Practicing a Lost Art

Chris Mayer on the hunt for the next 50-bagger...

(Source: Getty Images)

Dan Denning, checking in today from Laramie, Wyoming…

First up today, a quick message from our founder, Bill Bonner… who is alive and well, thanks for asking!

(Just click on the PLAY button to hear a quick message from Bill…)

Wouldn’t it be nice to ignore today’s bread and circuses about the Fed’s interest rate decision? As investors, we can’t. Investment Director Tom Dyson and myself will have more to say about what it all means (later today for Tom, Friday for me). Stay tuned.

In the meantime, a quick reminder that Bill has stepped away from his keyboard for a few weeks to work on a special project. As you can hear, above, Bill’s fine and in ruddy health. He’ll be back soon.

Until then, we’ve asked another member of Bill’s long-time inner circle to join the conversation. I’ve known Chris Mayer for over twenty years now (some long-time readers may have read his newsletter Capital and Crisis.) Chris left the newsletter world a few years ago to set up Woodlock House Family Capital. Please note Chris manages some of Bill’s family money. 

Instead of talking about interest rates and unelected banking cartels, Chris has written about great businesses and how to find them. Enjoy!

Dan

PS After reading Chris Mayer’s essay I couldn’t help but include the chart below. ExxonMobil was removed from the Dow Jones Industrials Index on August 25th, 2020. It had been in the index for 92 years, going all the way back to 1928. It was replaced by Salesforce.com. 

Since then, XOM’s share price is up almost 200% while CRM’s is down almost 25%. If you include reinvested dividends over that time, XOM’s outperformance (on a relative and absolute basis) is even greater. This is why it pays to be contrarian. 

As far as I know, XOM is not a holding of Woodlock House Family Capital. But the lesson is clear: if you focus on a good business at the right price and ignore everything else, you can sleep well at night. 

---

Practicing a Lost Art

By Chris Mayer

There are not many people left who do what I do. It’s a dying art, you might say. 

My focus is on businesses. What does that mean? 

Let me share the following anecdote.

I had lunch with a friend and well-known investor who told me about a stock he's owned for 27 years. He's up 50x and getting dividends that are 2/3rds of his cost basis every year.

I love this story (and I have collected dozens of similar stories) because embedded in this simple tale are several key points of investing success. The biggest one is probably the most obvious: He would never have recognized such a gain if he were trading in and out of the stock, trying to avoid the usual drawdowns of 30% (and more) along the way. 

He had to sit through the volatility. Recessions, wars, Fed moves – he had to “do nothing” through all of it.

The outcome my friend enjoyed represents an ideal. To get there, you have to own special businesses acquired at a good price – which he did. Identifying such opportunities is where I put most of my attention.

Most stocks are an easy “pass” because most businesses are not special. They have too much competition or they are too cyclical. And their overall returns on capital are mediocre.

What do I mean by returns on capital? This is an important concept individual investors miss. They just look at, say, the price-earnings ratio… but they don’t ask how much capital was required to produce $1 in earnings. Consider two businesses.

Business ABC: Invests $1 and increases earnings by $1 per year going forward. That’s a 100% return on capital.

Business XYZ: Invests $10 and increases earnings by $1 per year going forward. That’s a 10% return on capital.

The market is going to value ABC a lot higher than XYZ, all else being equal. There’s more to consider beyond this. But I just want to make the simple point that better businesses carry higher multiples. And they can still be cheap at a much higher valuation. In fact, they often are.

To make this clear, let me show you an example of the kind of business I look for and own today: Copart (CPRT).

The company has zero net debt. There is skin in the game as insiders own 11% of the stock. And it has basically one competitor, IAA. What these companies do is sell cars that have been totaled – because of an accident, or flooding from storms, etc. These cars wind up in Copart and IAA lots and then are sold to a variety of buyers who may salvage them for parts, or fix them or whatever. 

It’s a great business. Over the last ten years, the stock has returned 23% annually. But look at the underlying business. Look at those returns over the last decade:

How these are calculated and what they mean exactly is not important for our purposes here. Just eye-balling this table, you can see the business is generating high returns. 

If you knew nothing but these returns, would you ever have sold this business? Yet many investors did, every year. You can see it in the millions of shares that traded hands over these years. The stock price bounced around a lot, too. Even in a single year, there could be a 50% difference between the low and the high.

Yet… Over the long-term, your return as an investor would basically track that of the underlying business assuming the valuation stays the same. Knowing this, it’s not so surprising to see that 23% annual return Copart has earned.

As long as Copart continues to perform on these kinds of metrics, I leave it alone. If anything I’ll buy more when it’s down, like it is this year. (And I have bought more).

I mentioned valuation. I should add that to be right about the business is more important than being right about the valuation. Or put another way: Business first, valuation second.

Many times in my past, I have committed the error of reversing this. I spent too much time with crappy businesses just because they traded at low multiples of earnings or book value. By focusing too much on present day multiples, I missed out on some obviously wonderful businesses that would’ve earned me big returns.

To bring this back to Copart; I have admired Copart since 2011. I know this because I still have the report that got me interested in it in the first place. Murray Stahl was the author and his recommendation was to buy the stock back in March of 2011.

I remember being impressed with the whole entrepreneurial story. (Read Junk to Gold, by Copart’s founder Willis Johnson for the backstory.) Copart also had impressive margins, high growth and a dominant position running its online marketplace for salvaged vehicles.

I also remember why I didn’t buy it then and why I never owned it until I bought it in 2020: It always seemed expensive. The price-to-earnings ratio, to take one metric, was 22x back in 2011.

Copart, since that report, is up 12x.

Let me repeat: 12-fold in a decade. If you make 4x in a decade, that’s 15% annualized. That’s a darn good return. So what could you have paid for Copart back in 2011 and still made 15% annualized? The answer: ~66x earnings.

In other words, the stock at 22x earnings in 2011 was dirt cheap...even though 22x doesn’t look “cheap” on the face of it.

Instead of worrying so much about the multiple, I should’ve focused on what would happen if Copart continued to compound its capital at 20% plus every year for years on end. It wasn’t that hard to see. No great prognostication needed; it was in the numbers that anyone could look up. 

What was hard was holding on despite the endless distractions along the way – the endless stream of economic data, scary headlines, Fed officials yapping, etc. 

Today, Copart trades at about 25x earnings again. And it is still pumping out high returns on capital. Will the returns on the stock be much different for the next decade? We will see.

So, that’s what I do. And very few people do this. Most people are too focused on quarterly results, macro forecasting and the like. They often trade too much. They make it hard to succeed. 

Essentially, I look at investing in stocks just as a business owner would look at owning any business. People who think like business owners in the public markets are rare. But the rewards for those who do can be tremendous.

Regards,

Chris Mayer