Invest In High Quality Businesses That Earn High Returns On Capital

During his recent interview with Tobias, John Huber, Managing Partner at Saber Capital Management discussed Investing In High Quality Businesses That Earn High Returns On Capital. Here’s an excerpt from the interview:

John Huber:
If you think about, so to answer your question on why is it different in the public markets or why is my approach different? I really think of investing as a… If you think about the very simple elements of the transaction, providing a company with capital. You can think of it in terms of like a small company that you’re investing in, a startup company, or even a friend’s small business or something. If you invest capital into a venture, your objective is to achieve a return on that capital.

John Huber:
And so, you will judge your success other than any intangible factors like helping someone out or helping your friend get started or something. Most people will judge their success based on the return that they achieve on that capital investment. And so, investing in a business is… The point of investing is to achieve a good return on capital. And the same objective exists inside of a business. A good business can earn high returns on capital.

John Huber:
And so, when I look at the stocks that have generated the most wealth over time, they’re very rarely like these bargain basement Graham and Dodd type stocks, they tend to be companies that are high quality, companies that earn high returns on capital, and are simply going to earn a lot more money in the future than they are now. Or if you look back in the rear view mirror, companies that have generated a lot of wealth tend to be companies whose earning power has increased dramatically over the last 10, 15, 20 years. So that’s a very simple observation, good companies make good investments, and it’s something that your grandma in Iowa can easily understand.

John Huber:
And so, it’s a very simple concept, and it’s the concept that I employ. And so, when I think about the margin of safety concept, I think the margin of safety comes in large part due to the quality of the business as much as the perceived gap between price and value at any given moment. Because business is dynamic. So if you think of yourself as a part owner of the company that you’re invested in, you’re paying that management team to act in a certain way and to adjust to changes, and we live in a world where change is much more pervasive than it was 10, 15, 20 years ago.

John Huber:
And so, those are things you have to think about as an investor now. And I think, I’m personally more comfortable investing in companies that are good at adapting to those changes and are good at utilizing the capital that they employ effectively. And margin of safety comes from a company that their earning power is going to increase going forward. So that’s why I prefer the companies that tend to be on the growth year end of that spectrum, they tend to grow into their valuations. They’re much more forgiving. I’ve found that mistakes tend to be made a lot more on the valuation than… If you pick the right business, as Buffett says, you pick the right business, you’re going to make a lot of money over time.

John Huber:
So I think the mistakes I’ve made have been more when I’ve focused more on the static valuation of an enterprise versus what I think the company’s going to look like, say three, four or five years down the road.

Tobias Carlisle:
So let’s just talk about that a little bit. How are you making that assessment? How are you thinking about a valuation when you’re buying something? Are you looking… You’re thinking three to five years down the road, what I think this thing can be generating in terms of free cashflow and that’s what I’m looking at now. Is there some hurdle that you’re trying to meet at any given point in time?

John Huber:
Yeah, there’s a hurdle that I try to meet. I have an objective in mind. So I kind of work backwards, sort of a reverse DCF of sorts. But, yeah, the simple explanation is, I think of it in terms of future free cash flow. So I will do a DCF at times, but it’s typically very simple back of the envelope type thinking. And I try to do the analysis and then figure out what I think this company looks like in say five years. And I think much beyond that is very difficult because things can change so rapidly.

John Huber:
But I think on the rare occasions where I have an insight on what the company looks like in five years, and that insight differs from the market, is where the opportunities are. And those are, in my case, few and far between, but they do appear once in a while.

John Huber:
And so, yeah, I try to look at what I think the company is going to earn three, four, five years down the road and then work backwards to determine the return that I’ll get at this particular price. So you capitalize those earnings in year five and you can work, what is that worth? What’s the company going to earn in 2025? And what does that look like? What is that worth to the market? And then you can work backwards to determine the return that you’ll get. So that’s the end game.

John Huber:
But most, 95% of the work is understanding the company, understanding the threats, figuring out how it’s going to adapt to changes and risks and so forth. And so, most of the work is spent really taking my time reading about companies and watching them over the years and observing how they operate and understanding their competitive advantages and their risks. And then, at a certain time, the market gives you an opportunity to buy things at a certain price.

John Huber:
So the process for me is I create a watch list of these companies and then I just wait for evaluations on each company, and then I just wait for the market to give me a valuation that makes sense to me.

You can find out more about Tobias’ podcast here – The Acquirers Podcast. You can also listen to the podcast on your favorite podcast platforms here:

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