Guy Spier is the author of the excellent book The Education of a Value Investor: My Transformative Quest for Wealth, Wisdom, and Enlightenment, an exploration of his development as a value investor (and as a human). Guy’s book is unique because far from being a book on how to pick stocks, it is really a book about finding yourself and living your life in a way that is authentic and true to who you really are.

The connection that Guy draws between successful investing and truly knowing yourself resonated with me. In a recent interview I discussed the importance of aligning investment strategy with your own personality:

“One thing I’ve come to as an investor, is recognizing that there are a lot of ways to make money in the market. There are a lot of investment approaches and philosophies that can do very well, but all of them test the investor in one way or another. Therefore, it’s important for you to figure out how to align your investment philosophy with your own personality – so that when the investment philosophy inevitably tests you, you’re the sort of person who will pass the particular types of tests required to successful manage your investment strategy.”

Guy’s book describes how he had to remove himself, indeed move to Switzerland, to fully reach his potential as an investor. This doesn’t mean everyone needs to do this. But for Guy, an authentic examination of himself made him realize that the radical step of moving was right for him.

A couple months ago, Guy reached out to my colleague Arif to meet for coffee while he was in town. After the meeting, Guy sent me and Arif a nice thank you note (he’s a big fan of thank you notes), which included a bar of chocolate with a quote from Warren Buffett emblazoned across the label.

I love this quote (the chocolate was good too). Sometimes when we talk with clients about how we don’t try to predict the economy or the market we get strange looks that seem to say “then what am I paying you for?” We usually talk about how we focus on individual companies that have strong competitive advantages, but really we should just say:

“We’re building arks.”

Or more precisely, we’re looking to invest in arks. We don’t know when the rain will come. It sure would be nice to be able to predict the rain and maybe for some people, expending their time and resources in an effort to predict the rain fits their personalities. But for us, we know that ark building is our calling, not rain predicting.

Buffett uses the analogy of a moat to describe what he looks for in stocks. Arks might work as analogy for other people. Sometimes I’ve imagined investing as being like a wild, off-road race, in which our strategy is not to try to guess which route will be fastest, but instead to pick the vehicle that offers the best mix of speed and ruggedness, along with a great driver. Meanwhile most investors are look for shortcuts or flashy cars that offer turbo-charged engines, but always seem to spin out when the going gets rough.

Moats, off-road super cars, arks. They all have one thing in common. Rather then guess what is around the corner, they prepare themselves for the challenges ahead.

The rain is coming. We don’t know when. But it is always on its way. Away over the horizon, storms are brewing. Whether they come tomorrow or next year, or we see clear and sunny skies for the next five years, the storms will come.

Until then, we’ll build arks.

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

The information contained in this post represents Ensemble Capital Management’s general opinions and should not be construed as personalized or individualized investment, financial, tax, legal, or other advice. No advisor/client relationship is created by your access of this site. Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. If a security discussed in this blog entry is owned by an employee, principal and/or client of Ensemble Capital you will find a disclosure regarding the security held above. Should an employee, principal and/or client of Ensemble Capital subsequently purchase or sell any position in a security discussed in this blog entry, we will not update the above disclosure nor revise any archived blog entry after the date it is originally posted. If reviewing this blog entry after its original post date, please refer to our current 13F filing or contact us for a current or past copy of such filing. Each quarter we file a 13F report of holdings, which discloses all of our reportable client holdings. Ensemble Capital is a discretionary investment manager and does not make “recommendations” of securities. Nothing contained within this post (including any content we link to or other 3rd party content) constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instrument.

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Ensemble Capital’s CIO Sean Stannard-Stockton was interviewed in the investment journal The Manual of Ideas. We’ve excerpted a discussion about changing competitive characteristics below and you can read the full interview here.

MOI: You’ve previously shared with MOI Global: “We only invest in companies that we think benefit from sustainable competitive advantages that we are in a position to understand.” Are there industries in which you previously felt comfortable investing which are evolving into a “too hard” pile?

Stannard-Stockton: Certainly, all industries go through cycles, and they also go through secular changes and I think one’s view on industries needs to be continually updated. That updating shouldn’t be too rapid. Nate Silver talks about Bayesian analysis, the way in which you should update your forecast based on new information, and Bayesian forecasting suggests that each new incremental piece of information or evidence shouldn’t generally radically change what your prior views were, but that doesn’t mean new evidence should have no influence at all.

Our view on all industries and businesses changes over time. One change it’s undergoing right now that I think is important, especially to a moat-based investor, is the change in the value of brands. Strong brand names have always been seen as a very strong competitive advantage, and they’re at the heart of many of the post-Munger, Buffett-style investments like Coca-Cola. Certainly, brands continue to have power, but we think it’s important to recognize that there are two main categories of brands. One type of brand lowers the consumer’s search costs. These are brands that help consumers make sure that what they’re purchasing is of good quality and of good value when they’re confronted with a wide array of potential purchase options.

Another category of brands are “prestige brands.” They’re brands that communicates to the purchaser, as well as to the purchaser’s circle of peers, something about who that person is. We think that the latter, the prestige brands – such as Ferrari, or Tiffany, and Apple with their smartphone brand – are all brands that continue to have enormous value, and that value is not under any threat whatsoever from the emergence of online shopping, marketplaces like Amazon or social media, or changes in consumer preferences among millennials. “Prestige brands” are very resistant to any sort of technological or cultural changes going on, but “search cost brands” – which are found frequently in the consumer staple sector which has been actually the best performing sector in the stock market for the past 50 years and is the source of many of the ideas that have driven many great investors over time – we think these sorts of brands are under assault because the ability for consumers to find information to lower those search costs have gotten much easier over time.

Today, if you log-on to Amazon and type in what you’re looking for – not a brand name, but a type of product – the #1 ranked item, regardless of brand, is likely to have thousands of reviews. If those reviews are say 4 or 4 ½ stars or better – with reviews from thousands of people, most consumers will happily purchase the item, no matter what the brand is. In this case, Amazon has effectively not just become a logistics provider, not just made shipping easy, not just benefitted from network effects, but it has inserted its own brand into the purchasing behavior – and so the consumer says, ”I trust Amazon and Amazon’s reviews so much that I don’t need to spend time searching or depending on a brand name, I can simply purchase the product no matter what its brand is.”

At the same time, social media has allowed people to discover all sorts of brands that may not have much marketing power. If you look at a brand like Coca-Cola, it has thrown around tremendous spending on marketing and it’s built up this enormously valuable brand. Alternatively, you can look at a beverage like LaCroix Sparkling Water. It’s been around for a long time, but as LaCroix caught on along the West and East Coast with people who use social media, the no-calorie, unsweetened product – which is exactly what a lot of people were looking for and what the traditional soda companies, Pepsi and Coke, have been striving to produce; a hit in a no-calorie, non-artificially sweetened category – LaCroix was able to take off and grow tremendously, with enormous market capitalization added to the business. And so, those sorts of brands where their primary value is helping the consumer quickly make decisions about value and quality, we think are under assault from changes in technology, which we think investors need to really be aware of. We’ve always very highly weighted brands in our analysis, but if you look at our portfolio today, it’s populated by much more of the prestige brands, many of which we think are currently being thrown out with general retail brands, when in fact it’s only the search cost brands that are under assault.

Read the rest of the interview here.

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

The information contained in this post represents Ensemble Capital Management’s general opinions and should not be construed as personalized or individualized investment, financial, tax, legal, or other advice. No advisor/client relationship is created by your access of this site. Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. If a security discussed in this blog entry is owned by an employee, principal and/or client of Ensemble Capital you will find a disclosure regarding the security held above. Should an employee, principal and/or client of Ensemble Capital subsequently purchase or sell any position in a security discussed in this blog entry, we will not update the above disclosure nor revise any archived blog entry after the date it is originally posted. If reviewing this blog entry after its original post date, please refer to our current 13F filing or contact us for a current or past copy of such filing. Each quarter we file a 13F report of holdings, which discloses all of our reportable client holdings. Ensemble Capital is a discretionary investment manager and does not make “recommendations” of securities. Nothing contained within this post (including any content we link to or other 3rd party content) constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instrument.

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Weekend Reading

11 November 2017 | by Paul Perrino, CFA®

A summary of this week’s best articles. Follow us on Twitter (@INTRINSICINV) for similar ongoing posts and shares.

Tech Giants Are Paying Huge Salaries for Scarce A.I. Talent (Cade Metz, @CadeMetz, NYT)

The next frontier, Artificial Intelligence (AI), has businesses clamoring for experts, but the workforce can’t meet the demand. Attracting talent has started to spiral out of control, causing some to “joke the tech industry needs a National Football League-style salary cap on A.I. specialists.” This disequilibrium doesn’t appear to be slowing down any time soon. Its caused many academics familiar with AI to leave the industry, which is causing a shortage of professors and therefore less students learning AI.

Where Retail Has One Edge on Tech: Mobile Payment (Sarah Halzack, @sarahhalzack, BloombergGadfly)

The race is on for someone to step in as the mobile wallet provider for US consumers. Tencent’s WeChat dominates the Chinese market. People use WeChat for much more than mobile payments. “People can use Tencent’s WeChat, for example, to pay for dinner, but also to find parking, make dates, donate to charity and make appointments with doctors.”

12 books that shaped the way Jeff Bezos, now the world’s richest man, thinks about success (Marguerite Ward, @ForWardist, CNBC)

Like most successful people, Jeff Bezos is an avid reader. His reading list includes everything from business and technology books to novels.

Amazon Key is a new service that lets couriers unlock your front door (Ben Popper, @benpopper, The Verge)

Amazon is rolling out a new offering for Prime customers, Amazon Key. It includes a smart lock and camera. The smart lock allows the delivery driver to open your front door and leave a package securely inside your home. The camera is used to monitor the delivery person and provide reassurance that the person is not entering further into your home.

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

The information contained in this post represents Ensemble Capital Management’s general opinions and should not be construed as personalized or individualized investment, financial, tax, legal, or other advice. No advisor/client relationship is created by your access of this site. Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. If a security discussed in this blog entry is owned by an employee, principal and/or client of Ensemble Capital you will find a disclosure regarding the security held above. Should an employee, principal and/or client of Ensemble Capital subsequently purchase or sell any position in a security discussed in this blog entry, we will not update the above disclosure nor revise any archived blog entry after the date it is originally posted. If reviewing this blog entry after its original post date, please refer to our current 13F filing or contact us for a current or past copy of such filing. Each quarter we file a 13F report of holdings, which discloses all of our reportable client holdings. Ensemble Capital is a discretionary investment manager and does not make “recommendations” of securities. Nothing contained within this post (including any content we link to or other 3rd party content) constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instrument.

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We recently hosted our quarterly client conference call. You can read a full transcript HERE. Below is an excerpt from the call discussing our investment in First American Financial (FAF).

Excerpt (Sean Stannard-Stockton speaking):

While Apple is among our most widely known holdings, I also want to talk about First American Financial, a more under the radar investment of ours. While companies such as Apple generate enormous attention from investors, under the radar companies like First American can generate outstanding returns nonetheless. In fact, so far this year, Apple has returned 35%, while First American has been one of our best performing stocks returning an outstanding 42% year to date.

If you’ve ever bought a house, you know that one of the many things you need to do is buy title insurance. Unlike most insurance policies, which guard against unpredictable future events, title insurance guards against the risk that the property you are buying may not actually belong to the seller, either because of historical problems with how the title has been recorded or transferred or because there are outstanding liens against the property.

Title insurance is mandatory if you take out a mortgage to buy a house. And even if you pay with cash, the downside to finding out that the property you just bought was not actually owned by the seller or there is some debt collector out there who has a claim on the property you just bought, is so large relative to the small cost of the title insurance policy that very few home buyers go with out it.

In order to sell title insurance, title companies like First American need to assemble what is called a “title plant” in the industry. This title plant is a massive database of records showing all of the maps, deeds, mortgages, tax liens, etc that are associated with a property. Since many homes in the United States have histories going back a hundred years or more, the title histories on even a single property can include hundreds of pages of documents, including hand drawn maps and notes about rights of passage granted by one neighbor to another.

In fact, when I bought a new home last year, one of the houses we looked at had an extremely complex title history. A portion of the property had once been part of the adjoining town until it was transferred to facilitate the electric company’s efforts to bring electricity to the neighborhood a long time ago. Earlier in its history, that same odd segment of the property had been allowed a right of way for the neighbor to walk their sheep across. Now given I live in the middle of Silicon Valley, these aren’t the sorts of title issues you’d expect to find. But with people living in the same place for well over a hundred years, these are exactly the sort of issues found by title companies.

In my case, I reviewed the title in depth and believe me the records were not a neat and tidy database that your average computer engineer is used to dealing with. Instead, the title history was made up of scanned records of handwritten agreements and notes.

The complexity of title plants and the need to have records on most every piece of property in a given geographic area to be competitive in the market has led to the consolidation of the industry to a small group of large players. Over half of the title business national is controlled by First American and their main competitor Fidelity National. With title insurance premiums representing a relatively stable percentage of home price over time, title insurers enjoy a steadily increasing revenue stream as home prices appreciate. At the same time, while home prices have recovered since the recession, the number of home sales, especially the sale of new homes is still below what we believe are normalized levels. When you see news reports citing a lack of inventory as being the reason for rising home prices, one way to interpret this is to note that there are more willing buyers than there are willing sellers and thus the current volume of transactions is being inhibited by an imbalance in the market.

Like most holdings in our portfolio, First American does a good job optimizing their capital structure and returning excess cash to shareholders. As earnings have grown, so has the company’s dividend, which currently represents a 3% yield and which the company has increased by 320% over the last four years.

While First American isn’t a particularly sexy company and while they don’t show up in the news all that much, they are the sort of very profitable, dependable company, whose products and services make up important elements of the day to day life of their customers. These sorts of stocks are often overlooked by investors who too often prioritize exciting news flow over strong cash flow generation. In the case of First American, investors who saw through the boring business story could see a rather exciting profit machine, one which the market has spent the year steadily bidding higher.

You can read the full transcript HERE.

Clients of Ensemble Capital own shares of First American Financial (FAF).

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

The information contained in this post represents Ensemble Capital Management’s general opinions and should not be construed as personalized or individualized investment, financial, tax, legal, or other advice. No advisor/client relationship is created by your access of this site. Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. If a security discussed in this blog entry is owned by an employee, principal and/or client of Ensemble Capital you will find a disclosure regarding the security held above. Should an employee, principal and/or client of Ensemble Capital subsequently purchase or sell any position in a security discussed in this blog entry, we will not update the above disclosure nor revise any archived blog entry after the date it is originally posted. If reviewing this blog entry after its original post date, please refer to our current 13F filing or contact us for a current or past copy of such filing. Each quarter we file a 13F report of holdings, which discloses all of our reportable client holdings. Ensemble Capital is a discretionary investment manager and does not make “recommendations” of securities. Nothing contained within this post (including any content we link to or other 3rd party content) constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instrument.

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We recently hosted our quarterly client conference call. You can read a full transcript HERE. Below is an excerpt from the call discussing our investment in Apple (AAPL).

Excerpt (Sean Stannard-Stockton speaking):

We’ve talked about Apple in past calls and it’s a stock we’ve owned for a long time because our research has shown that it’s a company with competitive advantages, especially in its iPhone franchise.

Recall that the last time we spoke about the company on one of these calls was a year and a half ago when the stock was trading at about 10x earnings, near a low point, as the market had become disillusioned with its recent iPhone business trends. This had also occurred in 2013 for similar reasons. Our contention had been that Apple’s products are sticky with customers because it stirs emotional connections with its technology products and brand while its operating system, ecosystem of apps and services, and integration across product lines make it easy for its users to really integrate technology into their increasingly digital lives.

As a result of its simplification and integration of technology, and its brand, status and ecosystem, Apple has been delivering tremendous value to its customers even as it extracts a great profit. It’s the ideal type of business to own; selling a product that customers can’t live without, that is differentiated from the competition, and provides so much value to customers that it allows the business to generate high profits while leaving quite a bit of excess “surplus” value for its customers to enjoy as well, leaving them “delighted”, as Apple refers to the emotional state they seek to achieve. That emotional word is so associated with Apple’s products that it may as well be trademarked by the company!

Having said that, the stock is up over 40% since our call last spring (leaving shareholders “delighted” as well!) and more appropriately reflects the value that we’ve recognized in the company. While the market tends to have a fair bit of volatility in its assessment of what Apple’s stock is worth from one iPhone cycle to another, our assessment of its value has been consistent, with only small changes over the last year as we obtained more information about the company’s financial results.

Apple’s sales from one iPhone cycle to another tends to have some degree of volatility to it as the overall smartphone market has matured and slowed its growth to a low single digit rate while customers’ specific purchasing behaviors when it comes to upgrading has been “peaky”, depending on the timing of their need or desire to upgrade to the next iPhone.

As a result, we had a big surge of customers whose first iPhone was the 4S in 2012 followed by a major upgrade cycle in 2015 with the iPhone 6 and now market expectations are that many will find the recently announced iPhone X and 8 models to be compelling enough to upgrade again, causing optimism as to what sales numbers will be.

From our perspective, these peaks and valleys around iPhone cycles represent cyclical, but predictable, sales and profit trends that can be “normalized” across 3-year product cycles so long as we can be confident that Apple will retain the majority its existing customers when they next choose to upgrade their phone. As its base of iPhone customers grows every year, subsequent peak cycles should represent higher sales levels as should the sales valleys and that is the pattern we’ve historically witnessed and seems to be true today.

Interestingly, the iPhone X represents a more aggressive push for Apple’s pricing model, one in which the company is sub-segmenting its already high-end base of customers. We believe the applicable market for $350-$1,000 iPhones represents about 20% of the world’s most affluent customers. When Apple released the iPhone Plus models at the end of 2014 with the launch of the iPhone 6 Plus, it increased the price of the larger 5.5” screen model by $120 over the base 4.7” screen model, its first experiment with price segmentation. The larger screen was adopted with enthusiasm, with nary a complaint about pricing and nearly half of the last iPhone 7 cycle comprised the larger, more expensive Plus model.

With the iPhone X, Apple is proposing a $200 price increase over the Plus models on the back of a new form factor that features a new edge to edge higher quality OLED screen and sophisticated 3D Face ID technology replacing the Touch ID fingerprint security system. But really, the iPhone X is all about further sub-segmenting the 600 million base of iPhone users and getting 10-30% of the most affluent, status and technophile centric users among them to pay more for the most advanced iPhone Apple can create today. These are also the users who have the highest “surplus” value accruing to them given their relationship with the brand and the phone. And now Apple is trying to capture a greater portion of that surplus value by delivering a new iPhone at a 25% higher price.

And it’s not just the iPhone X that is seeing a higher price and rebalancing of the value share between Apple and its customer. The latest “regular” iPhones, the 8 and the 8Plus also see a $50 and $30 price increase, respectively. The combination of a new iPhone form factor driving more of the existing user base to upgrade their iPhone 6 and 6s’ and the higher selling prices has resulted in a dramatic closing of the gap between Apple’s share price and our assessment of the company’s intrinsic value, since last April.

As many of you may have noticed, that has led us to target a lower weight for our Apple position in client portfolios. Our opinion of the company hasn’t changed, and we still believe the company is worth more than the current price, however the discount to our fair value estimate has shrunk significantly as that value has become more widely recognized by the market, which means that the risk/reward trade-off has changed as well, effecting the amount of Apple we want to own for clients.

The old adage “buy low and sell high” is as true as ever, and despite it sounding very simple, practicing it is anything but that. The implementation of that adage often means buying great companies when its uncomfortable in the midst of negative headlines and poor near term trends, while selling high is also just as uncomfortable amid higher market enthusiasm and increasing sales and earnings estimates. We try to accomplish this by keeping our intrinsic value estimates grounded in data, research and analysis, and a long-term understanding of the qualitative business fundamentals to guide our buy, sell, and hold decisions.

You can read the full transcript HERE.

Clients of Ensemble Capital own shares of Apple (AAPL).

 

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

The information contained in this post represents Ensemble Capital Management’s general opinions and should not be construed as personalized or individualized investment, financial, tax, legal, or other advice. No advisor/client relationship is created by your access of this site. Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. If a security discussed in this blog entry is owned by an employee, principal and/or client of Ensemble Capital you will find a disclosure regarding the security held above. Should an employee, principal and/or client of Ensemble Capital subsequently purchase or sell any position in a security discussed in this blog entry, we will not update the above disclosure nor revise any archived blog entry after the date it is originally posted. If reviewing this blog entry after its original post date, please refer to our current 13F filing or contact us for a current or past copy of such filing. Each quarter we file a 13F report of holdings, which discloses all of our reportable client holdings. Ensemble Capital is a discretionary investment manager and does not make “recommendations” of securities. Nothing contained within this post (including any content we link to or other 3rd party content) constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instrument.

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