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@findingcompounders
FindingCompounders
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Life Long Learning
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Investors to clone
I thought I would list investors I admire and who I think many people can learn a lot from.

  1. Thomas Russo
  2. Guy Spier
  3. Nick Sleep
  4. Howard Marks
  5. Dev Kantesaria

If you had to pick who from the list do you feel is able to communicate and educate to a wider audience about investing most effectively ?
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Francois Rochon’s portfolio
Francois Rochon’s top 10 holdings.

Do you own any?

François Rochon runs Giveryn Capital which has returned 15.7% annually since 1993
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Google and Visa are core positions for me more or less and I think I own a starter position in HEICO.

It is an interesting family owned aerospace company that makes replacement parts for planes.

Happy to hear a successful investor likes it too. 😂
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Uber Cannibals
During his Q&A session at the Asian Institute of Technology , Mohnish Prabai talks about screening for “Uber Cannibals” in your quest for finding compounders
Uber Cannibals are companies that are aggressively buying back their shares
He uses NVR as an example
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$NVR is one of my favorites, I didn't know Mohnish ever talked about them.

$LOW, $EBAY, and $TPL are also strong share cannibals. Done right, they can be a compelling way to spike returns.
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Guy Spier’s Mental Model
While giving a lecture at Peking University, Mohnish Pabrai mentions a mental model used by Guy Spier
If Guy Spier identifies a great business in the USA, or any specific country, he then searches for the same type of business in other countries.
If Guy discovers that Coca-Cola bottlers in the USA are great businesses, he will go look for other Coca- Cola bottlers in other countries .
This helps him screen for quality businesses a lot more easier.

Warren Buffett’s Business Categories
In Berkshire Hathaway’s 2007 letter, Warren Buffett groups businesses into 3 categories: The Great, the Good and the Gruesome.
This is something every investor should read.
  1. The Great

  1. The Good

  1. The gruesome
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Regarding the ‘Great’ businesses, I thought it was interesting that he didn’t require a huge growth rate. Long term competitive advantages in a stable industries were a higher priority.

That’s something most investors got away from in the last decade.
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Key takeaways from Calculating Return on Invested Capital by
Michael Mauboussin and D.Callahan.
ROIC is a measure of a company's capital efficiency.
Value Creation includes the spread of what a company earns above the cost of capital and how much the company can invest
Buffett coined the $1 test
  • To test the success of a business, you should check if $1 invested in the company generate value more than one dollar in the market place eg. If a company invests $1000 into a factory and estimates the cost of capital at 10% . If the factory generates $80 in after tax earnings in perpetuity. The market value of the factory would be $800($80/0.10)and hence fail Buffett's $1 Test
We are interested in understanding the changes in ROIC over time, not just the present ROIC.
The goal of the investor is to find a mismatch between the expectations built into the stock price and the financial results the company will actually achieve.

The ROIC formula :

NOPAT
-measures the cash earnings of a company before financing costs
-assumes no financial leverage
-is the same whether a company is highly levered or debt free

NOPAT= EBIT - Cash Taxes

Invested Capital(IC)
-can think of it in 2 ways:
  1. Amount of net assets a company needs to run a business
  2. The amount of financing a company's creditors and shareholders need to supply to fund the net assets.

Let's look at Cisco as an example.
Cisco had a NOPAT of $10.4 billion and Invested Capital amounting to $30.4 billion.
Thus a ROIC=[$10.4billion/($33.6 billion+$27.2billion/2)]=34.1% in fiscal 2013

Practical Issues in Calculating ROIC
-hosts of issues require one to make adjustments when doing their calculation
  1. Excess Cash
  2. Goodwill
3.Restructuring Charges
4.Operating Leases
5.Minority interests
6.R&D capitalization
  1. Share Buybacks

Excess Cash
-treat ROIC and capital allocation issues separately
-the goal of ROIC is to understand how efficiently a company uses its operating capital, so we should only consider the cash a company needs to run its business
-so in calculations we need to exclude excess cash

Goodwill
-for a proper ROIC calculation, we need to make sure the numerator and denominator consistent.
-so we need to ;ay attention to companies that have been in M&A's
-if the company has been acquisitive, distinguish between operating returns and acquisition returns, thus we calculate ROIC including and excluding goodwill

Restructuring Charges
-restructuring charges include costs related to items such as reducing the size of the work force and plant closings
-you don't have to make any adjustments to capture the provision for charges

Operating Leases
-are any lease obligations the company has put on the balance sheet or capitalized
-if a company leases a substantial percentages of its assets, you should make adjustments for ROIC
-there are 2 steps to do this:
1.Adjust NOPAT by reclassifying the implied interest expense portion of the lease payments from an operating expense to a financing cost. This increases EBITA.
2.Add the implied principal amount of the lease to assets as well as the debt. This increases the invested capital

Minority interests
-adjustment for minority interests is relevant either:
  1. When another company owns a meaningful minority percentage of the company you are analyzing
  2. When the company you are analyzing owns a meaningful minority stake in another company
-in the first case: Calculate ROIC as if the business is wholly owned
-in the second case: Calculate ROIC as you would normally excluding the minority stake

Share Buybacks
-ROIC is not affected by share buybacks provided you strip out excess cash

Return on Incremental Invested Capital(ROIIC)
-it is not the absolute ROIC that matters, but rather the change in ROIC. Having a sense of where ROIC is going can be of great value. A useful measure is ROIIC.
-ROIIC recognizes that sunk costs are irrelevant and what matters is the relationship between incremental earnings and incremental investments.

Calculate ROIIC on a rolling 3 or 5 year basis. This is due to the fact that businesses sometimes have a volatile pattern of investments or NOPAT

This image below is of the ROIIC formula:

ROIC and Competitive Strategy Analysis
-companies with large excess returns generally have some competitive advantage
-an analysis of ROIC can indicate not only whether a company has a competitive advantage but it also shows what lies at the foundation of that advantage
-there are 2 sources of a competitive advantage:
1. Consumer Advantage - due to habitual use of a product and high switching costs
2.Production Advantage- allows the company to deliver its goods/ services more cheaply than its competitors

Lets breakdown ROIC:

NOPAT/ Sales = NOPAT margin

Sales/ Invested Capital= Invested capital Turnover

Low Cost Retailer
-low NOPAT margin
-higher invested capital turnover

Luxury Goods retailer
-higher NOPAT margin
-low invested capital turnover

If a company has a high ROIC through a high NOPAT margin- you should focus your analysis on a consumer advantage.

If high ROIC comes from a high turnover ratio- emphasize analysis of a production advantage

That's all for today. Please follow
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Key takeaways from Distribution Moat- An Undepreciated Moat by The Nomad Investor
When buying high quality companies, we want them to have growing moats so that they can fend off existing or future competitors. The distribution moat, which can be categorized as an intangible asset, is one moat that goes relatively unrecognized.

A strong distribution allows a business to reach its customers effectively and efficiently.
There are two forms of distribution channels:
  1. Direct forms
-company distributes its product/service directly to the end customers
  1. Indirect forms
-the company distributes its products/services to the end customer indirectly(eg. through distributors, wholesalers or retailers)

Each of these forms have their own pros and cons, which include:
-speed to market
-resources and capital requirements
-profitability
-quality control
-extent of risks taken up
-impact on working capital cycle

Lets take a look at the direct distribution networks by looking at two examples:

1.Apple
-Apple owns and runs its own retail stores across the globe. This requires major resource and capital requirements from Apple
-This however allows Apple to have direct control over quality control and the customer experience. This allows Apple to build a good relationship with it customers, which allows Apple to charge a premium for its products. ( Apples brand also plays a role in its pricing power)

  1. Coca- Cola
-Coca-Cola is an example of a business that has a wide distribution network. Coca- Cola products can reach the most remote places in over 200 countries.
-Coke is able to acquire good brands and distribute the products to a wider market, due to their strong and wide distribution network. Even if a product could be as good as Coca-Cola's, it would not be able to compete as the competitor would find it difficult to achieve the same scale in distribution network as Coca-Cola

Let's look at a company using the distribution moat playbook: StoneCo
-StoneCo provides fintech solutions in Brazil. It offers small and medium businesses :
i. payment and acquiring services
ii. banking services
iii. credit solutions
-StoneCo has a go to market approach. They set up local operations called Stone Hubs all across Brazil. This allows StoneCo to develop close relationships with their clients allowing them to have a massive distribution network moat
-StoneCo has started acquiring/ developing new solutions. They then sell these solutions to their already existing clients effectively and efficiently. This has lead to StoneCo's recording massive revenue and net profit growth

That's all for today. Please follow if you enjoyed the thread.

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