Glenn Greenberg is the founder and portfolio manager of Brave Warrior Capital. Previously, Greenberg ran Chieftain Capital Management, which he founded in 1984. Brave Warrior Capital has $3.2 Billion in Assets Under Management.
Mr. Greenberg holds an English degree from Yale and is a graduate of Columbia Business School. When he was at business school, the only thing that appealed to him was a portion of one class that dealt with security analysis, so clearly his pedigree is in the value investing camp.
In 2010 Greenberg did a great interview for the Graham and Doddsville Newsletter where he shared some insight into his investing strategy. His thoughts on investing time horizons, going for too much certainty holding you back, and what is ‘fair value’ when it comes to investing, are all valuable lessons for value investors.
Let’s take a look at Graham and Doddsville interview…
This is an excerpt from the 2010 Graham and Doddsville interview which you can read in full here:
G&D: Could you tell us a little about your background, how you got interested in investing, and how you’ve evolved over time as an investor?
GG: I was an English major in college and taught school during the Vietnam War era. I went to business school at the recommendation of one of my bosses. When I was at business school, the only thing that appealed to me was a portion of one class that dealt with security analysis. It seemed like a lot of fun to study a company and figure out whether its stock would be a good investment.
I didn’t understand what investment bankers did. I didn’t think I’d be interested in being a management consultant, which attracted all the best and brightest. So I took a job at Morgan Guaranty, now JP Morgan Chase, in their trust and investments department.
I had a knack for figuring out which companies were undervalued. I was quickly promoted to what I call ‘Money Mismanager.’
After five years there, I left to join a small private investment group as a research analyst for a very successful investor. I spent five years crunching his numbers and analyzing his investments. One thing that’s changed a lot is that we were much more qualitative, we didn’t have PCs to do these fabulous, complex multi-variable models, but I don’t think we lost anything by not having that available.
It forced you to think more clearly about the quality of the business and what would give it legs as an investment, as opposed to tweaking models and changing assumptions, and worrying about the latest data point and what that did to your IRR. After being in the business 10 years, I started Chieftain Capital Management in 1984, and took with me as my junior partner John Shapiro, who was working with me at Central National.
We started with $40 million, 2/3rds of which was family money. By 2006 we compounded that to 100x its original value before fees just by concentrated investment in pretty pedestrian, easy to understand businesses that seemed undervalued. That meant no turnarounds, no crummy businesses, no highly competitive businesses, and no tech businesses, which we didn’t understand. It was boring stuff.
Almost every year, we’d look in the portfolio and say gosh, how are we going to do 15% or 20% this year with this group of dull investments, but somehow it happened. We had 23 great years of investment performance, but the last 3 were not so hot. The firm broke up at the end of last year, and I started Brave Warrior with the same precepts, and hired some super bright young guys.
One of them dropped out of college at 19 to start a pharmaceutical company, which he is now in the process of selling. Got the directors, raised the capital, got the rights to the drugs that he wanted to market. I thought that with that kind of motivation and ingenuity, he’s a very creative person who knows how to think about a business. I think I’ve built a team of that kind of people.
There are five of us: my partner and I, and three younger people. We have one person who does special projects research. We give him a question that we want answered, which may involve conducting interviews or getting documents other people haven’t bothered to get. It’s a whole different vantage point on these investments that we’re looking at.
Then we have one fellow who has a more conventional investment background. He’s done distressed and private equity, but he loves publicly traded securities. Very bright and has a similar investment approach to what I do. So, we have a great team.
G&D: How has the investment business changed since you were a student at Columbia?
GG: I think it’s a harder business because of two big factors. Number one, a lot more smart people are attracted to the financial rewards and the challenge. And number two, regulation FD makes it more difficult to get insights into businesses by meeting with management and gleaning information before the crowd does.
Basically, these companies undress themselves four times a year, plus every conference they attend. People are focusing on every little number and change in business direction and it’s harder to get a differentiated view of what might be happening. There’s not that much that you’re going to think of that no one has thought to ask. Now that you have analysts bombarding management with questions for the whole world to hear, your question is probably going to come out.
Even if you’re an idiot and you’re just listening to the call, or attended a group one-on-one, you’re getting the benefit of other people’s brains.
G&D: On the other hand, is it possible that this has led to a lot of noise, where thinking about things differently remains valuable?
GG: I would say our edge is the willingness to take a longer view of a business. Maybe the willingness to take advantage of somebody getting jittery about something that’s a short-term development and being willing to take a position at a time when other people are bailing out. If I could go back to the world of 20 or 25 years ago I would.
There was real value in being a detail-oriented, handson manager who went out and visited with management.
There was real advantage in spending that time because other people weren’t. Managements weren’t out on the road talking all the time. They would announce earnings, and if you were quick to read the 10-Q, you could glean if there was some important new information before the rest of the world.
G&D: What are some of the characteristics you look for in a high-quality business?
GG: There are a number of models of what could be an investible business. For example, the Ryanair model is similar to the Geico model in my view, which is to take a big fragmented business that is commoditized, where one company is so much lower cost that they are in a position to gain market share.
So as the market grows, the company grows much faster. Their costs are so low that when other people are barely earning acceptable rates of return, they’re still earning very acceptable rates of return. When the industry is having good times, they’re having great times.
That’s one model. Another model is the LabCorp model. It was terrible business in the early 90’s, when there were 7 or 8 national lab companies all of whom could perfectly well perform a blood test.
But it’s quite a different thing when there are two national lab companies and reimbursement is coming from 3 rd parties who are interested in the lowest cost and who make contracts with LabCorp and Quest and basically force people who use other labs to make a higher co-pay. Suddenly, you can’t just get into the business.
It’s the model of a maturing business that’s growing, but not fast enough to attract new competition, and where new competition would have a difficult time getting scale and getting reimbursement. So there’s natural barriers to that business, very high returns on capital, very high profit margins, very high free cash flow generation, some opportunities to do fold-in acquisitions, where once you buy another lab you can kick out almost all of the costs.
That’s a dwindling opportunity because it’s already been rolled up. Then, there’s the idea of companies that do not have to spend money to get big revenue opportunities, where other people are spending the money.
If you think about testing, there are other companies that are trying to come up with new tests for diseases, but LabCorp doesn’t have to spend any of that money. So, they’re hitchhiking on the success of other people coming up with tests. Some of those tests are pretty pedestrian, like vitamin D testing, which we didn’t monitor 10 years ago.
The big opportunity for a company like LabCorp is if there is a blood test for the early stages of prostate or lung cancer that’s really accurate. I think that’s a high likelihood. And, that would be a test that would be administered annually and would be a big windfall for the lab testing companies and they’re not spending any of their own money on it.
So, it’s a great business with big barriers, high profitability, and with the opportunity for rapid or even explosive growth with the development of new tests.
G&D: You run very concentrated portfolios and you’re willing to hold positions for a long time. How do you manage risk in such a concentrated portfolio?
GG: I define risk as the probability that a business trajectory will change dramatically for the worse. First of all, you choose your businesses carefully. By picking businesses that have very few competitors and that are basic, essential-type businesses, you mitigate the possibility of that happening. It tends to be a more boring business. Lab testing is not going away.
Air travel is not going away. Broadband usage for the cable companies is not going away. We try to pick businesses where there’s not likely to be any radical change for the negative. That’s how you mitigate risk. On the point regarding holding things for the long term, a lot of people say that they invest for the long term.
But it can be difficult to stay in a very good business because you’re constantly being bombarded with ideas. When I look at our big winners over the years, that really drove the performance of the portfolio, they didn’t happen in one year. They very often happened over a period of five or seven years. The trick is not to discard them just because you’ve already made good money on them.
It’s not so easy to stay in something for 10 years and make 10x your money, it’s very tempting after something goes up 40% in the first nine months to ditch it and leave the next 5x behind.
G&D: What was your biggest winner over the last 26 years?
GG: Probably Freddie Mac. When it went public in 1989, it only competed with Fannie Mae. The stock at that time was a preferred stock that thrifts were required to hold as part of their capital and it traded on a yield basis.
At that time, interest rates were pretty high and it traded at a very low P/E. Congress decided to convert it to common and allow public shareholders to buy it from the thrifts on the basis that it would increase the capital of the thrifts.
We bought it at that point, and it did brilliantly in the first year and we sold our whole position. Then it came back down the following year when the Gulf War broke out, and we bought it back and ended up holding it for the next nine years. Basically, it was an incredible business model that was augmented by buying mortgages for their own portfolio and selling debt to lock in the spread.
The combination of their basic business and the new one propelled growth in earnings phenomenally well for an extended period of time. Eventually it got a higher valuation and its business model became more risky as it began buying junkier mortgages and we sold our stake.
I think we made some 20 odd times our money over that period of time, and that’s before calculating the times we trimmed our position after it ran up and bought some back after it came down. We also bought the cable industry in the mid-90’s when satellite was just coming on the scene.
Business Week published a front page story about the death of cable, and the cable stocks were really depressed. It was just at the verge of the internet via broadband, which we thought would be a huge driver. There were a lot of issues with the early satellite product offering so we didn’t think that the cable companies were going to lose so many of their TV subscribers.
So we made a huge bet in that industry: we invested in one company and then we found another company we liked, and then a third company, and finally ended up with about 40% of our portfolio in three cable stocks. We were very fortunate that they went from very depressed valuations to exceedingly generous ones.
By the late 90’s they were trading at 15 or 20 times EBITDA after trading at 5 times EBITDA. Two of them got taken over, and the third one we ended up selling. I think we made about 4x or 5x our money on each of them. We still own Comcast and we’re getting pay-back on our rates of return in the cable industry because we haven’t made any money since we’ve owned it. They’ve done OK and they’re generating a lot of free cash flow, but there’s always one issue or another.
G&D: How do you think about valuation, both in terms of a multiple and what measure of earnings you tend to focus on?
GG: I tend to focus on free cash flow. We focused on free cash flow before the metric was popular. We basically looked at the amount of cash that the business could return to us as shareholders and valued that. If you could buy a decent — not great, but decent — quality business with a 10% free cash flow yield, my experience is that you would not lose money.
A decent business is going to grow – maybe not really fast, but if you can start out with a 10% free cash flow yield and it is going to grow at some modest rate, 3-4%, you are going to end up with a pretty decent investment – a theoretical 13-14% rate of return. Think about how that compares with what anyone says the market can offer over a given period of time, which is between 7-8%.
So the question is why should a decent quality or good quality business be priced to give you a 13-15% return when the market is priced to give you a return of about half that? Eventually somebody discovers this, somebody wakes up – it is not necessarily that the boring company with a double-digit cash flow yield has got some major trick up its sleeve; it just gets recognized as mispriced relative to the market.
I would say that even though the equity market has run up quite a bit, there are still a lot of those companies around. That is what we focus on and if you can load your portfolio with those kinds of investments, I think you will do quite well. Then occasionally, you hope to find a real race horse, a company with a huge opportunity and you invest heavily in it.
But, they are not easy to find. Those investments may be what really give you the excess returns; but, it is basically loading your portfolio with work-horses where the risks are low and you will be okay.
G&D: You mentioned that the investment management industry has been getting more competitive. Has that hurdle, the 10% free cash flow yield, or 15% total rate of return, changed over time?
GG: Twenty years ago, I would ask myself if I could see making 50% at least in every stock over the next two years through a combination of the earnings growing and where I thought the stock should properly sell – kind of a subjective judgment. At that time, I could imagine every stock in my portfolio being ahead 50%.
It did not always work out of course, but I could easily imagine it. That was sort of the test. I do not think you can do that today. I cannot look in my portfolio and envision every stock being 50% higher because the earnings growth rates are lower or because I am not willing to assume that multiples will go through the roof. I just think that securities are not priced for the kind of returns that we were able to realize for most of my career.
G&D: What percent of company’s that you study end up in the portfolio?
GG: That is easy – 99% of the companies we look at do not make the cut. In the past, we would buy three new names in a good year.
In other years, when stocks were high – zero! There are three or four people, each looking around every day and we may end up buying two or three new names in a given year. Also, I have a view that there is nothing wrong with starting a position, continuing to do your homework, and then deciding to either build that position up or eliminate it.
There is nothing wrong with that. It is not a matter of having to do 102% of your research before purchasing a company – by that time, the stock may have moved up 30%, in which case you’ll never own it, but realize that you should have owned it. Sometimes you look at something and get to a point fairly quickly, where you say you should begin to own some of this.
Then, you continue to do your homework and you know it better and you follow it, and you begin to figure out what the right size position should be. That will change over time, depending on how well the stock does. If the stock doubles and is now double its size in the portfolio, you may decide that percentage of the portfolio is not justified and you may trim back at the higher price. It is a process.
Going for too much certainty can hold you back – there is no certainty. A lot of it is weighing probability, a lot is judgment, and a lot less is number crunching and multi-variable modeling. I have seen so many cases where there is a complex model that is exactly wrong. This focus on a model may cause you to move away from thinking about the competitive advantages of the business.
Then you are making decisions based on all these numbers rather than thinking about whether this is one of the ten businesses that you would like to own. What I have found is that we look at the past carefully to develop questions about the future. We model this year, next year, and a glimpse of the third year out.
That is about the extent of how far your modeling should go, just to have a sense of where the earnings and free cash flow will be in a year or two. However, the idea of projecting it out further than that and discounting it back is not useful. Is it a business I would want to own over a long period of time?
If it was cut in half because the markets collapsed, would I still feel comfortable owning this company? Would I be enthusiastic about buying more because it is such a good business? If the answer is yes, then okay, it is one of the names that I want to consider. Next, is it cheap enough based on where I think it will be in a couple of years? If the answer is yes, then it probably should be in your portfolio.
G&D: Where do you find those types of ideas?
GG: I have been in the business since 1973, so I have been looking at companies for a long time. There are a lot of things in my head. There are a number of different models of the kinds of business or situations that can work. It may be the local monopoly concept, the low-cost commodity producer concept, the consolidated industry that has come down to a few competitors, a basic essential service that isn’t going to stop growing, or an industry that may be growing too slowly to attract any competition.
So, there are a lot of different models. Usually, brand new frameworks do not fit in – they can make you a lot of money, but it is not consistent with our approach. Starting with a top-down idea, such as ‘I think all medical records are going to be digital in five years. Therefore, let me go find a company that digitizes health care records’. I have not been very good at starting with a concept and then finding the companies.
More often, I find the company and it seems cheap, it seems like it has good potential, and it seems like there is not much that could happen to disturb it. I typically start from that angle.
G&D: Going back to the concentrated portfolio. We’ve talked about a success and the impact that can have, but can we discuss one of your worst investment mistakes and what you learned from it?
GG: We never had any really big losers, but the single one that stands out was a fairly large position. I think we put 8% of our money in AT&T back in 2000 and it was sort of a classic value analysis. It had four parts to the business – one of which was already public, which was AT&T Wireless, so you had a valuation on that piece.
They were in the cable business and we knew that very well and we valued that segment. That left us with the two telephone pieces – first, consumer telephone, which was shrinking, but generating monster amounts of cash, and they gave forecasts about the amount of cash flow generation going forward.
We put a very low multiple on it because it was not growing. Second was the business communications division, which also was not really growing, but was generating a lot of cash. We had these four pieces and we built up a model that it was worth $55 and we were paying $34.
Then, one quarter later, they said that actually, the two telephone parts of their business were worse than they had predicted. The consumer business was shrinking faster and the business communications business was also shrinking, compared with their prior belief that it was growing slowly. So, the free cash flow of those businesses came down and the stock got knocked off by a quarter, I believe.
You could have done the same sum-of-the-parts analysis again and it would have been worth $40, with the stock at $26. We just said ‘no’. Sum-of-the-parts is one of the many valueschool type tools we avoid. It is really trying to find high quality businesses where we have a lot of confidence in the business. If we make a mistake it is going to be that we mis-analyzed the business – it was not as good as we thought it was.
Maybe it did not have the pricing leverage that we thought it had, or maybe someone is nibbling away at market share in a way that we didn’t really expect. With a sum-of-the-parts analysis, if it is a piece of junk, and you really do not have a lot of confidence that the pieces are going up in value – and they may be going down in value – I do not want to guess what the fair price to pay is.
G&D: Are there any other mistakes that you see the value investing community in particular making systematically?
GG: I do not know whether we are value or growth because every business we buy, we want growth. I think we are buying growth at a price that is unjustifiably low. It is a different approach than somebody who is adding up the pieces and deciding that this is a Picasso that I could trade for $1 million and am getting it for $600,000. Therefore I am getting a huge discount to what it is worth today. Some might say ‘what is something worth today?
How can you say what it is worth – it depends on whether an investor wants a 6% rate of return or a 16% return. If investors want a 16% rate of return, it is worth a lot less. If investors are very happy to get 6%, it is worth a lot more. This idea of an intrinsic value implies that all investors, or average investors, will insist on a certain rate of return.
I don’t even know what the term fair value means and that seems to be bandied about a lot. I do not think we could agree upon what the fair value of the market is because we all have different return requirements. I just come back down to micro – is it a business that I have a lot of confidence in, one that will grow and be more prosperous in the future.
I determine a sense of what a minimum rate of growth might be and then I am paying a price that will give me a very adequate rate of return over time, even if it hits the low-end of what I think the expectation of its growth is.
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