Thursday, April 20, 2017

Boyles Asset Management – Q1 2017 Letter Excerpt

Delayed Gratification

“You’re looking for people who will delay gratification; who will focus on building a moat; who will focus on building a franchise; who will focus on the longevity of the business.” -Sanjay Bakshi, Adjunct Professor of Finance, Management Development Institute, India

In a recent podcast interview, when discussing the importance of investing in businesses and management teams that are willing to forgo near-term earnings in order to increase long-term value, Professor Sanjay Bakshi mentioned the compound interest formula as being a useful tool to help one think about building that kind of long-term value.  

That formula is:


a = the total amount after n years
p = the principal investment amount
r = the annual interest rate (or annual return)
n = the number of years the rate is earned

All too often, companies and their shareholders focus too much on the r variable in the equation.  They want instant gratification with high profit margins and high growth in earnings per share without having to wait.  This causes many management teams to pass on investments that would create long-term value, but look bad in the short run.  It can cause companies to make as much money as they can off of their present customers in order to report good quarterly numbers, instead of offering a fair price that creates goodwill and a long-term win-win relationship with those customers.

Some companies, however, are able to look past maximizing short-run r and instead focus on maximizing n in order to create maximum long-term value, and happy customers.  Amazon and Costco are probably two of the most commonly cited examples.  As they’ve grown and achieved economies of scale over time, they’ve continued to share those benefits with customers by keeping prices low and by continuing to add benefits to their respective membership bases, with little to no increase in the price of membership.  This not only makes for happy customers that then spend more with those companies, it makes those businesses harder to compete with over time.  As CEO Jeff Bezos said in a 2011 interview with Wired:
“If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people.  But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that.  Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue.”

We are often asked about the traits we look for in the businesses in which we invest, and near the top of our list are management teams that understand capital allocation and are willing to take a long-term view in building a durable business.  This is especially true among many of the smaller businesses that we’ve spent much of our time analyzing, and it is why we place so much emphasis on making sure that management incentives are aligned with us as shareholders.  System1 Group is a great example of a company with the desired traits we look for, and that’s why we continue to hold shares despite their rise and increased position size in our portfolio.  We believe the company is both benefiting from past investments, as well as continuing to make new investments and do the things it needs to do to become a much more valuable business a decade from now than it is today.  We are happy being partners with a skilled and well-aligned management team.

Capitalizing on businesses that operate on a long timeline of value creation is only possible if we operate with a long-term view as well.  We have to judge our investments, and potential investments, on their actions and business results, not the movements of their stock prices.  If the business performs, the stock price will eventually follow; whether that happens in five months or five years is hard to predict.

But a long-term investment horizon must also be married with an investment process willing to continually question investment theses.  All too often long-term investments are the names given to things that don’t work out in the short-term.  When one spends a lot of time getting to know a business and management team before investing—as we do—it can be hard to change one’s mind quickly, or at all, as one doesn’t want to feel like all that time was wasted learning things one didn’t act upon.  But staying intellectually honest while looking at many businesses, and only investing in the few where we think the odds are significantly in our favor, is how we think we can gain an advantage over time.


Disclosure: I am a portfolio manager at Boyles Asset Management, LLC("Boyles") and the fund managed by Boyles may in the future buy or sell shares of the stocks mentioned below and we are under no obligation to update our activities. This is for information purposes only and is not a recommendation to buy or sell a security. Please do your own research before making an investment decision.