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

Atul Gawande, a surgeon injecting humanity into US healthcare (Anjana Ahuja, @anjahuja, FT)

A profile of Atul Gawande, who is tasked to head the “non-profit venture funded jointly by Amazon, Berkshire Hathaway and JPMorgan Chase.”  Dr. Gawande is “an endocrinologist and surgeon at Brigham and Women’s Hospital in Boston and a professor of public health at Harvard.” He has also written several books. I’ve read his book The Checklist Manifesto, which is fantastic. I look forward to seeing his continued positive impact on the health care industry.

How Amazon Steers Shoppers to Its Own Products (Julie Creswell, @julie_creswell, NYT)

Amazon’s move into the private label retail space started small and quiet. As the article says, “It started with a simple battery.” Now, AmazonBasics batteries account for a third of online battery sales. To stay competitive, brands like Energizer are paying to advertise at the top of relevant search results. While AmazonBasics only has about 100 products, the room for growth is large, and they have the data to see what products to take private next. “About 70 percent of the word searches done on Amazon’s search browser are for generic goods. That means consumers are typing in “men’s underwear” or “running shoes” rather than asking, specifically, for Hanes or Nike.”

Amazon Has a Business Proposition for You: Deliver Its Packages (Julie Creswell, @julie_creswell, NYT)

So far, Amazon has done an amazing job managing the speedy delivery of its products to customers. In typical Amazon fashion, they’re looking into optimizing it even more and becoming more vertically integrated. One new option is the use of contract drivers. This will help reduce their dependence on current shippers like USPS, UPS, and FedEx.

Industries, Looking for Efficiency, Turn to Blockchains (Laura Shin, @laurashin, NYT)

The uses of Blockchain are great and they’re now moving from being theoretical to practical. Firms from insurance companies to logistic companies are developing processes to utilize Blockchain technology. It has the potential to reduce fraud and improve efficiency. One of the biggest hurdles is the lack of a clear network. In order for this technology to be effective, there needs to be enough people on the network to make it worth it.

 

 

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 clients invested in Ensemble Capital’s core equity strategy you will find a disclosure regarding the security held above. 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. Ensemble Capital employees and related persons may hold positions or other interests in the securities mentioned herein. Employees and related persons trade for their own accounts on the basis of their personal investment goals and financial circumstances.

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

This quarter’s call will be held on Tuesday, July 17 at 1:00 pm (PST)

We’d love for you to join us on the call, which you can do by registering here or following the dial-in information below:

  • Dial: 1-800-895-1549
  • Conference ID: Ensemble

If you’d like to listen to our previously-held quarterly calls, 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.

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 clients invested in Ensemble Capital’s core equity strategy you will find a disclosure regarding the security held above. 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. Ensemble Capital employees and related persons may hold positions or other interests in the securities mentioned herein. Employees and related persons trade for their own accounts on the basis of their personal investment goals and financial circumstances.

Ensemble Capital Management Named to 2018 Financial Times 300 Top Registered Investment Advisers

 June 28, 2018 – Ensemble Capital Management is pleased to announce it has been named to the 2018 edition of the Financial Times 300 Top Registered Investment Advisers. The list recognizes top independent RIA firms from across the U.S.

This is the fifth annual FT 300 list, produced independently by the Financial Times in collaboration with Ignites Research, a subsidiary of the FT that provides business intelligence on the asset management industry.

RIA firms applied for consideration, having met a minimum set of criteria. Applicants were then graded on six factors: assets under management (AUM); AUM growth rate; years in existence; advanced industry credentials of the firm’s advisers; online accessibility; and compliance records. There are no fees or other considerations required of RIAs that apply for the FT 300.

The final FT 300 represents an impressive cohort of elite RIA firms, as the “average” practice in this year’s list has been in existence for over 22 years and manages $4 billion in assets. The FT 300 Top RIAs hail from 38 states and Washington, D.C.

The FT 300 is one in series of rankings of top advisers by the Financial Times, including the FT 401 (DC retirement plan advisers) and the FT 400 (broker-dealer advisers).

You can download a copy of the Press Release Here.

 

The Financial Times 300 Top Registered Investment Advisers is an independent listing produced annually by the Financial Times (June 2018). The FT 300 is based on data gathered from RIA firms, regulatory disclosures, and the FT’s research. The listing reflected each practice’s performance in six primary areas: assets under management, asset growth, compliance record, years in existence, credentials and online accessibility. This award does not evaluate the quality of services provided to clients and is not indicative of the practice’s future performance. Neither the RIA firms nor their employees pay a fee to The Financial Times in exchange for inclusion in the FT 300.

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 clients invested in Ensemble Capital’s core equity strategy you will find a disclosure regarding the security held above. 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. Ensemble Capital employees and related persons may hold positions or other interests in the securities mentioned herein. Employees and related persons trade for their own accounts on the basis of their personal investment goals and financial circumstances.

At the 2017 Berkshire Hathaway Annual Meeting, Warren Buffett and Charlie Munger lamented not investing in Amazon, Google, and Wal-Mart earlier on.

Berkshire-owned GEICO was a major Google search customer and Google executives even asked Buffett’s advice on how to lay out their prospectus ahead of the company’s 2004 IPO. “I had plenty of ways to ask questions…and educate myself,” Buffett recalled, “but I blew it.”

Why might Buffett and Munger have missed those golden opportunities? While the complete answer is more nuanced, one reason might be natural value investor skepticism when it comes to investing in Visionary leadership.

Visionaries

A common thread among Amazon, Google, and Wal-Mart is that they were all built by Visionary leaders: Jeff Bezos, Sergey Brin and Larry Page, and Sam Walton, respectively.

Visionaries tend to be purpose-driven, intrinsically motivated, and growth oriented. Moats are typically non-existent initially, though there can be massive moat potential if they execute on their vision.

Company 5-year revenue growth post-IPO year (CAGR) Purpose/Mission Big question marks in early years
Amazon 92.8% “To be Earth’s most customer-centric company, where customers can find and discover anything they might want to buy online, and endeavors to offer its customers the lowest possible prices.” · When will Amazon turn a profit?

· What happens when Wal-Mart responds?

· Isn’t it just an online bookstore?

Google 49.3% “Organize the world’s information and make it universally accessible and useful.” · Is Google just another dotcom stock?

· What stops another tech company from doing search?

· Isn’t the dual-class structure a sign management isn’t shareholder friendly?

Wal-Mart 43.4% “Saving people money so they can live better.” · Can it work outside its home territory?

· Why won’t shoppers stick with full-service retailers?

· Why can’t others mimic their discounting model?

Source: Bloomberg and company annual reports

With the benefit of hindsight, we know these three turned out to be slam-dunk investments, yet their success was hardly assured along the way. Indeed, Amazon’s stock had massive drawdowns on the path to its stellar long-term performance. And sometimes for good reason.

From a capital allocation standpoint, Visionaries can make bold bets in the wrong direction. Amazon made several large investments that failed miserably, the most notable being the Amazon Fire smartphone. Google Plus never took off as a social media challenger to Facebook.

Further, Visionary CEOs can make investments today that are designed to achieve a long-term goal, but may seem stupid in the short-term. A classic example is Netflix founder, Reed Hastings’ decision in 2011 to turn away from the DVD rental business and toward internet streaming. Such decisions don’t always sit well with analysts and investors focused on quarter-to-quarter results.

We can also point to plenty of Visionary-led businesses that flopped altogether. Sales growth stalled, profit margins never materialized, the company couldn’t execute, or competitors came along before the company could fully scale. When you’re investing in an early-stage, Visionary-led business, the range of potential outcomes is extremely wide.

But that’s what you hope to find in a Visionary-led business: optionality. No one building a valuation model on Amazon in the late 1990s could have possibly factored in the new businesses the company would enter in the subsequent decade and beyond.

Because of the call option-like payoffs of investing in Visionary-led businesses, their stocks also tend to trade at high multipless relative to comparable firms in their industries. These are often idiosyncratic businesses, as well, making them difficult to value based on relative multiples.

The combination of massive uncertainty, unproven business models, and expensive-looking stocks is not an ideal mix for traditional value investors.

Optimizers

Value investors are much more comfortable with what we call Optimizer CEOs. Optimizers typically run mature businesses where efficiency, frugality, and a repeatable capital allocation strategy are paramount to success. Moats have already been established in many cases.

The Optimizer CEO is best exemplified in Will Thorndike’s book, The Outsiders, which heralded eight CEOs (including Buffett) that, according to Thorndike, “followed a virtually identical blueprint: they disdained dividends, made disciplined (occasionally large) acquisitions, used leverage selectively, bought back a lot of stock, minimized taxes, ran decentralized organizations, and focused on cash flow over reported net income.”

To be a great allocator, Optimizer/Outsider CEOs need a steady source of cash flow from the underlying operations. As such, they’re often found in businesses and industries that feature recurring revenues, long-term contracts, or habitual consumer purchases. Among the companies featured in The Outsiders, for instance, are defense (General Dynamics), cable television (TCI), and insurance (Berkshire Hathaway).

Or consider Danaher, which rose to prominence under the leadership of Steven and Mitchell Rales in the late 1980s by acquiring manufacturing businesses and applying their kaizen-based Danaher Business System to remove inefficiencies and improve margins and cash flows. These cash flows were reinvested to acquire more companies that were subsequently immersed in the Danaher Business System. Rinse, wash, repeat.

Even if the stocks of proven Optimizers are expensive, the range of outcomes is narrower given the steadier nature of the operations and management’s track record. Their effectiveness is regularly evident in quarterly and annual results. When a large acquisition is made, synergy targets are reliable and often exceeded.

Visionaries vs. Optimizers

Neither type of CEO is uniformly better than the other. Much depends on the company’s stage in its lifecycle and its underlying business. For example, a company that installs an Optimizer too early in its lifecycle could unduly smother innovation and growth.

Conversely, a Visionary may need to hand the reins to an Optimizer once the company has reached scale, and margins and returns on invested capital (ROIC) become more important to investors. Rarely can a person play both CEO types well. Companies like Starbucks, Microsoft, and Apple have all struggled with leadership style transitions.

Further, a given company might need a Visionary and Optimizer at different points. Consider the challenge blue chip consumer-packaged goods companies face today. For decades, it made sense to have an Optimizer as CEO of a CPG firm. There was steady demand for branded products, they had pricing power, and margins held up. Today, however, blue chip CPG firms face fresh competitive threats. Many of them could use a healthy dose of creativity and might benefit from a Visionary CEO.

Finally, you want a creative Visionary leader to solve problems for which there isn’t a known answer and to navigate dynamic competitive landscapes. You wouldn’t want a Visionary running a bank or regulated utility, however. Optimizers work best within relatively stable competitive settings and where best practices are known and achievable.

Traits

Both Visionary and Optimizer CEOs should be of interest to investors. The important thing is to know what you’re looking for.

Visionary Optimizer
Primary Motivation Intrinsic Extrinsic
Objective Growth and innovation; Fulfill mission Maximize cash flow and ROIC
Moat type Emerging/Reinvestment Legacy
Fiscal discipline Loose Frugal
Problem-solving style Creative, experimental Disciplined, methodical
Capital allocation strategy Reinvest in the core business Opportunistic buybacks and M&A
Corporate culture Energetic, perhaps cult-like Decentralized, reserved
Major risks Loss of focus, no moat materializes Poor execution, lack of investment opportunities

One reason value investors may balk at investing behind Visionaries may have to do with perception. If you incorrectly assess an Optimizer-led business, you’re unlikely to fail alone, but incorrectly assess a Visionary-led business and you invite ridicule. This is unfortunate and is something we try to inoculate ourselves against.

Bottom line

Decades from now as we recall old investments, we’ll undoubtedly recall a few winners we incorrectly passed on, just as Buffett and Munger did. We’ll also correctly pass on a few losers, too. We can live with both. What we will regret is passing on a company because we were afraid to make a mistake.

 

As of the date of this blog post, clients invested in Ensemble Capital Management’s core equity strategy own shares of Alphabet (GOOGL), Starbucks (SBUX), Apple (AAPL), and Netflix (NFLX). These companies represent only a percentage of the full strategy. As a result of client-specific circumstances, individual clients may hold positions that are not part of Ensemble Capital’s core equity strategy. Ensemble is a fully discretionary advisor and may exit a portfolio position at any time without notice, in its own discretion.

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 clients invested in Ensemble Capital’s core equity strategy you will find a disclosure regarding the security held above. 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. Ensemble Capital employees and related persons may hold positions or other interests in the securities mentioned herein. Employees and related persons trade for their own accounts on the basis of their personal investment goals and financial circumstances.

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

How Much Is That Sneaker in the Window? (Bee Shapiro, @BeeShapiro, NYT)

Similar to Baseball cards, there is a strong after-market for rare sneakers. Boutique shops have opened to bring legitimacy and ensure authenticity to consumers.  Their success is drawing the attention of many people; from luxury goods providers to pricing sites similar to Kelley Blue Book for cars.

Visa says service returning to normal (BBC)

When a system that processes “£1 in £3 of all UK spending,” any delay or disruption in service can be a headache. This happened to Visa on June 1, 2018 in the UK. Customers vented their frustration online. It shows how integral credit card processing is in today’s world and how far we’ve come from relaying on physical currency.

Worried About Big Tech? Chinese Giants Make America’s Look Tame (Raymond Zhong, @zhonggg, NYT)

If you think Amazon is a force to be reckoned with in the consumer space; look at the top tech companies in China – Tencent and Alibaba. They’re quickly becoming the consumer gatekeepers. Between these two apps it covers every aspect of Facebook, Google, Amazon, Whatsapp, Uber/Lyft, Doordash/Postmates, Instacart, and Paypal! That gives incredible power to Tencent and Alibaba. There is overlap between the two companies and they battle fiercely. Their battle is evening starting to shift from the cloud to the street.

Why You Should Read Those Boring 10-K Filings (Peter R. Orszag, @porszag, Bloomberg)

The devil’s in the details. While the amount of text in 10k’s have increased greatly over the past 20 years, there importance has kept pace. “A team of economists from Harvard Business School and the University of Illinois […] find that although there is little immediate impact, modifications to the text are highly predictive of changes in the company’s stock price over the months after the report, as the implications slowly and gradually become apparent to the market.”

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 clients invested in Ensemble Capital’s core equity strategy you will find a disclosure regarding the security held above. 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. Ensemble Capital employees and related persons may hold positions or other interests in the securities mentioned herein. Employees and related persons trade for their own accounts on the basis of their personal investment goals and financial circumstances.