Companies with a durable competitive advantage and a long growth runway have always been a favorite of many investors. If these growing, wide-moat businesses come with honest and capable management, they quickly get embraced as “great” companies with “great” management.
Successful investors, however, know that great companies with great management do not necessarily make for great investments. The price at which these companies are purchased is, of course, another key determinant of future investment return. So, how can investors increase their chances of identifying and investing in attractively-priced great companies?
In search for an answer to this question, we had an opportunity in 2013 to sit down with David Rolfe, Chief Investment Officer at Wedgewood Partners. David joined the firm in 1992 in his current role and has been instrumental in shaping Wedgewood’s investment philosophy and approach since then.
Our conversation with David Rolfe touched on many aspects important to investors in growing, wide-moat companies, including how to identify a wide-moat business, why do wide-moat businesses become mispriced, what are the best methodologies for valuing wide-moat businesses and, of course, how can investors increase their chances of investing in attractively-priced wide-moat businesses. David also generously shared the investment case for several of his major holdings and relayed an insightful story about GEICO and the lessons it holds for investors. We are pleased to share the below excerpts from the conversation.
Wide-Moat Investing Success Factor #1: Focus
When it comes to investing in growing, wide-moat companies, focus is a key success factor, according to David Rolfe. David limits his portfolio to 18-22 investments. This focused approach leads to fewer, but more impactful decisions where only his best ideas make it into the portfolio. To populate a larger portfolio, one would have to suspend a lot of the valuation criteria just to get them in the portfolio. And, of course, there are not that many attractively-priced wide-moat businesses to invest in, especially for investors running multi-billion dollar portfolios.
Says David Rolfe:
“By being focused at the company level, we’re going to be very picky. In other words, we’re putting our twenty best ideas in the portfolio and that’s where we stop. Given that we have very little turnover at Wedgewood, we hope to own these terrific growth companies for many years. Right out of the box, our focus to coin a phrase, no pun intended, is on those businesses that we think are best in class, that are uniquely competitively advantaged, that we believe at a minimum can double over the next three to five years. It’s not growth for growth’s sake, hyper growth, imprudent growth, risky balance sheet leverage growth. We’re looking for these terrific businesses, market share dominating leaders that don’t have to use financial leverage.”
Wide-Moat Investing Success Factor #2: Patience
Another key success factor of investing in growing, wide-moat companies is patience. According to David Rolfe, far too many growth-minded investors pay too high a price for these companies, so the biggest challenge is having the patience to wait for the company to get valued attractively. On the other hand, investors who have the patience are able to benefit, as even the best wide-moat businesses stumble at some point and offer investors an opportunity to buy them at an attractive price.
Says David Rolfe:
“You’ve got to be patient. No company clicks along without any bumps in the road forever. You look back at the great investments over time – Wal-Mart [WMT], Coca-Cola [KO], maybe even GEICO as an example here talking about Buffett. There’ve been plenty of times when those companies were out of favor, there’s something that’s going on at the company level where the valuation comes in.
The trick is to discern if it’s just a short term phenomenon that’s fixable or not. Our biggest mistakes over the years have been getting the company wrong, not the valuation wrong. We’re not chasing high momentum stocks of the day, paying 35, forty times earnings for a 20% grower…we have to be patient on the valuation to come to our levels where we believe the risk reward is attractive enough that we swing the bat.”
Growth vs. Value: A Lesson from GEICO
“In 1948, we made our GEICO investment and from then on, we seemed to be very brilliant people.” –Benjamin Graham, 1976
What can GEICO teach us about “value” versus “growth” investing? Plenty. As David Rolfe explains, both Benjamin Graham and Warren Buffett owe a substantial part of their wealth and public reputations — and deserved accolades — to a singular great “growth company”, the Government Employees Insurance Company (GEICO).
We share below David’s very instructive insights into GEICO.
Says David Rolfe:
“It’s a story that we’ve liked to tell when we’ve met with clients and prospective clients over the years because the long history of GEICO is ripe with examples for growth investors and value investors. The company was started in 1937 with about $100,000 in seed capital. Interestingly enough, in 1948 Benjamin Graham, again to coin a phrase, coin of the realm of late, he broke bad and he broke his rules, and he put 25% of his investment partnership in a privately held company.
Fate would have it that the SEC ultimately ruled to allow that purchase because he was an advisor buying an insurance company and there’s some regulations, and rules, and limitations. It allowed for the first publicly traded shares of GEICO, and GEICO soared, and it soared.
Graham was very quick to admit over the course of his career and at the end of his career, two things. Graham purchased half of GEICO in 1948 for about $712,000. Ultimately, it would rise in value to over $400 million at its peak in 1972. And Graham was very upfront admitting that the gain in GEICO was more than all of his other successes combined. And if it wasn’t for GEICO, his reputation for a great investor wouldn’t have been such.
But what’s interesting is that a lot of the study of Benjamin Graham, rightfully so, is that classic deep value, honed out of the scars, if you will, of the great depression. But he broke the rules and he bought this company, and held it for all those years where his discipline would have said to sell it.
Then, as fate would have it, Buffett became involved when he was going to school at Columbia, studying under Graham. He found out about GEICO. It was a company he hawked when he was a stockbroker after he left Columbia University. And as fate would have it, when GEICO stumbled in the early 1970s, it was Buffett who swooped in and started buying the shares when they had fallen. They reached a high of $61 in 1972, were about $40 in 1974, and they fell to a couple of dollars [by 1976].
And here was the opportunity, classic value opportunity. Buffett knew the underlying advantage of GEICO, their low cost advantage versus their competitors, was still intact and that would be the foundation for growth going forward.
For those who have followed Buffett’s career, they know that GEICO was a huge win for him, huge success. And ultimately, he bought about a third of the company in those dark days. His last investment was in 1980. He owned about a third of the company. Through share buybacks at GEICO, he ultimately got to about 50% of the ownership of GEICO. He bought the other half in late 1995 for $2.3 billion.
When you read the annual reports even when he first invested in GEICO, and then particularly in the annual reports starting in 1995, 1996, when the details were singing the praises of GEICO in terms of growth, and the opportunity, and the growth, and the growth.
Again, he liked to joke that he wanted Tony Nicely to step on the accelerator to spend all this advertising, and then Buffett kept his foot on Nicely’s foot. But when Buffett arrived on the scene, GEICO was spending about $33 million in advertising per year. They’re up to a billion now per year, like $1.1 billion. It’s three times the advertising, roughly, of their three largest competitors combined.
Even maybe more so than the mentor, teacher, pupil relationship that Buffett and Graham had over all those years, and then he would go work at the Graham-Newman Partnership, and a lifelong friend, and mentor, and hero, as Buffett describes Benjamin Graham.
But this GEICO connection, I’ve never heard Buffett talk about it in these terms, but it had to give him satisfaction, that he played a significant role in saving GEICO, if you will. And Benjamin Graham still owned it. His wife, when he passed away in 1976 I believe, members of the Graham family still had their GEICO investment and that was a significant part of that rebirth, if you will, was the impact of Buffett.
Again, the Graham-Buffett relationship, it’s been like sixty years now and Buffett still sings the praises of this great growth company, GEICO. At the risk of getting long-winded, it’s the story I like to tell that explains what we’re trying to do at Wedgewood.
There are plenty of times when a great growth company stumbles. Now, that was a significant stumble back then, but all along the way, there are times that GEICO was imminently investable in terms of a good valuation, and all the while, the growth was clicking along.”
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