Main focus: distinguish exceptional from average.
The best allocators underwrite
- People
- Philosophy
- Process
(not 5 year track record)
Swenson endowment model
Wait but Why: Chefs vs Cooks. Cooks look at a table of ingredients and cook a recipe. Chefs look at a table of ingredients and create something new and wonderful. Chefs get paid much more than cooks.
Exceptional businesses substantially out-earn their cost of capital over each cycle — these types of businesses are more focused in certain areas (e.g. precision parts, subscription software etc.) due to the economics of those areas, but will look anywhere.
Qualitative areas of research
- Moats
- Management
- Unique sources of growth
Every time they have tried to score these areas it has backfired. Research and conclusions are 100% qualitative — no formal scoring.
Process
- Level 1 write up (general review of business)
- If it could be a 30-best company in the space it goes to a full briefing for full team (120+ slides, full afternoon discussion, etc.)
- If it is an exceptional business, it goes on the Focus List (25-30 companies), only then is pricing work done to estimate intrinsic value vs. cost
If one owns exceptional businesses over the long-run the price at which the businesses were bought almost doesn't matter.
Willing to buy 90-cent dollars if highly convicted (can never be sure 60-cent dollars are really 60-cent dollars, and in the long-run quality of business including business growth dramatically outweigh impact of purchase price).
Ignoring price as an input to the process helps avoid value traps. For example, it may be the case that low P/B or low P/E is just the market recognizing businesses that under-earn their cost of capital — i.e. that the market is getting more efficient and thus worse businesses are being priced accordingly. Enables BCM to just focus on best businesses and best people.
The biggest mistake most people make is in the pricing appraisal of the business. BCM's process enables them to make mistakes in pricing appraisal of the business because the biggest factors in returns to a stock (held for the long-term) is the internal compounding of business value (not the beginning price) — with caveat of not severely over-paying.
~10 stock portfolio, average holding period of 3 years (therefore c. 3 new positions per year).
Sell if (sell discipline):
- Position is wildly over-valued
- Made a mistake / wrong about thesis
- Sell more over-valued position to buy more under-valued position with better characteristics
Default setting: to hang onto positions. Pricing/appraisal piece is usually the weakest part of any manager's process. Intentionally careful about trying to sell e.g. 150 cent dollars, because if you've found the next Starbucks it doesn't matter and trading around a long-term compounder harms returns.
Batting average is c. 65%. When you're right you're often really right.