Back in October, Arif Karim had the pleasure of presenting our investment thesis and company analysis on well-known sportscar maker Ferrari (RACE) at the virtually hosted 2020 MOI European Summit.

He argued that Ferrari is not in the business of selling cars, so much as it is in creating luxury experiences and products that cater to the emotional desires of its passionate customers. This underpins its moat and associated high return on invested capital (ROIC) while the company’s targeted model line up expansion and powertrain electrification, with cars like the SF90 Stradale and the upcoming Puro Sangue utility vehicle, support continued future unit growth while maintaining the exclusivity and value of the brand.

The presentation can be viewed at the link below, with additional information we’ve posted in the past here and here.


Ferrari: Luxury Identity Brand with Enviable Business Model

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“You do not need to know precisely what is happening, or exactly where it is all going. What you need is to recognize the possibilities and challenges offered by the present moment, and to embrace them with courage, faith and hope.” ― Thomas Merton

We’ve written in the past about the difference between thinking you can predict the future (hint: you can’t) vs being aware of the range of possibilities and the range of probabilities of each possible outcome. We’ve explored these concepts in posts such as Investing Under Conditions of Uncertainty and Pick Your Poison: Implicit vs Explicit Forecasts, both of which focused on how we think about incorporating macroeconomic assumptions into our evaluation of individual company investments.

Our message has been that while investors cannot hope to accurately forecast the behavior of the economy over the short term, it is inescapable that investors must maintain a set of expectations about the long-term path of macroeconomic variables. If investors do not make these expectations explicitly, then they do so implicitly, often without realizing that these assumptions are driving their individual company assessments.

When thinking about the future range of possibilities, not only for the economy but for anything related to how human society will operate, we can often look to history for guideposts. Could inflation in the US jump to 10% or more at some point in the future? Well it did in the 1970s, so this does seem to be a possibility we should consider. Could inflation jump to crazy levels like 50% or 100% a year or more? While this has happened in failing states such as in Germany after World War I, Zimbabwe in the years just before the global financial crisis or Venezuela in recent years, there is no precedent for hyperinflation in functional economies. And so, unless we are also willing to forecast the possible failure of the US economic system, it is very unlikely that we will see hyperinflation over any meaningful investment time horizon.

But despite the range of possible outcomes for inflation being relatively wide, until just recently it was very clear what American monetary authorities believed was the acceptable range of inflation outcomes. There was broad agreement that inflation should be guided towards a target of 2% while also never letting inflation rise much at all above 2% other than for very transitory periods. But this summer, the Fed updated their monetary policy framework saying:

“The Federal Open Market Committee has adjusted its strategy for achieving its longer-run inflation goal of 2 percent by noting that it “seeks to achieve inflation that averages 2 percent over time.” To this end, the revised statement states that “following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.”

Thus, the Fed changed the range of possible inflation that they would accept. Had they had this policy in place over the last decade, they may never have begun raising interest rates the way they did from 2016 to 2018 (and then subsequently had to reverse in 2019). While the Fed cannot completely control inflation, they are the most powerful actor in the global economy in influencing the rate of inflation. So, while previously it may have been logically inconsistent to think that inflation could run at 3% for a number of years, even while the Fed kept rates low, the Fed has now signaled that this sort of economic outcome is not off the table.

The best way to understand what happened at the Fed, is through the lens of The Overton Window. At Ensemble Capital, we believe the Overton Window is moving, not only in relation to the Federal Reserve policy towards inflation, but across a range of very important social contracts that govern the economic possibilities. We think it is critically important that investors pay attention to these shifts and consider to what extent the shifting Overton Window changes the possible range of explicit or implicit expectations they have about the future.

The Overton Window

The Overton Window is a concept named for Joseph Overton, a political theorist. Overton argued that the range of political policy possibilities was not directly related to any politician’s individual preferences, but rather by the range of options that are politically acceptable to mainstream voters. This range of politically acceptable outcomes changes over time, but at any given moment, only policy options that fall within the Overton Window have any hope of becoming reality.

(Source: Hydrargyrum via Wikipedia)

As the diagram shows, the Overton Window covers the range of options that are considered Popular or Sensible, but once a particular policy is only deemed Acceptable, its odds of becoming reality start falling. Radical or Unthinkable proposals have no chance of actually being implemented, even if they are completely possible in a practical sense.

This short video from the MacKinac Center for Public Policy, where Overton worked until the time of his death in 2003, offers a simple, two and half minute explainer on the Overton Window.

Some key points:

  • The Overton Window does not say what is good or bad, it only describes the range of possibilities that society will accept.
  • The authorities do not decide where the Overton Window lies, rather society collectively defines the Overton Window and authorities operate within the window.
  • The Overton Window is not static. It moves over time, typically slowly, but occasionally rapidly. These changes are triggered by a range of different inputs, but notably one key trigger for abrupt and large shifts in the Overton Window are major society-wide crises.

While the Overton Window concept is meant to describe political possibilities, the concept has broader application to any situation in which a group of people are collectively[…]

During our 3rd quarter portfolio update, we profiled our portfolio company Chipotle Mexican Grill (CMG). Below is a replay of our live commentary on the company from our quarterly portfolio update webinar and an excerpt from our quarterly letter.

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

In our first quarter letter, we introduced our investment thesis on Chipotle. To review, few restaurant concepts – even highly successful ones – break out of their local or regional market. Once restaurants hit a certain “escape velocity” to break free of the natural gravity of their local or regional market and obtain national scale, it is difficult to unseat them. Consider that most of the fast-food restaurants that lined Main Street America in the 1980s – McDonalds, Burger King, KFC – are still there today.

One thing we find remarkable about Chipotle is that it achieved national scale with fresh, responsibly sourced food. There are no freezers, microwaves, or can openers at Chipotle restaurants. The Humane Society of The United States awarded Chipotle an “A+” score on its Food Industry Scorecard, which measures animal welfare. It is hard to see how another fresh food focused, quick-serve restaurant might be able to match this scale – over 2,600 restaurants today – within a decade or more and with the same level of quality as Chipotle.

First, handling fresh food is not easy. Chipotle learned this lesson the hard way when they struggled with foodborne illness issues in some Chipotle restaurants in 2015 and 2016. Many restaurants would have been forced to shut down as a result of these mistakes, but Chipotle learned and improved their processes, and emerged stronger on the other side.

Second, developing relationships with local meat and produce farmers takes time and farmers have limits on their supply. Chipotle is now a large and reliable enough buyer of fresh meat and produce that a small farmer would be crazy to cancel a Chipotle supply deal in favor of an upstart competitor.

Finally, whether you order your regular burrito bowl at your local Chipotle, the one in Missoula, Montana, or Morgantown, West Virginia, you expect it to taste the same. Making freshly prepared food nationally consistent is a massive obstacle and requires top-notch employee training and, more importantly, high rates of employee retention.

To this last point, Chipotle’s CFO Jack Hartung recently noted at an investor conference that the biggest constraint to restaurant location growth, which they expect to accelerate in the coming years, is as much about staffing as it is real estate. Front-line restaurant worker turnover is notoriously high, averaging about 130%-150% per year across the industry, which makes consistency and quality harder to deliver. In response, Chipotle has stepped up its employee pay and benefits packages for front-line workers and especially its restaurant general managers who run day-to-day local operations. At a time when many restaurants are unfortunately struggling to stay open, Chipotle has the financial resources to make it a more attractive place to work for food service workers.

In recent months, we’ve taken a closer look at how much stakeholder value our companies create. We believe companies that treat their stakeholders – customers, suppliers, employees, etc. – fairly will produce more sustainable shareholder value over time, all else equal. On the stakeholder value front, Chipotle is a shining star. We have recently seen more companies make reference to stakeholders in annual reports and press releases, but Chipotle has long been a mission-driven business and sets the standard for measuring stakeholder value.

Since 2016, Chipotle has released a Sustainability Report in which it sets goals and measures its progress in categories like people, food & animals, and environment. In short, Chipotle “gets it.” By making sure all its stakeholders see value in their relationship with the company, Chipotle increases its opportunities to innovate and execute better than a competitor that might be more indifferent to one or more stakeholder.

We often hear skeptics saying, “Chipotle is just an overvalued burrito shop.” We do not believe this to be the case. You can’t compare what Chipotle does with a taqueria or burrito shop. Two-thirds of orders placed at Chipotle are bowls – something you don’t see offered at traditional taquerias. We’ve found it more helpful to think about Chipotle as freshly prepared, quickly served food with Central American flavoring. Not being constrained by any delivery medium like a burrito or taco allows Chipotle to be creative with their menu offerings.

For example, Chipotle launched Lifestyle Bowls for customers who adhere to various nutritional disciplines, such as Keto, Paleo, Whole30, and high protein. The taqueria experience (which many people on the Ensemble team love!) is different from Chipotle’s and we do not believe the customer occasions (“I’m in the mood for…”) overlap much, if at all.

Finally, it is worth noting the success of Chipotle’s loyalty program, which has tripled in membership count over the past year to 15 million at the end of the second quarter. For some perspective, Starbucks’ best in class US loyalty program membership count is approximately 19 million. Not only does this speak to Chipotle’s relevance with its customers but it provides the company with better data analytics around customer order patterns.

Chipotle plans to offer more granular data around the impact of its loyalty program to sales and order activity, but if Starbucks’ loyalty program provides an indication of what to expect, Chipotle loyalty members will visit its restaurants more frequently and spend more per order. The loyalty program connection also allows Chipotle to target offers to specific customers. For example, a customer who recently ordered for a group of four may be offered a free large order of guacamole and chips if they place another order for four. In other words, the loyalty connection can create a dining occasion that[…]

During our 3rd quarter portfolio update, we profiled our portfolio company Intuitive Surgical (ISRG). Below is a replay of our live commentary from our quarterly portfolio update webinar and an excerpt from our quarterly letter.

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

Intuitive designs and manufactures the da Vinci family of robotically assisted surgical systems used by surgeons to enable better precision and visualization than humanly possible using minimally invasive surgical procedures.

We describe this combination of person and machine as the “Bionic Surgeon” because of the phenomenal “superhuman” capabilities Intuitive’s technologies bring to bear, enabling enhanced vision and more precise, tremor free articulation and navigation within the patient’s body.

In the typical surgery we can picture a surgeon leaning over a patient and using a scalpel to first make an incision, then cutting across to create a 6” or longer opening to gain access to a targeted area of the patient’s body.

This “open surgery” procedure literally exposes the patient to a host of risks that are normally protected against by the skin barrier and necessitates time for the person to heal and return to normal life. These include the risks and costs of infection, blood loss, extended length of hospital stays and readmission risk, recovery time and pain, as well as permanent scarring.

In contrast, minimally invasive surgery (MIS) is a surgical procedure that tries to minimize exposure by making small incisions into which a surgeon can insert tools while leaving the body much less exposed, reducing risk and recovery times. This is why surgeons will try to use MIS as often as they safely can as an alternative to open surgery.

MIS has been performed for a few decades now, using traditional laparoscopic tools. However along with patient benefits of MIS, these less articulated and less flexible tools also bring limitations to what the surgeon can do. As a result, adoption of traditional laparoscopic MIS has generally been limited to simpler procedure types.

With the da Vinci robotic surgical system, the system’s cart with tools attached to the robotic arms hovers over the patient while the surgeon can manipulate them comfortably seated off to the side at the surgical console. There she is immersed in the magnified 3D high-definition imaging scope while very precisely manipulating the robotic arms and instruments of the robotic patient cart with her fingers, hands, and feet in an “intuitive” way – features enabled by the decades of technological development at Intuitive. Visualization also goes beyond just magnifying human vision to even increasing the range of vision using wavelengths beyond visible light, helping to contrast among structures using its Firefly technology.

The net result of this is that the da Vinci system allows surgeons to take MIS beyond the limitations of traditional laparoscopic tools and really brings it into the realm of more complex surgeries that would typically require open surgery to perform.

The first da Vinci system got FDA approval in 2000 for use in general laparoscopic surgery. It initially found product-market fit in two procedure categories, radical prostatectomy, and malignant hysterectomy, where it enabled these open surgeries to convert to MIS. The adoption was very fast, taking only a decade for open surgery to give way to MIS as the “standard of care.” A majority of radical prostatectomy and malignant hysterectomy surgical procedures in the US are now performed on the da Vinci system.

The 4th generation Xi, with its improved features and capabilities, allowed for broader adoption in the general surgical procedure categories, as we’ve recently seen across hernia, colorectal, and cholecystectomy procedures. As a result, da Vinci procedures scaled from just 30,000 in 2005 to over 1.2 million in 2019 while Intuitive’s market cap has gone from $4 billion to $80 billion!

The broader application of robotic surgery to general surgery has increased the use of the da Vinci system to a larger number of doctors across more procedure categories.

There are now tens of thousands of surgeons trained and experienced on the da Vinci platform, which is far and away the de facto leader in the soft tissue robotically-assisted surgical market, with new medical school residents trained on da Vinci systems joining the ranks of practicing surgeons every year.

Despite the 1.2 million procedures in 2019, we see this point as only having crossed the tipping point of the adoption curve. Market penetration is still in the mid to low single digit range while the vast majority of surgical procedures remain open surgeries.

One of the most intriguing things we discovered in our research on Intuitive was the relationship it has built with surgeons in the field and their influence on how Intuitive invests in development of new da Vinci systems, capabilities and tools. The adoption of da Vinci has been on a procedure by procedure basis. Intuitive works on incorporating new technologies and learnings from the field that it believes will enhance the safety, utility, and value of the system. As new capabilities are introduced, intrepid, early adopter surgeons will try them in their practices in new procedure categories. When they find a fit, they share feedback with Intuitive and push it to develop the category appropriate tools to widen the systems use for it.

Growing use of advanced instruments and broader procedure adoption are the result of this powerful feedback loop between practitioner, innovator, and adoption, which demonstrates to us the enthusiasm among customers and the win-win nature of Intuitive’s shared benefits relationship with them.

Given the magnitude of growth and increasing adoption of da Vinci in the market, competitors have taken note and are busy developing their first-generation systems. Some of these competitors like Johnson & Johnson and Medtronic, are also seeing the traditional laparoscopic tools businesses being impacted in general surgery and are responding from a defensive position.

However, the bar for entry is high given the years[…]

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.