power of compounders. Let's

5:19

listen. For most of

5:21

my investing career, I always on buying 50-cent

5:24

dollar bills. And basically

5:26

the idea was to invest

5:28

50 cents, sell 90 cents. Hopefully,

5:30

transition from 50 to 90 happens in two

5:33

or three years. and that's a

5:35

great end of return. Well, there two

5:37

or three problems with that. Number

5:39

one is taxes because you end

5:41

up with a significant tax bill. And

5:44

the second is that you have

5:46

to continue to be right. So

5:49

if I invest in a company for three years and I

5:51

double my money. I I now have to

5:53

find a second investment for three years. And

5:56

I have to keep finding these two,

5:58

three, year - bests. And I have to always always

6:00

keeping right. And

6:02

so, It's not that

6:04

easy to continuously be right like that.

6:07

Fast forwarding a bit, Manish goes on to

6:09

add the following. Let's listen again. There

6:13

are three kinds of businesses. Businesses

6:16

that are cheap. but

6:19

not necessarily great compounders. They're just

6:21

cheap on current earnings and what

6:23

they'll make in the future. But

6:25

who knows where they are 10 years

6:27

from now, right? Then the second

6:29

is that there are compounders which are

6:31

well -known and Mastercard, Coke and AmEx

6:34

and so on and Costco. And

6:36

they've got huge runways ahead of them.

6:38

Those businesses which are known compounders

6:40

probably rightfully traded

6:42

high multiples. Then

6:44

there's the third class of businesses.

6:48

which I would say are

6:50

the hidden compounders. So

6:52

the hidden compounders is where I

6:54

have put all my efforts now.

6:57

Okay, because that's the holy grail for

6:59

me. may not be for the investors. I

7:03

couldn't put it any better. The holy

7:05

grail of investing is finding compounders that

7:07

most people don't even realize are compounders.

7:10

I really love this framework because it is

7:12

simple, but also true. In my

7:14

years of studying stocks, I have continuously been surprised

7:16

that there are so many wonderful companies to

7:18

be found out there that are not only great

7:20

compounders, but also largely hidden. In

7:22

part, these compounders may be hidden because their

7:24

motes aren't easily recognizable. Pretty

7:27

easy to explain why Meta has motes.

7:29

The company has billions of users across

7:31

Facebook, Instagram, and WhatsApp. And

7:33

that reinforces network effects that keep people engaged

7:35

with those platforms since those are the apps

7:37

everyone else is using. And

7:39

that success helps the company attract the best

7:41

engineers and programmers and all of those

7:43

advantages compound in the company's favor. But

7:46

what are we to make of companies that, based on

7:48

their track record? clearly have some competitive advantage,

7:50

though it's not easy to define

7:52

what that is. It's a

7:54

question that Chris Mayer of Woodlock House Capital

7:56

explored in his 2020 blog post called

7:58

Invisible Motes. economic moat

8:00

to in the words of Morningstar, How

8:03

likely a company is to keep competitors at

8:05

bay for an extended period. a

8:07

successful mode allows high returns on

8:09

capital to persist. One

8:11

of my favorite parts about companies is trying

8:13

to determine what moat there is, if any,

8:15

in debating that with friends. Old

8:18

Dominion Freight Lines, one of Mayer's portfolio

8:20

companies, is ripe for controversy on

8:22

that front. As I've alluded

8:24

to, to, this is a company with no

8:26

discernible moat. at least not one that is

8:28

easy to sum up in 30 seconds or less. For

8:31

context, Old Dominion is the third trucking

8:33

company in the US that in

8:36

being what's known as a

8:38

less-than-truckload carrier. These are essentially companies

8:40

that combine multiple smaller shipments from different

8:42

customers into a single truck as opposed

8:44

to loading a truck with inventories from

8:46

only one customer. Because they

8:48

cargo for multiple customers at the

8:50

same time, the for less than truckload

8:52

carriers or LTL as they're known can

8:54

be much more complicated. Though

8:57

those looking to ship cargo, LTL can be a

8:59

a great option because they only pay for their

9:01

portion of truck space and don't pay for

9:03

any empty trailer space. Supporting its

9:05

LTL business, Old Dominion has

9:07

around 235 service centers

9:09

and 9 ,200 trailers. and

9:12

and has earned a reputation for being one of

9:14

the most disciplined and efficient trucking companies in

9:16

the industry. Its profitability and

9:18

returns on are head and shoulders

9:20

above its Through 2019,

9:23

including dividends, shareholders earned more than

9:25

30 year per year over 3 year ten -year

9:27

time periods and in the past five

9:29

years. the has continued

9:31

that impressive streak by growing over

9:33

257 percent. which translates to

9:35

compound annual growth rate of 29 %

9:37

per year. In short,

9:39

the company has been a wonderful

9:41

compounder, yet competes in an

9:43

industry that is seemingly commoditized. Truck

9:46

is truck space and it's not immediately

9:48

clear why a a company should

9:50

have competitive advantages that extend across

9:52

decades. If it were solely

9:55

due to organization and efficiency, those

9:57

are surely factors that could fade away

9:59

over time. or or be copied by

10:01

competitors, but that hasn't happened. As

10:03

Matthew Young Morningstar puts it, quote, in

10:05

our view, even the best operators like

10:07

Old Dominion struggle to carve out a

10:09

sustainable competitive edge via the key

10:11

economic moat sources. cost advantage,

10:13

tangible assets, switching costs and

10:16

network effect. Young by

10:18

arguing that economies of scale

10:20

and trucking have largely insufficient as

10:22

a competitive advantage, given that the

10:24

trucking behemoth YRC Worldwide was to the

10:26

brink of bankruptcy during the

10:28

2009 recession. So despite

10:30

Dominion's track record of high and rising

10:32

returns on invested capital, with correspondingly

10:34

high returns for shareholders, there's not a

10:36

simple story to be told about why

10:38

this is happening. Working

10:40

in Old Dominion's favor is that its

10:42

drivers aren't unionized, as compared with IRC,

10:44

which certainly helps, and Old Dominion

10:46

has relatively little debt, too. Still,

10:49

as Chris Mayer writes, quote, I

10:51

admit Old Dominion doesn't seem to have a traditional

10:53

moat that fits in one of those buckets. Instead,

10:56

it it seems to have pieces of the different

10:58

buckets. Somehow the adds up to

11:00

a strong competitor versus just looking at

11:02

the parts. Old Dominion

11:05

does own about $1.5 .5 billion worth

11:07

of service centers, which isn't easy to

11:09

replicate and run efficiently, even if

11:11

you had $1.5 .5 billion lying around. But

11:14

there isn't much much keeping competitors from entering the

11:16

market, at least for full truckload shipping. All

11:18

that's needed are a truck and a trailer,

11:20

insurance and licensing, and a a driver. With

11:23

those parts in place, a truck driving simply

11:25

needs to win a shipping contract to begin

11:27

earning revenues. However, the

11:30

challenge that new startups many existing trucking companies face

11:32

is that there is very high turnover for

11:34

truck drivers because job is so demanding and

11:36

may require driving across the country in

11:38

a few days with little rest. Another

11:40

advantage for LTL is that while isn't an

11:42

option for short deliveries, it is

11:45

an option for longer deliveries. So not

11:47

only do full truckload carriers have

11:49

to deal with higher driver turnover, But

11:51

they're also competing more directly with railways tend

11:53

to be cheaper. So

11:55

are some less obvious advantages supporting a

11:57

company like Old Dominion that operates

11:59

as a less... truckload carrier, and LTL carriers

12:01

need to win many contracts to

12:03

operate profitably since they're carrying loads for a

12:05

handful of customers at any one

12:07

time, and importantly, they need to have

12:10

consolidation centers that can load and unload

12:12

cargoes mid -route. As a

12:14

result, the LTL tends to be much more

12:16

consolidated than the full load market, with the

12:18

top 10 LTL carriers holding about 55 market share.

12:20

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12:22

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to the show. On top

16:02

of that, Merr out that Old has an

16:04

ownership culture that gives it advantages as

16:06

well. The Congdon has continuously

16:09

run the company since Old founding

16:11

in 1934, retaining a a board

16:13

management presence over the company while

16:15

also holding a combined - 13%

16:17

ownership state. More impressive is that Old Dominion's

16:19

employees not only are loyal to the company,

16:21

but want to invest in it too. Over

16:24

20 % of Old Dominion's employees 401k

16:26

assets are invested in old Dominion

16:28

stock, And with an employee turnover rate

16:30

of just 10%, it's about as low as it

16:32

gets in the trucking business. an

16:34

ownership culture where the company is heavily

16:36

owned by both its founding family and

16:38

employees. plus the efficiency and

16:40

discipline it has shown in the LTL

16:43

business. truly makes for some kind

16:45

of of moat, right? A company doesn't

16:47

compound at 30 % per year for

16:49

15 years without any kind of of moats

16:51

it. As Chris As puts it, it, Old

16:53

Dominion has something of an invisible moat. The

16:55

company is a hidden compounder only

16:57

because its business model is unglamorous,

17:00

But but also many who have looked into

17:02

the company can't understand what competitive advantage

17:04

it has to support the business going

17:06

forward. so just assume that competition will erode

17:08

its above average returns in the future.

17:11

As we've mentioned, Old Dominion seems to benefit

17:13

from a range of factors that, in

17:15

total, form a moat, while each part in its

17:18

own is arguably not a full moat. To

17:20

me, the fact that there is so much room

17:23

for debate about Old Dominion's competitive positioning is

17:25

exactly what makes it a a hidden compounder. If

17:27

everyone agreed that Old Dominion was a dominant

17:29

player in its market and was unlikely to change

17:31

that, then the talk would be bit so much

17:33

that it would be harder for new investors

17:35

in the company to earn market beating returns.

17:38

Yet, uncertainty around Old Dominion's moats, in addition to

17:40

the company itself not being particularly exciting

17:42

to the average investor, I I think

17:44

contributes to the fact that the stock

17:47

has been able to compound reliably at

17:49

such incredible rates. Obviously, underlies

17:51

that too is the invisible moat the company's

17:53

high returns and capital. In

17:55

an interview with Guy Spear, who

17:57

runs the Aqua Marine Fund, Manish Pabrai suggests

18:00

But another great way to find hidden moats is

18:02

to look for younger companies that haven't operated

18:04

long enough for their advantages to be

18:06

appreciated by the market. He

18:08

uses the example of having discovered Chipotle

18:10

it had a few restaurant locations

18:12

open. you had stumbled upon

18:14

one of of early Chipotle locations, you

18:16

might have come away thinking that not only

18:18

was the food tasty, affordable, and reasonably

18:20

healthy, but that the company had the

18:22

chance to revolutionize the fast -casual dining

18:24

industry. As he puts it, he

18:26

likely would have a a sense that this business could appeal

18:28

to a large number of people. In

18:30

contrast to having a fully formed hidden moat

18:33

like Dominion, this is more akin to

18:35

a moat that is in construction. Chipotle

18:38

was in the process of building its

18:40

moat and anyone who recognized that would

18:42

have been rewarded generously. To

18:44

be perfectly candid with you, I I hesitate to

18:46

share these examples because I do think they

18:48

make everything sound much easier than it is. There

18:51

have been a ton of fast casual

18:53

chains that you might have had similar convictions in

18:55

that flopped while didn't. Whenever at case

18:57

studies on compounders, they have to be

18:59

mindful of survivorship bias. For

19:01

every company that has found

19:03

multi -decade success in returns for shareholders at

19:05

market beating rates, there probably dozens

19:07

of companies that went out of business,

19:10

underperformed, or simply delivered average results. As

19:12

with everything in life, there's an element of

19:14

randomness to it all that, stock investors. I think

19:16

we have to be honest with ourselves about. If

19:19

you found Chipotle on, it was probably

19:21

due to luck. Either having a location

19:23

open near you, having someone recommend to

19:25

you, or whether you came across some

19:27

on the company, it was a

19:29

huge element of randomness involved. There's

19:32

even luck on Chipotle's side too, where you could

19:34

imagine a number of things could have gone

19:36

wrong early on that sidetracked the company's

19:38

success. Being lucky, though, doesn't make

19:40

you a good investor. That

19:42

said, to be a bit cliche, what does distinguish

19:44

investors is not letting those sorts of

19:47

opportunities pass them by. To

19:49

me, it's about always keeping your eyes open to

19:51

investment opportunities that might be sitting right in front

19:53

of you. Whether that's where you're

19:55

eating lunch or thinking about the company that

19:57

delivers things for you by truck, there are great opportunities.

20:00

founders and all around us. I

20:02

want to keep going here to show some more

20:04

examples of what you might call hidden compounders. Murphy

20:07

is a gas station company

20:09

that operates convenience stores across 1

20:11

,800 locations mainly in the Southwestern,

20:13

southeastern, and and regions of the United

20:15

States. Despite that very basic

20:17

business model. Murphy's has averaged an

20:19

excellent return on invested capital of 18 %

20:21

per year for the last five years, while

20:23

its stock has grown at a compound annual

20:25

growth rate of 25 % per year over

20:27

the past decade. If you've

20:30

ever driven through the regions it

20:32

operates in, you'd see the company's locations

20:34

as either just Murphy or QuickCheck. Interestingly,

20:36

the company aims to differentiate itself

20:38

by maintaining a strategic proximity to

20:40

Walmart many of its locations and

20:42

by selling gasoline at relatively discounted

20:45

prices. The company does have

20:47

a a formal relationship with Walmart too,

20:49

where Walmart Plus customers get special

20:51

discounts at Murphy's. But on top

20:53

of that, Murphy's is clearly trying to appeal

20:55

to the types of price sensitive shoppers

20:57

who frequent Walmart. As a result, their

20:59

margins on gas are very thin, but

21:01

they make up for that with higher

21:03

sales volumes and sales of retail products,

21:05

particularly tobacco products. Murphy's

21:07

is essentially an industry leader in per store

21:09

sales among gas stations driven primarily

21:12

by its proximity to Walmart, as well

21:14

as its rewards programs on tobacco

21:16

products. With Murphy's, there's probably

21:18

five or six factors that work

21:20

in their favor, And I've already

21:22

mentioned a few, but like Old Dominion,

21:24

there's no obvious single wide to point

21:26

to. The advantages aren't

21:28

neatly categorized, yet its track record speaks

21:30

for itself and implies some form

21:32

of of durable moats. I haven't

21:35

done enough research on Murphy's to argue strongly

21:37

that it's a hitting compounder, but I think it's

21:39

at least a strong contender. It

21:41

operates in an unglamorous business model that most

21:43

people take for granted in their daily lives. It

21:45

lacks the type of obvious moat that some of

21:47

the best known possess. And

21:49

still it is both incredibly profitable and in

21:51

a way that has created a tremendous amount

21:53

of wealth for shareholders. That

21:56

last point may seem obvious, where

21:58

profitable companies earn strong returns shareholders,

22:00

but you'd be surprised at how many companies

22:02

operate profitably but find a way to destroy

22:04

value for investors. From

22:06

paying dividends when cash would be

22:08

better reinvested, to to making frivolous and

22:10

expensive acquisitions of other companies and

22:12

issuing so much stock to employees

22:14

and executives that despite total profits

22:16

increasing, profits per share remain flat or

22:18

even decline. As crazy

22:20

as it may sound, there are profitable

22:22

companies that are terrible investments. And

22:25

my point here is to say that

22:27

a potential hidden compounder like Murphy says a strong

22:29

financial track record in terms of profits

22:31

earned from its operating business and a

22:33

strong track record of ensuring shareholders reap

22:35

the benefits of that operating success. Another

22:39

example of a hidden compounder I'll

22:41

spend a little more time on

22:43

is a company my colleagues on our We

22:45

Study Billionaires podcast talked about in past episodes, Technion.

22:48

I'll link to the full discussion in

22:50

the show notes, but Technion is what's

22:52

known as a serial acquirer. So So than

22:54

operating a hidden themselves, they manage a

22:56

holding company that buys up stakes in these

22:58

sorts of companies. In other

23:00

words, they find the hidden for you,

23:03

and in doing so, become hidden

23:05

compounder themselves. Technion operates

23:07

in a very narrow niche,

23:09

targeting small Swedish B2B companies. Here's

23:12

Technion's director of M&A, Daniel Zhang, to paint

23:14

some more color around their business. We

23:17

like to say in order to finish first,

23:19

you must first finish. So

23:23

we're saying that We never want net

23:25

to be too high. And in our

23:27

case, we we say, let's not make it

23:29

go over 2 .5. And And you've seen,

23:32

would be much more conservative that. And

23:36

Secondly, when stability is

23:38

fine, we focus on

23:40

profitability, which means that we want

23:42

to ensure that all of our companies

23:44

are actually creating value. And

23:47

that is not enough. We want them

23:49

to create value, but also to capture enough

23:51

of that value so that they are relevant.

23:54

and can money for

23:56

themselves and for us to deploy

23:58

to acquire new companies. Suffice

24:01

to say, investing in companies that

24:03

invest in boring yet profitable businesses

24:05

can also be quite rewarding. Serial

24:08

like Technion aren't hitting compounders in their

24:10

own way. Because acquisitions have

24:12

such a negative perception in the financial world,

24:14

these types of companies are often ridden off

24:16

by mainstream investors. Correspondingly,

24:18

there's no shortage of literature documenting

24:20

how mergers and acquisitions have destroyed

24:22

value for shareholders historically. In part, that's

24:24

because a premium must be paid

24:26

typically to acquire company, leading acquirers

24:28

to overpay, and also on top of

24:31

that, those deals usually involve large

24:33

amounts of debt to finance everything. Wow,

24:35

this is true. I believe there's

24:38

precedent for overseeing value -creating serial acquisition. It's

24:40

just rare. There are examples

24:42

of serial with exceptional track

24:45

records and delivering returns for shareholders. The

24:47

most famous example is, of of course, Berkshire

24:49

Hathaway. Led by Warren Buffett, Berkshire

24:51

is very much a a serial acquirer, and

24:53

for a long time you could argue that

24:55

the company was a hitting compounder Buffett and

24:58

gained a cult following. Berkshire

25:00

is vehicle for making these

25:02

acquisitions as it buys up majority

25:04

minority stakes in businesses and holds

25:06

them indefinitely until something materially

25:08

changes about the target company's business

25:10

model or valuation. Serial

25:12

acquirers like Technion and early Berkshire be undervalued

25:14

and dismissed, turning them into hitting compounders,

25:17

not just because of the

25:19

stigma around conglomerate acquisitions but also

25:21

because of the messy system

25:23

behind how they report earnings. Since

25:25

2018, companies like Berkshire have been required

25:27

by accounting standards to report changes in

25:30

market value of their portfolio companies and

25:32

their own net earnings. Meaning

25:34

a 2 % stake in Apple, Rather

25:36

than reporting of Apple's $100 of in $100

25:38

billion in net income in the last

25:40

12 months as its profit, Berkshire would

25:42

have to adjust its earnings to reflect

25:44

unrealized gains and losses from swings in Apple's

25:46

stock price. As Warren

25:48

Buffett wrote in 2017 in anticipation

25:51

of the accounting rule change, quote, The

25:53

new rule says that net change in investment

25:56

gains in losses and stocks we hold

25:58

must be included in all net income

26:00

figures report for you. That

26:02

requirement will produce some truly wild

26:04

and capricious swings in our... our gap bottom line.

26:07

Berkshire owns owns $170 billion marketable

26:09

stocks, and the value of these

26:11

holdings can easily swing by $10

26:14

billion or more within a quarterly

26:16

reporting period. including gyrations of

26:18

that magnitude in our reported net income

26:20

will the truly important numbers that

26:22

describe our operating performance. For

26:24

analytical purposes, Berkshire's bottom line

26:26

will be useless. With

26:29

Technion, the situation is different because Technion

26:31

is listed in Sweden and therefore doesn't

26:33

adhere to the same accounting standards. It

26:35

also primarily invests in private companies that

26:38

aren't listed on stock exchanges. but

26:40

still the point remains that serial acquirers can

26:42

be great compounders in their own right

26:44

while also being hidden to an extent because

26:46

valuing a a company like Technion or Berkshire is

26:48

really a valuation of dozens of other companies

26:50

that they own stakes in which can

26:52

get messy quickly. As As

26:54

Chris explains, as the name suggests, a

26:57

large part of a a serial growth

26:59

comes from acquiring many smaller companies.

27:02

Serial are typically decentralized, the acquired

27:04

companies enjoying quite a bit of autonomy.

27:06

The free cash flow of these daughter

27:08

companies is funneled to the mothership where

27:10

it is deployed in new acquisitions, dividends,

27:12

or whatever. Typically, Typically serial acquirers

27:14

look to hold companies forever. Looking

27:17

at Technion, the company has done this to

27:19

an impressive extent. even though it's

27:21

just getting started after being founded in 2006.

27:25

Since going public in 2019, Technion

27:27

has delivered annual returns of

27:29

well over 30 % per year on average

27:31

for shareholders. Like Berkshire

27:33

and successful serial acquirers, I think

27:36

Technion has a hidden moat. In

27:39

theory, there's no reason a serial acquirer should

27:41

have any and be able to generate

27:43

these types of returns over time. As

27:45

we know with stock investing, very few

27:47

people can consistently beat the market averages and

27:49

serial acquisition is the same idea on

27:51

a different scale. Seemingly

27:54

could come in and copy the playbook

27:56

that someone like Warren Buffett has used and

27:58

with all that competition, it it would

28:00

become difficult. difficult a company focused on serial

28:02

acquisition to find enough attractive opportunities for

28:04

them to compound returns at above average rates.

28:07

While there is some evidence that after 60

28:09

years, Berkshire is brushing up against this

28:11

problem due to simply how large it

28:13

has gotten, leaving it with fewer and

28:15

fewer meaningful acquisition targets. smaller

28:17

serial acquirers like Technion to have

28:20

a secret sauce that, like Dominion

28:22

is both powerful and hard to define. It

28:25

seems as though Technion is in the

28:27

process of building its moat, an invisible moat that,

28:29

also like Dominion may have a a lot

28:31

to do with culture. While

28:33

While acquisition seems as simple as just

28:35

buying and holding companies and then

28:37

using their earnings to buy more businesses.

28:40

There's a a lot that can go catastrophically wrong with

28:42

this model. One concentrated bat

28:44

that blows up is more than

28:46

enough to derail a serial acquirer. Doing

28:49

Doing acquisition well in a way

28:51

that is both sustainable and accretive

28:53

to shareholders requires discipline. I'll

28:55

you a list of a few of the things they

28:58

look for in making an acquisition. Technion

29:00

wants to buy companies that operate in

29:02

niche markets with strong competitive advantages built

29:04

up over the years. Additionally, they

29:06

want their target companies to be

29:08

profitable market leaders with operating margins above

29:10

9%. Generally, these will

29:12

also be companies that can be acquired for

29:15

between $2 and $10 million, where the

29:17

initial investment can be recouped within five years

29:19

with a 15 % annual return. And

29:21

And last not least, Technion wants to

29:23

acquire companies that have good

29:25

and honest management teams with the

29:27

founders family ideally still involved in

29:29

the company. While this

29:31

formula does give some criteria that shape

29:33

their capital allocation decisions, it's not

29:36

as simple as following this formula and

29:38

finding success, because as I've said,

29:40

anyone could theoretically do this and compete

29:42

with them, though that hasn't happened to

29:44

a meaningful extent, at least not

29:46

yet. In part, I think that's

29:48

because much of what they're doing is

29:50

so personalized, which has also been a tailwind

29:52

for Buffett and Munger in their careers from

29:54

into treating people well and building lasting relationships.

29:57

That in its own way the moat. Right

30:00

Neon is buying family businesses Berkshire

30:02

did in its early days with C's

30:04

Candy Nebraska Furniture Market. And

30:06

when you're selling the business you spend lifetime

30:08

building, where your employees are your friends and neighbors.

30:10

you care a great deal about who

30:12

you sell it to. Rather

30:14

than being some soulless equity firm that's planning

30:16

on buying the company and gutting it, Technion

30:18

provides an alternative for business owners who

30:20

are looking to cash out all or of

30:22

their sake in the company they built. But

30:24

they still probably care a lot about what happens

30:26

to the company and that's where the team at

30:29

thrives. Being Swedish and focusing

30:31

on acquiring Swedish companies, being

30:33

honest and trustworthy, and

30:35

promising to leave their acquired companies intact

30:37

with a hands -off ownership approach, helps

30:39

build the relationships that enables these deals to

30:41

happen at all. And And

30:43

they've acquired companies, and sellers have been

30:45

more than satisfied by how they were

30:47

treated. that spreads by word of mouth. and

30:50

I'm sure that has helped Technion more founders

30:52

willing to sell their businesses to the right

30:54

buyer. In some academic setting,

30:56

I would probably be unable

30:58

to describe this competitive advantage because it's

31:00

an invisible moat. In theory, it

31:02

probably shouldn't exist, but I think it does. Trust,

31:05

relationships, and reputation are not things you

31:07

can quantify easily, but but in the real

31:09

world, they do exist and can be quite

31:11

powerful. Technion's financial results

31:13

and shareholder returns, like Old Dominion,

31:15

are a testament to it. After

31:17

having met both Technion's and

31:19

Chief Acquisitions Officer myself the Berkshire

31:21

shareholder meeting in 2023, I,

31:24

I, like Chris Mayer, am inclined to say

31:26

that I see the invisible in action

31:28

here. Their modesty reverence for Warren

31:30

Buffett and Charlie Munger, combined with

31:32

their track record, signals to mean that they

31:34

are very likely spearheading a culture

31:36

at Technion that is the explanatory factor

31:38

behind their success beyond how well

31:40

any single investment has worked out for

31:43

them. Technion Technion is hidden compounder

31:45

not only because it is a

31:47

small company based in a small European

31:49

market, but also, also as I've mentioned,

31:51

because it is a serial acquirer where

31:53

the returns it's compounding are happening

31:55

behind the scenes at its portfolio of

31:57

private companies, which do not have the

31:59

same transparency. transparency the types of

32:01

publicly traded companies that a large cereal acquire

32:04

like Berkshire to invest in. Nothing

32:06

about Berkshire is hidden these days. It's

32:08

probably the most well studied company on

32:10

earth. It is arguably still a compounder,

32:12

but not like what it was in the

32:14

past, and as I said, it's not hidden. Let's

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right, back to the show. For reference,

35:54

I'll go ahead and just read off a few

35:56

more companies that are candidates for being what

35:59

we might call hitting compounders. due to their

36:01

simple, boring businesses, excellent returns, and

36:03

a lack of easy -to -define moat. Rollins,

36:06

ticker ROL, is a pest extermination company

36:08

with an average annual return on on

36:10

capital of 18% 18 % per year in

36:12

the last five years and a compounded

36:14

annual growth rate in stock price of

36:16

almost 20 % per year over the

36:18

last two decades. Another

36:20

candidate for a hidden status is Transtheim Group,

36:22

ticker TDG, which operates in the exceedingly

36:24

boring business of airline components yet

36:26

has delivered an average annual return

36:28

on on capital of 15 for per

36:31

year for the last 15 years

36:33

while compounding its stock at more

36:35

than 22 % over the last decade.

36:38

And more for a good measure is Sherwin

36:40

-Williams, a company that simply sells paint.

36:43

With an average return on invested capital

36:45

of 28 % in the last 10

36:47

years, a simple manufacturer and distributor

36:49

of paint products has earned returns at

36:51

rival Google's parent company Alphabet, which has an

36:53

ROIC in in recent years of 29%. To

36:56

shareholders and this wonderful company's delight,

36:59

Sherwin-Williams stock price has earned compounded returns of

37:01

18 % per year in

37:03

the last decade. So,

37:05

as said, some of the most boring

37:07

businesses you can imagine quite literally compound

37:09

profits and returns for shareholders at rates you'd

37:11

expect only from the best known big

37:13

tech companies. To me, this

37:15

is the epitome of being a

37:17

hidden compounder. Of course, there

37:19

are of hiddenness whether a company is

37:21

considered a hidden compounder is definitely

37:24

subjective. Technion is clearly

37:26

much more quote-unquote than Sherwin-Williams, which despite

37:28

being a boring business, is at

37:30

least a household name across the

37:32

United States. So again, there's

37:34

some subjectivity to this, and I really

37:36

hope that your takeaway is the essence

37:38

behind the idea of hitting compounders rather than

37:40

fixating too much on an explicit definition

37:42

for it. And I'll add as

37:44

well that there's clearly some companies where it's

37:46

easier to define their moats than others. Just

37:49

because there's room for debate on a

37:51

company's moat doesn't make it a hidden compounder though. You

37:53

may decide on a different definition for hidden

37:55

compounders, but at its core, the idea is

37:57

to find companies with impressive track records and

37:59

- compounding returns that, for one reason

38:01

or another, are not appreciated by markets

38:03

the full extent they should be.

38:06

Evidently, I've talked a good deal about

38:08

so -called boring businesses because I do

38:10

think these compounders with boring business models

38:12

are more likely to be overlooked

38:14

than some company that's doing something really

38:16

exciting at the forefront of the

38:18

latest hyped-up fad and markets, whether that be editing,

38:20

3D printing, or more recently, AI. Relatedly,

38:24

boring companies in particular are likely

38:26

to have what Chris Mayer calls invisible where

38:29

their competitive advantages may not be as

38:31

clear cut as a leading tech company that

38:33

has some network effect advanced software working in

38:35

its favor. yet on their

38:37

abnormal profits. clearly has combination

38:39

of less visible collaborating to

38:41

their benefit. There was nothing

38:43

wrong with focusing on compounders with flashy

38:45

moats, it's just a different game to

38:48

play, and one that's more competitive and the

38:50

companies probably don't slip to attract as

38:52

frequently. Another point

38:54

worth mentioning here in today's

38:56

conversation on on businesses and hitting compounders

38:58

a concept known as the Lindy Effect.

39:01

That to say all have a

39:03

shelf life, eventually all competitive

39:05

advantages will erode and economies will

39:07

grow and contract. But

39:09

the Lindy Effect argues that certain things like

39:11

ideas or books actually get more durable

39:13

over time. For example, the

39:16

odds are higher that Shakespeare will be read

39:18

in a thousand years from now than

39:20

the chances are any of today's best sellers will

39:22

be. We can probably learn

39:24

more from timeless classics because their

39:26

lasting legacy has meant that they added

39:28

value to generations of people rather

39:30

than finding fleeting popularity before fading into

39:32

obscurity. I think the same

39:34

principle holds for companies too. I'd rather

39:36

bet on a company to survive another decade

39:38

that has operated profitably for four decades than would

39:40

on a hot new company that's only a

39:42

few years old. The Lindy

39:44

Effect suggests that the longer something

39:46

has been around and weathered storm after

39:49

storm, the greater the likelihood is

39:51

continue to endure. Generally,

39:53

I I I think that companies in boring, old

39:55

-fashioned businesses tend to be the most lindy. Firms

39:58

in -paced industries are are to

40:00

much greater threats of disruptive innovation. which

40:03

is why there's so much turnover and market leaders

40:05

on the cutting edge of technology. It

40:07

comes as little surprise then that Warren

40:10

Buffett, who is the master

40:12

of finding hidden compounders and boring to own,

40:14

avoids rapidly evolving high -tech industries

40:16

as much as possible. Much

40:19

of what Buffett has looked for his

40:21

entire career is implicitly based on this

40:23

Lindy effect trying to identify which business

40:25

models are are positioned to stand the test

40:27

of time. In that vein,

40:29

Coke is one of his all -time

40:31

favorite investments, since people's thirst for sugary,

40:33

carbonated, and caffeinated drinks isn't going away

40:35

anytime soon. Same with Geico, which is

40:37

a leader in car insurance. For

40:39

many decades, car insurance has been

40:41

a boring yet profitable business, hardly

40:43

threatened by disruptive innovations that would

40:45

fundamentally displace their operations. The

40:48

only threat of this nature on the horizon for

40:50

a company like Geico is if we all switch

40:52

to self -driving cars, but even that

40:54

doesn't really seem to be on the horizon

40:56

anytime soon. Here's

40:58

himself on Geico. But

41:00

But Geico a jewel, and

41:03

it's really our... Yeah,

41:05

I'll head in this right here. because

41:08

others we feel awfully close to

41:10

summary about, but... but it's

41:13

incredible company, It it has a

41:16

culture of all of its own. It's

41:19

saving customers. probably

41:23

$4 or $5 billion a year or

41:25

five billion dollars a year against they

41:27

would otherwise be paying what they would either

41:29

was. Be paying based

41:31

on the average in auto insurance. And

41:35

it will be profitable on underwriting a

41:37

very high percentage of a year, and contributing to

41:39

that other $2 billion to flow

41:42

year. It is a terrific

41:44

company. And like I say, the first four months

41:47

are dramatically better.

41:49

Now, there's some seasonal

41:53

in auto insurance, so first quarter. It

41:56

is usually the

41:58

of the four quarters, but it sounded great. dramatic

42:00

season all sigh. I When

42:02

you read the 10 10 Q and

42:05

you're taking word for it, I I

42:07

think, hey, the cycle is on

42:10

good profit track. That's what was a good growth

42:13

track. the more it grows, the better I like it. Berkshire

42:17

Hathaway's investments over time are, in some

42:19

way, the ultimate compilation of boring businesses

42:21

that are great but often overlooked compounders.

42:23

I'll just read you a handful of

42:25

them in case you aren't familiar. Berkshire's

42:28

roster of past and current boring

42:30

include names like Kraft Foods,

42:32

Chevron, American Express, Kroger,

42:34

Duracell Batteries, Clayton Homes, Dairy

42:36

Queen, Helzberg Diamonds, B&SF Railroad Company, and

42:39

and Queen, dozens more.

42:42

You'll notice that none of these companies are

42:44

particularly flashy. Instead, they're intensely

42:46

practical companies rooted deeply in

42:48

businesses that are changing very slowly.

42:51

Grocery stores catering to the middle

42:53

class, diamond companies, home builders, railroads aren't

42:55

going away anytime soon. By

42:58

nature, these companies reflect the lindy effect

43:00

both their long track records of success

43:02

as well as through the simple durable industries

43:04

they operate in. Boring businesses make

43:06

up the fabric of our society,

43:08

providing us with what we need,

43:10

while almost on purpose, proving forgettable

43:12

along the way. As the

43:14

last topic today, to pull the thread a little

43:16

further, I want to share some of

43:18

my takeaways from a 2016 report from Morgan

43:20

Stanley on compounders and value of compounding in

43:22

an uncertain world. Eight years

43:24

later, reading the paper in its nature

43:27

warning about an uncertain world with

43:29

serious geopolitical risks, it's a reminder

43:31

to me that rarely do markets

43:33

ever look quote unquote normal, and periods of

43:35

tranquility are fleeting at best. As

43:37

uncertain as the world looks today, it

43:39

looked equally so back then too. The

43:42

world always feels crazy and that's just

43:44

the challenge we face as investors. If

43:46

the world were safe and predictable,

43:48

we wouldn't deserve to earn the risk

43:50

premium and returns that offer. The

43:53

uncertainty is, by definition, what makes

43:55

stock investing potentially more rewarding than putting

43:57

your money in a savings account. Still,

44:00

the Morgan Stanley paper is interesting

44:02

because the authors discuss how compounders

44:04

can offer protection and stability in

44:06

an otherwise unstable world. The

44:08

writes, quote, Our research shows

44:11

that these compounders, which exhibit

44:13

characteristics such as strong franchise durability,

44:15

high cash flow generation, low

44:17

capital intensity, and minimal financial

44:19

leverage, have generated superior risk -adjusted

44:21

returns across the economic cycle.

44:24

Correspondingly, they recommend that long -term investors,

44:26

quote, adopt a back -to -basics

44:28

approach to portfolio management to generate

44:30

superior returns regardless of what's happening

44:32

in markets more broadly. Over

44:34

a 15 -year period, they found that

44:36

the top 25 % of stocks, in terms

44:38

of their returns on invested capital, considerably

44:41

outperformed the rest. So

44:43

their research isn't focused on hidden compounders

44:45

per se, but I find it useful

44:47

to better understand generally what compounders look

44:49

like. As the authors write, quote,

44:51

In our experience, relatively few companies

44:53

have been able to consistently compound

44:55

shareholder wealth at superior rates of

44:57

return over the long term. Instead,

45:00

we have found that most companies are

45:02

erratic or inferior creators of long -term

45:04

wealth. Some of the

45:06

most durable advantages they found among compounders

45:08

to be intangible assets like customer

45:10

loyalty, innovation, and brand recognition, which

45:12

I think plays into this idea

45:14

of invisible moats, as as which we've discussed. Intangible

45:17

assets are, well, intangible, meaning we

45:19

can't directly observe them per day, but

45:21

that doesn't make them any less real

45:23

than tangible assets. In fact,

45:25

over time, intangible assets have become increasingly

45:28

important to the modern economy, and you

45:30

can definitely make a case that some

45:32

of these more abstract assets and competitive

45:34

advantages resemble the type of invisible moats that

45:36

Chris described when examining Old Dominion freight lines. As

45:39

the researchers that Morgan Stanley put

45:41

it, quote, In contrast, dominant assets that

45:43

are physical are easily replicated and often

45:45

lead to price competition and erosion of

45:48

a company's returns on capital. So So

45:50

sure you can see how these

45:52

comments play into what we've discussed in

45:54

this episode. The advantages that

45:56

companies like Old Dominion and Technion have

45:58

are very much intangible. When people

46:00

think of intangible assets, they typically think

46:02

of things like patents and software, which

46:04

you might expect big tech companies to

46:07

have. then certainly true, but even boring

46:09

businesses can have intangible advantages too as we've

46:11

learned today. Even better is

46:13

that they found that compounders, especially ones

46:15

operating in more dull areas of the

46:17

economy, tended to have less cyclical

46:19

profits due to the nondiscretionary nature of

46:21

their services. And of course,

46:23

that makes sense, a company like Murphy's isn't going

46:25

to see a huge decline in a recession. Because

46:28

people are still going to need gas and going to

46:30

want cigarettes. The same is

46:32

true even for a trucking company like Dominion. where

46:35

only fell 2% in 2020 in 2020 during the

46:37

pandemic. Even when the world

46:39

is seemingly at a standstill, there's still a

46:41

lot of cargo being shipped around, and

46:43

Old Dominion clearly has some advantages that position

46:45

it to fare better in a downturn

46:47

than others in the trucking business. And

46:50

And despite modest downturn, revenues jumped

46:52

20 % in 2021. That

46:55

is just classic hidden

46:57

behavior. Things are less bad in

46:59

the bad times and really good in the

47:01

good times. This line from

47:03

Morgan Stanley also validates the approach that

47:05

Technion has taken in finding boring companies

47:07

that are industry leaders. They

47:10

the following. When seeking compounders, we

47:12

believe that the relative strength of

47:14

company within its industry is more important

47:16

than market capitalization. In terms

47:18

of industry structure, we typically

47:20

find that compounders enjoy high relative

47:22

market share in monopolistic or

47:24

oligopolistic markets. These companies

47:26

generally enjoy high barriers to entry, usually as

47:29

a result of the intangible assets

47:31

they possess and their ability to

47:33

continually innovate. The researchers

47:35

actually cite their own example of

47:37

what you might call a boring or hidden

47:39

compounder a Swedish coffee and chocolate

47:41

company that, through thick thin, hasn't seen negative

47:43

sales growth in 23 years, while

47:45

growing earnings per share five -fold

47:47

in that period, thanks largely to

47:49

managing their intangible brand so well. Morgan

47:52

Stanley provides some warnings too, for

47:54

investors on the hunt for hitting

47:56

compounders. They write, When

47:58

searching for compounders, and Investors must

48:00

avoid traps in the form of

48:02

fading companies or companies. By

48:04

companies, we mean those where patents

48:07

or licenses are soon to expire,

48:09

where new technology or a change in

48:11

fashion or new can disrupt the franchise. Companies

48:14

that are overly dependent on a single

48:16

brand or product more vulnerable to disruption. Adding

48:19

to that, they suggest that poor

48:21

or gritty management can similarly derail

48:23

compounders over time, while acquisitions can

48:25

be especially damaging. Imagine,

48:27

for example, a a company earning 30 %

48:29

returns on invested capital that a business

48:31

earning just 5-10% to 10 on returns

48:33

on capital. While this acquisition

48:35

would artificially boost profits, it

48:37

would destroy value for shareholders over

48:39

time because returns on capital are

48:41

what most. And this acquisition

48:43

would obviously be reducing that

48:45

average ROIC. So are the biggest

48:47

highlights from the paper, which as always, I'll link

48:49

to it the show notes in case you'd like to

48:51

read it for yourself. To

48:54

wrap things up today, I I want to

48:56

reiterate the old saying that sound should be like

48:58

watching paint dry. Unless you're among

49:00

the rare breed that finds reading financial

49:02

statements of practical businesses exciting, which is a

49:04

great thing, then you really shouldn't find

49:06

too much about it investing exciting thinking about

49:08

how your returns will compound over time

49:11

if they're invested in durable, well -run businesses.

49:14

That is to say, if if you're

49:16

fixated on the hottest, most innovative companies

49:18

and markets, you're probably gonna get

49:20

burned eventually a few different reasons, ranging

49:22

from bursting bubbles to simply not having

49:24

the technical expertise to determine whether,

49:26

say, one cutting -edge computer chip maker

49:28

has a sustainable advantage over another. As

49:31

Wall Street legend Soros puts it, quote, if

49:33

is entertaining, if if you're having

49:35

fun, you're probably not making

49:37

money. Good Good is boring.

49:40

And And really, couldn't have put it any better

49:42

myself. Good Good takes patience. It

49:44

involves finding hidden compounders holding them

49:46

for long periods of time. letting

49:49

them simply do their thing and it requires

49:51

very little action from you. If

49:53

you can just one or two great ideas

49:55

a year for companies to invest in, over

49:57

a lifetime, you'll do quite well. That's

50:00

all today, folks! I

50:02

hope you enjoyed this conversation on hitting compounders

50:04

the best boring businesses hidden in

50:06

plain sight. I'll be back again

50:08

next week with another episode that hopefully you a

50:10

little wiser about investing. I'll

50:12

see you then. Thank you for

50:14

listening to TIP. Make sure to

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