By The Acquirer’s Multiple. Originally published at ValueWalk.
One of the investors we watch closely here at The Acquirer’s Multiple is Bill Ackman. In 2015 Ackman did a great interview with The Graham & Doddsville Newsletter in which he discusses how to find great businesses to invest in, why he prefers to be concentrated, and the importance of converting GAAP earnings into owner earnings, or economic earnings when you’re assessing a potential investment.
Here’s an excerpt from that interview:
(G&D): If we were to go back to the period before launching Gotham, how did you get your start in investing?
Bill Ackman (BA): I started investing in business school. A friend recommended that I read Ben Graham’s The Intelligent Investor and it resonated with me. I decided to go to Harvard Business School and learn how to become an investor.
I got to HBS and unfortunately there were no classes really focused on investing. The first year is a set program – it didn’t have much in the way of choice. I thought the best way to learn is by doing, so I started investing on my own. I found that it fit with what I like to do. The first stock I bought went up. I think if it had gone down I would have become a real estate developer or something. Then, six months later, I roped in a classmate, David Berkowitz, who was in my section – it was a little lonely going back to the dorm room on my own to do this kind of thing. The two of us started looking at investments together toward the end of my first year and the beginning of my second year. At a certain point in time, I said, “What if we did this as a real business?” I figured the worst case, if we failed, is we’d have a lot of very good experiences. And if we’re successful, great.
G&D: How would you describe the evolution of your investing philosophy from Gotham to Pershing Square?
BA: Gotham was not set up to be an activist hedge fund – it just sort of happened. I don’t remember the moment we decided to intervene in a company. There were a couple of different cases where it seemed obvious what should happen. The basic evolution was this: Version 1.0 was classic value investing, which entailed investing in statistically cheap securities. Version 2.0 was recognizing the difference between businesses of different quality. I think over time we developed more of an appreciation for the value of a quality business. Version 3.0 was understanding the impact of activism. More recently, Version 4.0 is understanding that if you can find a great business, and if you can switch out a mediocre management team for a great one, you can create a lot of value. That was an evolution over 22 years.
G&D: You manage a concentrated portfolio and there are some inherent risks to that. Broadly speaking, how do you think about constructing the portfolio today and how has that changed over time?
BA: I’m a big believer in concentration. But it’s not just analysis that protects you, it’s the nature of the things you invest in. If you invest in super high quality, durable, simple, predictable, free cash flow generating businesses, that should protect you as well. If you pay a fair to cheap price for businesses of that quality, I think it’s hard to lose a lot of money. The key is you have to be a good analyst in order to determine whether it truly is a great business. You have to really understand what the moats are. You have to understand the risk of technological entrants – the two guys in a California garage working on the next new thing. Buffett would always write about the newspaper business being one of the great businesses, but print has been disintermediated as a result of changes in technology. So we’re concentrated, but we try to invest in businesses where it’s very hard to lose money, particularly at the price we pay.
We size things based on how much we think we can make versus how much we think we can lose. We’ll probably be willing to lose 5-6% of our capital in any one investment. With Fannie (FNMA) and Freddie (FMCC), you have highly leveraged companies where the government is effectively taking 100% of the profits forever. There’s legal risk and political risk, and an enormous of amount of uncertainty. We could realistically lose our entire investment. That’s a 2-2.5% position at today’s market price.
In our other investments, it is very hard to lose money. We like to own businesses with dominant competitive positions, such as railroads, industrial gases, and specialty pharmaceuticals. Some of our investments also benefit from undermanaged operations or reported earnings that understate true economic earnings. When we pay a fair price for those situations, we can make it a significant position.
The biggest investment we ever made was Allergan (AGN), which, at cost, was approximately 27% of our capital. There we were partnering with a strategic acquirer and it had an immediate catalyst to unlock value. It was a very high quality business. We felt it was hard for us to lose a lot of money, so the position could be quite large. Could we lose 20% of our capital? Sure, it was possible, but very unlikely. So in some sense, we think about losing 20% on 27% as risking 5- 6% of our capital.
G&D: You mentioned companies failing to achieve their true earnings potential as possible opportunities. How do you evaluate management teams and what metrics do you consider?
BA: We look at management the same way we judge people we want to hire for Pershing Square. We’re looking for character, intelligence, and energy, but we’re also looking for relevant experience. If you look at Seifi Ghasemi at Air Products (APD), he knows the industrial gas business very well. He spent nearly 20 years with The BOC Group and spent the last 13 years at specialty chemical company Rockwood Holdings (ROC). So he had both disciplines – the qualitative characteristics and the experience. He had been a public company CEO for a meaningful period of time. It was very easy to support him as CEO of the company. We helped recruit Hunter Harrison to Canadian Pacific Railway (CP). He had turned around two other railroads including a Canadian competitor. If you meet him, you’ll understand his leadership qualities. It’s easy if you’re backing someone who’s already done it before. It’s more difficult when you are taking someone who has not been successful before and betting on their success.
G&D: Buffett uses the concept of owner earnings. Are there any particular metrics you find helpful?
BA: I think the job of the security analyst is to take the reported GAAP earnings of a business and translate them into what Buffett calls owner earnings. I call
The post Bill Ackman – Try To Invest In Businesses Where It’s Very Hard To Lose Money appeared first on ValueWalk.
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