During our third quarter 2020 portfolio update, Ensemble Capital’s Chief Investment Officer Sean Stannard-Stockton, and Senior Investment Analysts Arif Karim and Todd Wenning, discussed the current market and economic situation, and two of our holdings, Intuitive Surgical, Inc (ISRG) and Chipotle Mexican Grill, Inc. (CMG).

Below is a replay of the webinar as well as a link to Ensemble Capital’s quarterly letter.

 

While our quarterly webinar is an unscripted, more casual discussion, we also produce a quarterly letter that covers the same topics but in written form and with somewhat more detail. You can find a copy of our third quarter letter here.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

Below is the Q3 2020 quarterly letter for the ENSEMBLE FUND (ENSBX). You can find historical Investor Communications HERE and information on how to invest HEREEnjoy!

 

The performance of the Ensemble Fund (“the Fund”) this quarter was up sharply, producing strong relative and absolute returns. After a second quarter that saw little in the way of pullbacks, the third quarter was more volatile with the S&P 500 at one point being up a remarkable 16% for the quarter, before experiencing the first greater than 10% correction of the current recovery. The Fund was up 11.60% vs the S&P 500 up 8.93%. On a year to date basis, this brings the Fund to up 11.37% percent versus the S&P 500 up 5.57%.

As of September 30, 2020

3Q20 1 Year 3 Year Since Inception*
Ensemble Fund 11.60% 22.36% 16.82% 14.69%
S&P 500 8.93% 15.15% 12.28% 12.28%

*Inception Date: November 2, 2015

Performance data represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment in the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than the performance data quoted. Performance data current to the most recent month end are available on our website at www.EnsembleFund.com.

Fund Fees: No loads; 1% gross expense ratio.

A quarter ago, we wrote about the more rapid than expected economic recovery that had been playing out since mid-April. We also highlighted the growing wave of COVID cases in Southern border states and the risk to the recovery of unemployment benefits coming to an end in late July. Now three months later we can see that the more rapid than expected economic recovery has continued, even picking up steam.

New daily COVID-related hospitalizations did indeed double during July from the levels observed at the end of the second quarter. A heart breaking 80,000 Americans died from the virus during the quarter. But just as the wave of infections in the Northeast peaked and went into decline in April, the wave of infections in the Southern border states peaked in late July and went into decline. Today there are signs that a wave of infection is growing in the Midwest. It seems likely to us that case counts in the Midwest will follow a similar path as the wave of infection that swept first the Northeast and then the Southern border states, with cases continuing to rise until human reactions and the basic math of viral outbreaks causes new cases to peak and then go into decline.

As we wrote last quarter, there is no way to return to normal life absent an effective vaccine. But in aggregate the country has shown amazing adaptability in figuring out how to continue engaging in economic activity, even while it remains unsafe to do so many of the things we all once took for granted. For instance, the US housing market continued its torrid recovery, despite the fact that open houses are banned in many parts of the country. Yet, amazingly, this has not seemed to constrain home sales given the volume of transactions occurring in the third quarter exceeded the level of sales seen in the third quarter of 2019, bringing the year to date volume of home sale transactions to a bit above 2019 results.

So despite the fact that it is estimated that more Americans contracted the virus during the wave of cases this summer than did during the horrifying months of March and April, the economy was able to operate at a far higher level of activity.

Last quarter we wrote:

“One mistake we think some investors have made during this unprecedented period, is substituting a forecast of the virus for a forecast about the economy or financial market performance.”

Indeed, one way to think about the disconnect between a pandemic that has yet to be controlled and an economy that is recovering faster than expected, is to realize that economics and investing are forms of social sciences, not the hard sciences. No matter how accurately you can model the behavior of the virus, this does not tell you how people are going to behave or the level of economic activity they will engage in.

As an example, for many Americans flying on an airplane seems like one of the last things they would choose to do in the midst of a pandemic. And it is true that airlines and other travel related companies are experiencing much slower economic recoveries. Yet, by the end of September, an average of about 700,000 people were flying on a commercial flight in the US every day. While this is about a third of the volume of airline passengers who traveled last year, it also means that in the midst of a pandemic one out of every three potential airline passengers chose to fly anyway.

The study of epidemiology will not provide an accurate forecast of economic activity during a pandemic. It turns out that sociology and psychology play a huge role as well. This is of course what makes economic and financial markets so difficult to forecast. While the hard sciences offer the potential to make highly accurate forecasts if you have the right data, the economy and financial markets are made up of people whose behavior is not guided by logical algorithms. Or as famed physicist Richard Feynman once said, “imagine how much harder physics would be if electrons had feelings.”

So our view on the virus and its impact on the economy is relatively similar to our views a quarter ago. We believe widespread distribution of an effective vaccine is likely to occur next year. That until that occurs, we will see the virus continuing to circulate in the US and other major global economic centers. Waves of outbreaks are likely to continue, with a Midwest wave appearing to be growing now and a major second wave of cases clearly building in Europe. But we also think that while a full recovery of the economy will not occur until after a vaccine is broadly administered, humanity will continue to innovate, adapt, and engage in increasing levels of economic activity.

One key driver of economic activity has been the fiscal stimulus that was approved on a bipartisan basis at the beginning of the pandemic. Last quarter, we indicated that we thought the expiration of the enhanced unemployment benefits at the end of July would lead to a material slowdown in consumer spending in the following months. But we seem to have be wrong in this assessment. There has been little in the way of signs of a slowdown in consumer spending since the enhanced benefits expired, despite the fact that many millions of Americans had their income slashed by as much as 75% and are now living on a couple hundred dollars a week from the standard unemployment benefits that remain ongoing.

It is not clear to us why a spending slowdown has not materialized. It may be the fiscal stimulus pumped up the amount of savings these households had on hand and they’ve been spending down those savings over the last two months. If that’s the case, the savings would be running out very soon and a slowdown may still materialize. Indeed, senior members of the Federal Reserve have been giving multiple speeches saying that it is critical that Congress pass more stimulus. While it seemed likely at the end of the quarter that any sort of new stimulus deal was dead until after the election, as this letter was going to press, there was rising hope that a deal might get done. The GOP’s official position has been that they want to pass a $1 trillion stimulus bill, while the president has endorsed the bipartisan Problem Solvers Caucus’s $1.5 trillion bill and the Democrats are advocating for a $2.4 trillion bill, although these positions were all shifting quickly as the fourth quarter began.

Even the GOP’s $1 trillion bill would represent a similar amount of stimulus spending as was done during the entire financial crisis in 2008-2009. So, with all parties at the table wanting some sort of massive stimulus bill, we do think that one will eventually pass with only the timing being uncertain.

The timing and character of that bill (or series of bills) will be largely shaped by the outcome of the election in November. We believe that in general, investors should ignore politics when it comes to making investment decisions. Certainly, individual government policies can and do impact the financial opportunities of individual companies. But history shows clearly that who sits in the White House or controls Congress has never been a major driver of economic growth or market returns.

In 2008 and 2012, investors with conservative political views were horrified by the election of Barack Obama, but if they let their political views cause them to have a very negative investment outlook, they missed out on massive gains. Similarly, investors with liberal political views who were shocked and worried by the election of Donald Trump in 2016 missed out on massive gains if they let these views dictate how they managed their portfolio.

One thing to keep in mind is that the stock market is not a mechanism for passing judgement on everything that happens in the world. Instead, the market is simply a way for investors to trade ownership of various companies whose value is primarily a function of how much those companies will earn in the future.

Whether Donald Trump or Joe Biden is president has almost no influence on how many people will subscribe to Netflix (9.0% weight in portfolio), or how many home loans First Republic (7.7% weight in portfolio) will make, or how many ads Google (5.0% weight in portfolio) users will click on. Yes, corporate tax rates could be different, or the level of stimulus could be different. And yes, very dramatic things that are highly relevant to all of us as citizens could be quite different depending on the outcome of the election. But the level of economic activity and the fortunes of individual companies is simply not heavily influenced by government actions.

All that being said, it would be disingenuous of us not to acknowledge that to many people, including us, this feels like an election of unprecedented importance. Our point is just that this importance is much more about how we as a society decide to conduct ourselves as a collection of 330 million citizens seeking to build a common community, then it is about how much money Booking Holdings (4.6% weight in portfolio) or Mastercard (5.9% weight in portfolio) or Home Depot (8.3% weight in portfolio) will generate for shareholders in the decade ahead.

We also know that large, unprecedented events cause unprecedented reactions. Back in March, it was viewed as conventional wisdom that we were on the verge of a depression and that companies of all types and sizes would be under enormous pressures. But instead what has happened is the unprecedented event of the pandemic led to many unexpected outcomes, with a surprising number of large companies actually seeing their earnings enhanced by the pandemic.

Case in point: Home Depot came into 2020 with a Wall Street consensus that they would grow their revenue by about 4% for the year. By early April, the consensus was that the company would see revenue decline as the pandemic roiled the economy. But this downward revision wasn’t just an overreaction, it got the direction of change wrong. Today, with the benefit of seeing how American homeowners reacted to the pandemic by splurging on home improvement projects, the consensus expects 2020 to see the fastest revenue growth for Home Depot since the turn of the century when the company was less than half the size it is today and a housing boom was just getting started.

So while we will be up late on election night like the rest of the country and we fully recognize the stark choice that has been laid out for American voters, we also intend to stick to our discipline of finding competitively advantaged companies with strong, long term growth prospects, that trade at a price that we believe will reward shareholders for sticking with them through good times and bad.

CLICK HERE TO READ THE FULL LETTER

 

Disclosures

Investors should consider the investment objectives, risks, and charges and expenses of the Fund carefully before investing. The prospectus contains this and other information about the Fund. You may obtain a prospectus at www.EnsembleFund.com or by calling the transfer agent at 1-800-785-8165. The prospectus should be read carefully before investing.

An investment in the Fund is subject to investment risks, including the possible loss of the principal amount invested. There can be no assurance that the Fund will be successful in meeting its objectives. The Fund invests in common stocks which subjects investors to market risk. The Fund invests in small and mid-cap companies, which involve additional risks such as limited liquidity and greater volatility. The Fund invests in undervalued securities. Undervalued securities are, by definition, out of favor with investors, and there is no way to predict when, if ever, the securities may return to favor. The Fund may invest in foreign securities which involve greater volatility and political, economic and currency risks and differences in accounting methods. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. More information about these risks and other risks can be found in the Fund’s prospectus. The Fund is a non-diversified fund and therefore may be subject to greater volatility than a more diversified investment.

Distributed by Rafferty Capital Markets, LLC Garden City, NY 11530.

 

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

In September, Ensemble Capital’s CIO Sean Stannard-Stockton appeared on Motley Fool’s live video broadcast for an interview with John Rotonti. The interview covered a wide range of topics such as:

  • An overview of Ensemble Capital and our investment philosophy.
  • How we think about stakeholder value and why the value a company creates for employees, vendors and society at large are a source of, not detraction from, shareholder profits.
  • And a wide range of our portfolio holdings.


(Click here to watch the video if you are viewing this in an email)

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

For important disclosures related to this interview, please click here.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

“Invest in a promising company you don’t care about, and you might enjoy it when everything’s going well. But when the tide inevitably turns you’re suddenly losing money on something you’re not interested in. It’s a double burden, and the path of least resistance is to move onto something else. But if you’re passionate about the company to begin with – you love the mission, the product, the team, the science, whatever – the inevitable down times when you’re losing money or the company needs help are blunted by the fact that at least feel like you’re part of something meaningful, which is fuel to stop you from giving up and moving on.” – Morgan Housel

In early March, when global markets sold off amid COVID-19 concerns, the Ensemble Capital research team held a special portfolio review session.

The purpose of the exercise was two-fold:

  • Stress test our valuation assumptions. No reasonable pre-COVID bear case for certain companies would have assumed months with no revenue, for example.
  • Review our convictions. We only invest in companies we believe will survive recessions and come out stronger on the other side, but this was a unique scenario.

We concluded that our companies could both bear acute short-term revenue declines without impairing long-term value and were well positioned to emerge stronger on the other side of COVID-related lockdowns.

This was still true of the one company we sold, but we considered it our lowest-conviction holding and reallocated the capital to higher-conviction holdings. When you’re heading into a storm, you want the crew that gives you the best chance of navigating through it.

Now, this might be a clear example of endowment effect (people tend to overvalue a thing they already own than if they didn’t own it), but I think there’s more to it than that. Let me explain.

When I joined Ensemble Capital, I pitched the team on some businesses I determined had economic moats, or durable competitive advantages. While Sean and Arif agreed the companies had moats, they didn’t think they fit Ensemble Capital’s strategy.

I was confused. Don’t we want to own companies with moats? Sean clarified: these are good businesses, but we want great businesses.

This is an important distinction between what we believe we’re doing and what a generic “quality” strategy might pursue.

In other words, the “good” businesses I presented would likely be in the top 10-20% of all publicly traded companies in terms of quality. They’d fit just fine in a quality strategy. They might even turn out to be good long-term investments, but they don’t make our cut.

So, what makes for a great company?

In short, they do something interesting.

In the book Good Strategy, Bad Strategy, business professor Richard Rumelt gives an example of a silver machine dropped on Earth by aliens. The silver machine produces silver at zero cost. Does it have a low-cost moat? Yes. Is it interesting? No (other than the fact that aliens made it, of course).

Rumelt explains the difference:

“The silver machine’s advantage gives it value, but the advantage isn’t interesting because there is no way for an owner to engineer an increase in its value. The machine cannot be made more efficient. Pure silver cannot be differentiated. One small producer cannot pump up the global demand for silver. You can no more increase the value of the silver machine than you can, by yourself, engineer an increase in the value of a Treasury bond. Therefore, owning this advantage is no more interesting than owning a bond.”

What makes a competitive advantage interesting is when there are opportunities for management to use it to dramatically increase the firm’s value and widen the moat. If the best management can do is manage the status quo, that’s not interesting.

As an analyst, you’re always looking for an insight or a hook about a business that engages your interest. Not only does this make the research process more enjoyable, but it helps you to stay the course.

To illustrate, I’d known about Chipotle as a customer and investor, but I only got interested when I put together how hard it is for a restaurant to reach “escape velocity” from the gravity of its local/regional market and realize national scale advantages. Chipotle was in the early stages of realizing this benefit. More impressively, it was doing so with freshly prepared, responsibly sourced food. There are no microwaves, freezers, or can openers in the kitchens.

Source: Bernstein

Once I established the longer-term implications of Chipotle’s strategy, the short-term fluctuations didn’t seem to matter as much.

To be sure, interesting doesn’t have to equal exciting.

Fastenal is a distributor of industrial supplies and, for most of its existence, its largest product category was fasteners (i.e. nuts, bolts, screws, etc.). Pretty boring at face value, right? But Fastenal has been one of the best performing stocks in recent decades.

What makes Fastenal interesting to us is that it steadily added more services to its traditional distribution business. This made Fastenal even more entrenched in its major customers’ day-to-day operations.

Source: Fastenal

Idiosyncratic businesses in boring industries can also be interesting. Traditional banking itself is bland and commoditized, but we view First Republic Bank as a customer service franchise disguised as a bank. In an industry where customer satisfaction tends to be indifferent at best, First Republic’s Net Promoter Scores are akin to consumer favorites like Apple, Ritz Carlton, and Southwest Airlines.

Happy customers are great, but what makes First Republic interesting is that customer delight translates into superior financial performance. Over 50% of First Republic’s growth comes from existing clients and another 25% from satisfied clients’ word-of-mouth referrals.

Source: First Republic

Great businesses are interesting businesses. They are peculiar in their ability to widen their moats and enhance shareholder value over the long term, even during times of economic downturn.

Market sell-offs produce the very-human inclination to take action in the face of danger. Charlie Munger’s sage advice to never interrupt compounding unnecessarily can be cold comfort when the market drops 20% or 30%.

Owning truly great businesses, therefore, is somewhat of a brain hack. When you own great and interesting businesses and see the bigger picture, you’re more likely to hold them through the short-term turbulence, and increase your chances of maximizing returns.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

Each quarter, Ensemble Capital hosts a conference call with investors to discuss the current market, economic conditions, and a few of our portfolio holdings.

The event will use a webinar format. Participants will have a chance to ask live questions of the research team during the Q&A portion of the event.

This quarter’s webinar will be held on Thursday, October 8th at 1:30 pm (PST)

We’d love for you to join us, which you can do by REGISTERING HERE.

If you’d like to listen to our previously-held quarterly updates, an archive can be FOUND HERE.

 

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.