Dan Loeb: Q2 2020 – Invest In ‘Compounders’, But Only At An Attractive Entry Point

Johnny HopkinsDan LoebLeave a Comment

In his latest Q2 2020 investor letter Dan Loeb recommends investing in quality or ‘compounder’ companies, but only at an attractive entry point. Here’s an excerpt from the letter:

In 2010, I remember sharing with investors at our annual event the quotation attributed to John Maynard Keynes: “When the facts change, I change my mind. What do you do, sir?”

Categories are important and central to how our minds make sense of a complex world by structuring and holding disparate information in our brains. Third Point was founded originally as an “event‐driven, value‐oriented” strategy that specialized in both credit and special situations such as spin‐offs, demutualizations, and post‐reorg equities.

Over time, we developed the additional skill of creating our own events through activism. By structuring our funnel of ideas around these categories, we could easily prioritize our research process toward companies that were undergoing or could be catalyzed into making some sort of financial or operational “event”. As markets have changed, I have realized that while event‐driven is still an essential investment lens (clearly, as our two largest investments, Pacific Gas & Electric and Prudential plc, are both event‐driven situations that together comprise nearly 20% of our exposure), today, quality is also an essential screen.

This investment environment is characterized by breakneck technological innovation and sluggish growth which has only been amplified by COVID‐19. Considering this, it is essential to find companies with great leadership and unique products in growing end‐markets in which they are gaining share and achieving high topline growth and strong margins. These factors drive robust earnings and free cash flow growth supported by high returns on existing invested capital.

However, when investing in a quality or “compounder” company, it is critical to find an entry point at which an investment is attractive since most of these businesses trade at relatively high multiples.

Interestingly, our most successful activist investments have been in companies that embody these very characteristics, where we were able to find appealing entry points when companies were changing positively in measure of quality. Our investments in Baxter and Nestlé were made at transition points in margin, ROIC and earnings growth. Our investment in Yahoo! was also driven primarily by our interest in buying a high‐quality business, Alibaba, in which Yahoo! held a substantial stake at an extremely attractive price.

Investing in “quality” companies or “compounders” is not a new endeavor for us but a long‐time category. Some of our most successful investments that have doubled or tripled during the lengthy periods of our ownership including S&P Global, Visa, Danaher, Adobe, Salesforce and Sherwin Williams can rightly be described as such. To be clear, investing in compounders and event‐driven situations are not mutually exclusive activities.

It has been our experience that our event‐driven focus provides us with a unique window into the creation or evolution of a quality company, since they are often born out of corporate events or management changes. As we discuss in the equity section below, recent market dislocations have created several unique opportunities for us to acquire more of these kinds of companies at bargain prices. We anticipate selectively adding to this long‐term portfolio when opportunities present themselves.

You can read the entire letter below. To scroll through pages simply hover over the letter and a scroll bar will appear at the bottom.

Third-Point-Q2-2020-Investor-Letter-TPOI

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