Earlier this month I had the pleasure of doing a presentation on our investment thesis for Sensata Technologies at MOI Global’s Best Ideas 2019 conference. The full presentation is below. You can also learn more about Sensata from our blog post on the company as well as the profile Barron’s did on our investment in the company in October.

As of the date of the post, clients invested in Ensemble Capital Management’s core equity strategy own shares of Sensata Technologies (ST). This company 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.

One of the most basic (both in the sense of “simple” as well as the slangy put down) start up pitches is “It’s like Uber for X!”. While this vocabulary has fallen out of favor in recent years, for a time it was a very common premise for new startups. Despite it falling out of favor, there is still a sense among investors that an app-based competitor might come out of nowhere at any time and destroy an established business or industry. We’ve seen this worry crop up in relation to our investment in Landstar Systems, a trucking logistics business, so I thought I’d lay out why Uber was a special case that doesn’t apply to long haul trucking and how investors should think of the Uber for X risk in the context of public market investing.

Uber for X is short hand for a company that uses an app to connect two sides of a transaction. For instance, see this long list of on demand services listed under the heading Uber for X. It includes Cleanly (Uber for Laundry!), VetPronto (Uber for Vets!), Push for Pizza (Uber for Pizza!) and even Transfix (Uber for Trucking!) one of the many app-based trucking logistics companies that some investors view as a threat to Landstar Systems.

However, none of these businesses appear to be tapping into the critical market feature that made Uber a roaring success. Uber wasn’t a success because they made an app. They weren’t a success because their app connected two sides of an existing market. They were a success because their app-based business model drew in a simply massive source of new supply, which caused prices to fall and triggered a surge of demand. This dynamic then kicked off a flywheel effect that transformed the entire industry.

Pre-Uber, people took taxis. Taxi companies acted as matchmakers between the potential rider and an available driver. Uber did not simply replicate the matchmaking part of the process with an app, they entered a market with huge untapped potential supply (all the people who own a car and would like to make money either on the side or as a full time job) and made it super simple for that supply to enter the market. Critically, Uber didn’t need to convince drivers to make Uber their full time job. Instead, Uber allowed for drivers to provide transportation in whatever windows of the day they had available. Uber didn’t match riders with the existing transportation supply (taxi drivers), they matched riders with an entirely new source of supply. This upended the market, crushed prices to extremely low levels and utterly transformed the passenger transportation market.

Here’s a chart of the value of taxi medallions. This is the chart that worries investors in incumbent businesses when they hear about app-based competitors emerging.

Source: American Enterprise Institute

One case of an Uber for X working out as promised is Airbnb. The company could easily be characterized as Uber for Lodging. And its success, just like Uber’s is based on the way the company did not simply connect people wanting to rent a room with existing supply (hotels), but instead by creating a massive new source of supply (people who have an extra room or spare apartment they don’t use all of the time).

So what about Cleanly, VetPronto and Push for Pizza? These Uber for X businesses are offering an app that connects people who wear clothes with laundry companies, pet owners with veterinarians or hungry people with pizza shops. There is no reason to think that any of them will unleash a large pool of latent supply. There aren’t a bunch of people with veterinarian skills who just need a simple way to source clients to fill their spare time. There’s no big inventory of pizza ovens sitting underutilized.

In the case of Transfix (or more credible competitors such as Conway or even Uber’s own Uber Freight business) there simply aren’t a bunch of underutilized big rigs in people’s back yards or a bunch of people who know how to drive big rigs and could do so in their spare time. So yes, apps offer a nice user interface. But simply creating “an app for that” doesn’t come close to creating a viable Uber for X business model.

There are certainly real Uber for X opportunities out there. But the condition that needs to be met is you must find a market that has a large, underutilized source of supply (like Uber and Airbnb found) and offer a logistical interface that serves the needs of both the demand and the latent supply in such a way that unlocks the supply.

These conditions don’t exist in the laundry, pizza or pet care business. They don’t exist in the long haul trucking market (although they may well exist in the last mile, home delivery business). And when these conditions don’t exist, any Uber for X business model isn’t actually replicating Uber at all and has little hope of success.

As of the date of the post, clients invested in Ensemble Capital Management’s core equity strategy own shares of Landstar Systems (LSTR). This company 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.

For most of my driving years, I relied on repair shops to do all the work on my cars. It wasn’t until a few years ago, after getting a $100 charge for changing a single headlight bulb, that I evaluated what repairs, if any, I could do by myself.

With the help of some YouTube videos, I figured out how to replace my headlights and filters at a fraction of the cost, with no discernible drop-off in quality. (At least not yet.)

On the other hand, there’s no way I’d tackle my car’s brakes, engine, or transmission. The risk-to-reward ratio just isn’t attractive.

This isn’t to say that I couldn’t learn how to do the repairs, but it would require extensive training and experience to become proficient. The financial payoff to work on just my car wouldn’t be worth the effort.

Circle of competence

Investors face similar challenges when we research new companies. If we just bought “what we know,” as the saying goes, our investible universe would be tiny. Learning about new companies and expanding your circle of competence is part of the fun of investing. Still, we need to know where to draw the line.

More specifically, how much effort will it take to:

  • Learn the company’s products and services?
  • Identify the company’s moat sources (if any)?
  • Explain how the business turns revenue into profit and cash flow?
  • Appreciate the customer value proposition and why they win and lose business?
  • Differentiate secular and cyclical industry themes?

On the one hand, there are businesses that, like switching headlights and filters, are easy to grasp. We call these intrinsically understandable businesses. Put another way, a good investor can relatively quickly figure out 80% of what’s important to the business without being an expert in the field.

On the other hand, there are attractive businesses that either require years of first-hand experience or a Ph.D. to reach the same 80% understanding threshold. Perhaps key information is inaccessible or the operations are complex or otherwise technically challenging. These should be tossed into the proverbial “too hard” pile, yet some investors like a good intellectual challenge and dive straight in.

Of course, there’s potential payoff for digging through complex businesses, but the return on time also needs to be considered. For us, this is like learning how to fix your car engine. Could we figure it out given enough time? Sure. Would it be worth our while, given other demands on our time? Probably not. There are more fish in the sea.

Importantly, understanding a business does not require complete knowledge of its operations. Investors can obsess over quantitative minutia and overlook valuable qualitative aspects like moat and management quality.

Two sides of understanding

The other question we ask when evaluating our overall understanding of a business is, “Is this company intrinsically forecastable?”

To be sure, understandability and predictability are two different things. For example, you might be able to quickly understand how a gold mining company makes money. It’s much harder to confidently forecast its cash flows over five or ten years.

Companies with secular tailwinds, high recurring revenues, and tollbooth characteristics lend themselves to being more forecastable, relative to the average company. We like owning these sorts of businesses. Our holdings in Mastercard and Broadridge Financial are two examples.

Now, none of our cash flow projections will be perfect, but if we can identify three to five key metrics that drive such a company’s valuation, that’s about as good as you can get as an outside shareholder from a predictability standpoint.

Bottom line

Understandability is an oft-discussed, yet poorly-defined investing term. By setting some guideposts, we hope to more accurately identify businesses worth further research and discard ideas not worth our time.

As of the date of the post, clients invested in Ensemble Capital Management’s core equity strategy own shares of Mastercard (MA) and Broadridge (BR). This company 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.

Earlier this month, SumZero (an online community of investment professionals) interviewed Ensemble Capital’s president and chief investment officer Sean Stannard-Stockton and senior investment analyst Todd Wenning on their approach to evaluating company management teams.

Among other things, Sean and Todd discussed the right metric for measuring management performance, what they look for in smart capital allocators, and two of their favorite but less well-known CEOs.

You can read the full 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 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.

Netflix Raises Prices on All of Its Subscription Plans (Joe Flint, @JBFlint, Wall Street Journal)

Netflix opted to raise prices across all of their subscription plans this week.  The new prices will go into effect immediately for new customers and over the next few months for existing customers.  Ensemble Capital’s Arif Karim wrote about Netflix’s Pricing Power, explaining the ability for Netflix to raise prices and not lose customers.  Arif also did a deeper dive on the reasons behind investors’ enthusiasm for Netflix in his blog post Netflix and the Rise of the Global Scale Media.

China’s Annual Trade Surplus With U.S. Hits Record Despite Trump’s Tariff Offensive (Liyan Qi, @QiLiyan, & Xiao Xiao, Wall Street Journal)

Despite the Trump administration’s tariff policy targeted at China, the country’s trade surplus with the United States hit a new record high last year.  Part of the increased surplus was due to exporters who accelerated their shipments in anticipation of increased tariffs.  The US and China had been aiming to reach an agreement by March 1 to help ease the trade conflict, but U.S. Officials are currently debating lifting China tariffs to hasten a potential trade deal and calm the financial markets (Bob Davis, @bobdavis187, & Lingling Wei, Wall Street Journal).  The equity markets reacted positively to the news.

Microsoft’s Leap Into Housing Illuminates Government’s Retreat (Emily Badger, @emilymbadger, The New York Times)

In an effort to combat the affordable housing crisis in Seattle, Microsoft announced a pledge of $500 million to help build affordable housing in Seattle.  The pledge is indicative of a nationwide void in addressing the issue of affordable housing.  Rather than cut a check to charities or build housing just for their own employees, Microsoft is aiming to fix a market failure.  “It really represents something almost unprecedented,” said Matthew Gordon Lasner, an associate professor of urban studies and planning at Hunter College. “What we’re seeing Microsoft do is in effect privately assume the role that historically the federal government and the states have played.”

As Americans Drink Less, Booze Makers Look Beyond the Barrel (Saabira Chaudhuri, @SaabiraC, & Jennifer Maloney, @maloneyfiles, The Wall Street Journal)

Americans are consuming less alcohol driven by “a growing trend toward mindful drinking or complete abstinence, particularly among the millennial cohort,” says IWSR’s U.S. head Brandy Rand.  To combat the slowdown in sales, producers are looking for ways to expand their product line into non-alcoholic alternatives to appeal to teetotalers.  “IWSR forecasts low- and no-alcohol products in the U.S.—still a small slice of the market—to grow 32.1% between 2018 and 2022, triple the category’s growth over the past five years.”  Sean Stannard-Stockton wrote about the influence of the millennial generation in a recent blog post.

Rihanna and LVMH Make a Deal and, Possibly, History (Vanessa Friedman, @VVFriedman, The New York Times)

Moët Hennessy Louis Vuitton LVMH, the parent company of Dior, Givenchy and Fendi, recently agreed to a deal to back Rihanna’s fashion brand, “making her the first female designer of color at the largest luxury conglomerate in the world.”  The deal represents a shift in the fashion industry as celebrity and social media influencers have a new power in how brands target different audiences.  Besides Rihanna’s 14 No. 1 singles on the Billboard 100 chart, more than 50 Top 40 hits, and 67 million Instagram followers, her influence in the fashion and beauty world has already been notable with the incredible success of her Fenty Beauty brand.

The Most Powerful Person in Silicon Valley (Katrina Brooker, Fast Company)

According to Fast Company, the most powerful person in Silicon Valley isn’t Elon Musk, Jeff Bezos, or Mark Zuckerberg, it’s billionaire Masayoshi Son.  Through his Vision Fund, he is spending hundreds of billions of dollars to create an AI-powered utopia where machines control how we live.  The Vision Fund invests a minimum of $100 million in the companies in its portfolio and since October 2016, the fund has committed over $70 billion of capital into some of the most influential companies in the world including Uber, WeWork, Nvidia, ARM and Flipkart among many others.  The companies within the Vision Fund have the potential and power to influence the $228 trillion real estate market, the $5.9 trillion global transportation market, and the $25 trillion retail business.

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.