Contributor Since 2012
My name is Ouissam Youssef, I am the CEO and founder of the Valsef group. We look to allocate capital at high rates of returns in both private and publicly traded companies. We have been fortunate to do really well in the public markets over the last 5 years using our 4 pillar investment strategy. Our returns were quite high and our loss ratio ( investments were we incurred capital losses) was really low. Here is how we invest:
Pillar #1: Only invest with the world's best Management teams, this is almost always an undervalued asset
The first and most important pillar of our investment philosophy is management. Here at Valsef we believe that our competitive advantage as investors is rooted in our ability to value people. Why then is this oft the most overlooked component of an investment thesis? Wall Street excels in crunching numbers to determine the future performance of a company but dismisses the people that are responsible for driving that performance. We believe that the strength of any company is built on the strength of their people and that culture permeates from the very top. One of the greatest assets you can have in a company identified as a candidate to deliver long-term risk adjusted excess return (alpha) is management. Now, I do not claim that identifying excellent management teams is a mundane exercise that can be learned overnight. It can be particularly tricky when you are overwhelmed with the flowery rhetoric pushed by poor
management teams decorating short-term achievements or strategies that are unlikely to deliver long term value to shareholders.
If you can challenge yourself to think about this pillar rationally, it can help a great deal in simplifying your assessment of management. Ask yourself, is the business managed by people that are passionate about the success and future of the company? Yes I know, every CEO has to be the cheerleader for their company but for me the proof is in the pudding. As a shareholder, you are a capital provider to the company and proof of great management can be seen in their track record of allocating your capital to generate returns to you, the shareholder. Great managers have a relentless commitment to value creation and they have the ability to act boldly and will consistently allocate capital effectively. They have a clear vision and are transparent about the benchmarks they set for corporate performance which they continuously outperform. In contrast to poor management teams, they are responsible with your capital and have an obsession with operational efficiency. Peter Lynch, the legendary manager of Fidelity's Magellan fund, famously claimed that "the extravagance of any corporate office is directly proportional to management's reluctance to reward shareholders". The best way to learn how to detect greatness in management is to study a few examples, here are management teams I recommend studying in depth to get a good grasp on the concept:
1. Mark Leonard; Constellation software
2. Alain Bouchard and co; Alimentation Couche tard
3. Bill stone; SSNC technologies
4. Jeff Bezos; Amazon
5. Daniel Shwartz & 3g; Restaurant Brands international
6. Jeffrey Sprecher; Intercontinental exchange
7. Jeff Boyd & Co: Priceline group
8. Jonathan Goodman: Paladin labs, Knight therapeutics
In reference to my last point, Chronically over the last decade investors have underestimated Mark Leonard; Investors are generally scared of companies where management is a major asset( Berkshire Hathaway being another example). We find one of the most reliably predictable asset a company has, is management greatness.
Pillar #2: Only invest in companies that are currently enjoying a Competitive advantage period
As an investor you pay for value creation and understanding where a company is in its life cycle will determine the extent to which you capture that value. In my view, the life cycle of a company is split into 4 stages:
Start-up: This is when an entrepreneur has an idea and tries it out, hires a few people and tests his skills. 95% of companies never make it past this stage. And the entrepreneur goes back to get a job.
The Hustle: The few companies that make it past the start-up phase will enter the hustle. Now there is a business, there are profits and you have to fight for them. This is akin to fighting in a knife fight and you are holding a knife. If you are a skilled fighter you might do good. A company might grow in the hustle but 95% of companies will stay here forever. Most public companies are in this phase, where they earn a small return on equity and keep fighting to live
another day. The most skilled fighters will take their companies out of the hustle onto the next phase in the evolution of their business.
The CAP (Competitive advantage period): There are very few companies in this phase and this is the only phase where we invest in a public company. This is akin to holding a gun in a knife fight, you're just aiming and shooting. It is then a matter of how lethal the gun is or running out of people to shoot that will determine how long this competitive advantage can be sustained and, subsequently, the superior returns that come with it. A company earning high economic returns will attract competitors that want a piece of the action. It is intuitive that the increased competition will push the returns on invested capital towards the opportunity cost of capital. The interaction of industry and firm-specific factors will dictate the difficulty that competitors will face in attempting to gain a share of the excess returns. To this end, an analysis of competitive advantage involves a thorough understanding of sources of value at the industry and firm level and how defensible the company's position is in extracting that value.
The maturity: This phase comes after a CAP and there is also lots of big publicly traded companies in this phase. It comes in 2 flavors, either straight up maturity where you ran out of people to shoot, or maturity going towards irrelevance. The former is alright if you are looking for good dividends. The latter is dangerous...
Pillar #3: Quality, top economics
I like to think about the quality of a company as the strength of the core business model irrespective of the skill of management running it. Some of the things I look for in a quality company are:
1. Low cyclicality. Enables the manager to better run the business.
2. Narrow range of outcomes, again predictability. Better ability to measure and compensate people.
3. Recurring or highly re-occuring revenues. Enables the management to be more capital efficient in running the business.
4. Highly measurable. I.E software. Those types of companies will be much more productive. What can't be measured, can't be controlled.
5. Low capital intensity. We want a business that doesn't need capital to grow.
6. High re-investments opportunities. Management can grow through organic and non-organic initiatives.
7. High returns on capital employed
8. Operating leverage. Build it once sell it many times. (I.e. Mastercard, Salesforce, Faceboook).
9. Sustainable pricing power
Let us consider a simple example, the underlying economics of operating a restaurant vs. operating a franchisor of restaurants, the latter of which I believe to be a high quality business model.
When operating a franchisor of restaurants, you are selling a franchisee the right to use your business model, operational practices, brand and marketing, in exchange for a percentage of their revenues. Much of the capital cost and risk is passed through to the franchisee. The economics of this business is powerful - there are minimal capital requirements for organic growth, the replicable business model provides recurring revenues and is easily measurable, and a proven business model can afford franchisors considerable pricing power. Perhaps most importantly, the failure of management at the franchisee level poses no mortal risk to the franchisor.
Now take the restaurant which is a low quality business model. The restaurateur has fixed costs in the form of rent, a minimum amount of shift workers, utilities and ingredients. It is a hustle every day to sell a sufficient amount of tables to cover the fixed costs and generate a profit. The restaurant must contend with intense competition and minimal pricing power making this a daunting task. The skill and reputation of the restaurateur is directly linked to the success or failure of the business.
The last pillar, while central to our investment philosophy, is relevant when the other three pillars stand tall, and it ultimately determines our decision to invest. Benjamin Graham, the father of value investing, made a simple and sensible proclamation, "price is what you pay, value is what you get". As the CEO of Valsef , it would be grossly hypocritical if I did not employ the capital of Valsef shareholders with the same rigor and diligence that I expect from the management teams of companies that I invest in. If the price of a security deviates too far above the future value it is expected to generate, the margin of safety erodes and there is an increased risk of permanent loss of capital. Our ideal investments are those where the price does not capture the value that will be created by the first three pillars. This philosophy takes patience and discipline. We are committed to managing a portfolio of four pillar investments but, if the price of our holdings is too high relative to their intrinsic value, we will reposition ourselves accordingly and search for another four pillar investment. Similarly, we will increase our position in holdings
that we feel are a bargain at their current market price. I feel that the repetition of this formula will ensure sustainable value creation for Valsef shareholders while minimizing risk.
People ask me "Ouissam, so you are looking for the best managed companies in the world, currently enjoying a long and prosperous competitive advantage period, those companies must have phenomenal economic characteristics.....Why the hell would those companies be available at a bargain price ? "
The answer is, It is very hard. We work full time to find 2-3 investments a year, when we find them we go big. That's what we find is the safest way to invest Valsef's capital.
Disclosure: I am/we are long CNSWF, ICE, SSNC, PCLN.