We scan and assume. It’s in our nature as humans. Little influences pile up. We see red and think bad. We see down and think the worst will continue. As a value investor and armchair philosopher, I pre-empt this natural tendency by making “down” green in our internal dashboards. Huh? What?
Our business partnership is split between buying best-in-class, make-to-order service companies within our target geography in order to create deal flow tipping action for future deals –and, buying marketable securities cheap. Part of the magic of our business model is the ability to move between these two good options. If control sellers go cold we have other outlets for reinvestment. If market goes red hot (high) then we can reinvest in private companies. At the very center of this logic is a simple dashboard that rank-sorts reinvestment opportunities. And, when price to value detach –with prices being low– my attention grows like a lush green pasture ready for harvest. When my attention grows my actions are soon to follow. I simply cannot help myself!
If you drill down through our highest level dashboard, but go toward our marketable security business unit rather than our private company ideas, you would find a dashboard that rank-sorts and color codes estimates of opportunity, where green is highest expected yield on invested capital. How is that estimate derived? Two big parts. First is price to value spread is assumed to return to value over a 3 year period as a matter of simplicity. Second, the earnings are assumed to persist for 3 years and the discount rate is the same then as now. (who knows what it will do?) If the value is well reasoned, the rebound of price occurs, and look through earnings continue then the ultimate compound annual growth rate of our investment can be estimated. We then “light up” the individual, big discounts in dark green. Typically, the prices move more than the underlying business and the dashboard shouts at us: “Hooray! Prices are down on this idea!”
We roll up a weighted average of existing positions and produce an estimate that looks out over the next 3 years. This is totally an estimate. It will be inaccurate, but directionally, we have found it extremely helpful. And have found it self-correcting. We get out of prices above value (if they’re not a forever hold they light up red) and we return capital to prices that are attractive relative to value (the green colors!)
Then, we compare these ideas to ideas within our private companies (existing and considered) and vice versa. Where is the next place to place our next dollar? Typically, our managers only bring forward ideas above a 50% return because they are paid bonuses on clearing hurdles that begin at 50%. In the public markets, the sellers don’t think our way and instead think crazy things I don’t understand… one possibility is “it’s going down, I better get out before it goes down further and stays down forever.” In those situations, I’m a ready buyer who increases volume as the price continues downward.
The dashboards are tight enough (it’s not about precision here, but directional aim and conviction to act in size) and have been utilized for years now. The assumptions on the other hand… well, those are an on-going work in progress…