John Harris - Resilience and Imagination - [Invest Like the Best, EP. 230]

Podcast Summary

• The Challenges of Predicting Long-Term Growth: Focus on businesses with a durable competitive advantage, strong management, and understand the underlying economics for long-term growth potential. Utilize resources like Tigas for efficient research.

  Markets sometimes undervalue the long-term growth potential of companies. According to John Harris, managing partner of Ruane, Cunefa and Goldfarb, this is due to the inherent difficulty of predicting the future. The conversation on Invest Like the Best highlighted how investors often struggle to assess a company's growth potential over an extended period. Harris emphasized the importance of focusing on businesses with a durable competitive advantage and strong management. He also discussed the importance of understanding the underlying economics of a business and the potential for reinvestment opportunities. Additionally, Tigas, a platform that simplifies primary research for investors, was introduced as a solution to make research faster and more accessible. Overall, the conversation underscored the importance of long-term thinking and careful analysis in the investment process.

• DCF models may not accurately predict nonlinear business growth: Investing involves more than just numerical models, intuition and understanding the business are crucial

  While Discounted Cash Flow (DCF) models can be a useful tool for understanding the financial fundamentals of a business, they may not accurately predict the nonlinear nature of real-world business growth. The human tendency is to simplify complex future scenarios with linear assumptions, but experience shows that the world is nonlinear. Some businesses may exhibit accelerating or sustained high growth, which can lead to significant returns, but these scenarios are unlikely to be captured in a DCF. Ultimately, investing is more about intuition and understanding the business than relying solely on numerical models. While some investors find DCFs helpful, others, like the speaker, prefer to focus on historical financial data and the underlying business model. The key is to find an approach that works best for the individual investor.

• Understanding a business through qualitative research: Thorough research beyond numbers reduces investment risk and increases chances of long-term success.

  Thorough research and understanding of a business from every angle is crucial for successful investments. The numbers on paper may look attractive, but the real value lies in the qualitative research. The closer you look, the more you'll understand the business's unique strengths, risks, and future potential. This process involves talking to industry experts, reading extensively, and broadening your circle of competence. Quality reduces investment risk by providing a deeper understanding of the business and its ability to thrive in the future. Assuming qualitative equivalence in investing is dangerous, as two businesses with similar numbers can have vastly different futures depending on their specific circumstances and leadership. The market may underestimate the importance of quality, but investors who appreciate the nuance behind the numbers are more likely to achieve long-term success.

• Investing in strong businesses reduces the need for frequent decisions: Focus on investing in businesses with strong people, cultures, and dominant positions to minimize the need for frequent decisions and potential mistakes, leading to greater long-term success

  The future of businesses is uncertain, and while experience and people are crucial factors in making informed decisions, it's essential to minimize the number of predictions required to achieve long-term success. By investing in businesses with strong people, cultures, and dominant competitive positions, the need for frequent decision-making and potential mistakes is reduced. Long-term ownership and minimizing the number of investments can lead to greater success and fewer opportunities to be wrong. For instance, owning a company like Google for over a decade has taught the importance of staying patient and appreciating how things can go right even when faced with volatility and change. Ultimately, the key to successful investing is focusing on what can be controlled, such as the quality of people and businesses, and minimizing the number of unpredictable variables.

• Missing out on great investments can lead to significant opportunity cost: Maintain an open mind, patience, and long-term perspective to capture great investment opportunities and avoid regret of not buying enough of a great company

  Missing out on great investment opportunities can result in significant opportunity cost, which can far outweigh the pain of losing money in actual investments. Long-term ownership of great businesses, such as TJX, Fastenal, Google, and Mastercard, has taught investors that things can go right, and sometimes they can go really right. The ability to keep an open mind, maintain patience, and maintain a long-term perspective are crucial skills for investors to capture such opportunities. It's easier to focus on what could go wrong than what could go right, but it's essential to keep in mind that the potential rewards can be enormous. The biggest regret for many investors is not buying enough of a great company when they had the chance, rather than making an investment that went down.

• The importance of discipline and imagination in business: Discipline prevents bad decisions, while imagination leads to significant returns. Find great businesses run by great people for profitable investments. Regret mistakes for missed opportunities. Undervalued big companies offer potential. Stay curious for new trends and growth potential.

  Both discipline and imagination are crucial in making fortunes in business. While discipline is necessary to avoid making badly stupid decisions, an open mind and a healthy sense of imagination can lead to significant returns. The speaker shares that there have been 10 investments in their 50-year experience that have driven the majority of the returns, where they found great businesses run by great people and made significant profits. However, not all investments have been successful, and mistakes are often regretted for what wasn't done rather than what was. The speaker also notes that even big companies with huge market caps can be undervalued and offer opportunities for significant returns. The current market environment, with a focus on human capital and digital businesses, offers opportunities for nonlinear outcomes and long-term growth potential. Despite the conventional wisdom that has emerged, it's essential to stay curious and keep an open mind to new trends, technologies, and business models.

• Invest in diverse businesses for long-term success: Diversify portfolio across industries, models, and geographies to increase chances of long-term investment success and resilience. Prioritize businesses that prioritize their users for long-term confidence.

  Adaptability is key in investing. The world is unpredictable and conditions can change, so it's important for investors to not put all their eggs in one basket. This means owning a diverse portfolio of businesses that operate in various industries, models, and geographies. While this approach may not make an investor the best performer in any given year, it increases the chances of long-term success and resilience. Another important factor is owning businesses that prioritize their users, as these companies are more likely to thrive and provide confidence for long-term investment. The ability to adapt and focus on businesses that delight their users has become increasingly important in recent years.

• Identifying businesses with unique value propositions: Success lies in backing businesses with strong management, unique culture, and user-delighting products or services, which inspire confidence in defying market assumptions and delivering high growth rates.

  Successful investments often require having a different perspective from the market. This means identifying businesses that inspire confidence in their ability to defy market assumptions and deliver high growth rates over an extended period. These businesses typically have a strong management team, unique culture, and a product or service that is difficult to replicate and delights users. Wayfair is an example of such a business, which built a user proposition early on and then relentlessly reinvested in improving the proposition to create a flywheel effect of more sales, profits, and investment. The key to success is identifying these businesses early and having the confidence to stick with them despite market skepticism. This requires a deep understanding of the business, its market, and the user experience.

• Investing in user proposition for a flywheel effect: Successful businesses invest in improving their user proposition to attract more users, buyers, and sellers, creating a flywheel effect. Even businesses with complex operations and hard-to-replicate assets can succeed with the right approach, but investors may face brutal episodes and must learn from their mistakes.

  Successful businesses often differentiate themselves by investing heavily in improving their user proposition, even if it requires significant resources and expertise. This can create a flywheel effect, attracting more users, buyers, and sellers, and ultimately allowing the business to pull away from competitors. This approach, which requires a willingness to get "hands dirty," has been a successful strategy for Rouenkeneff in their long-duration investments. Another key point is that businesses with complex operations and hard-to-replicate assets, such as UnitedHealth, have a competitive advantage that can earn them the right to succeed. However, even the most experienced investors can face brutal episodes, like Rouenkeneff's experience with Volkswagen in 2007-2008. Despite losing a third of their investors' capital in just five days, they were able to learn from the experience and move on, recognizing that the pain of the loss was outweighed by the opportunities that arose in the subsequent years.

• Appreciating the potential of overlooked opportunities: An open mind and ability to value niche businesses can lead to remarkable success, even without heavy reliance on scale

  Having an open mind and the ability to fully appreciate the potential of good opportunities can lead to remarkable success. This was exemplified by CEOs like Mark Leonard at Constellation Software and Gilles Martin at Eurofin Scientific, who saw the value in businesses that others underestimated. These businesses, such as niche software and testing and measurement, offered significant pricing power and profit potential due to their stickiness and importance to customers. While scale can be a significant driver of competitive advantage, there are also examples of successful businesses where this isn't the primary factor. One such example is Fastenal, which was a successful investment for the firm despite not relying heavily on scale. Overall, the key takeaway is to not let a narrow focus on valuation or a failure of imagination limit your opportunities for success.

• The importance of unique business culture: Fastenal's success came from exceptional service culture, attracting talented individuals. Investing requires imagination, reading widely, debates, diverse perspectives, and adaptability.

  The success of a business often comes down to its unique culture and the people who build and harness it. Fastenal, for instance, thrived not because of any unique patents or scale advantages, but due to its exceptional service culture that attracted and retained talented individuals. While some businesses, like Mastercard, may not require a special culture to succeed due to their inherent strengths, the importance of a strong culture cannot be overstated. In the investment industry, active management continues to hold value despite the market's increasing efficiency. Imagination plays a crucial role in investing, and it's not just about intelligence; it's about having the right temperament and the ability to adapt to changing market conditions. To expand their imaginations, investors can read widely, engage in thoughtful debates, and seek out diverse perspectives. Ultimately, investing is as much an art as it is a science.

• The Power of Unconditional Love and Family Support: Unconditional love from family provides strength to face life's challenges, and diverse perspectives from former employees and customers enhance investment decisions.

  Unconditional love and family support are essential for personal resilience and success in life. In the discussion, Patrick shared how the greatest gift he received was unconditional love from his parents and wife, which gave him the strength to face life's challenges. He also mentioned the importance of finding that bedrock of family support and love to prepare for anything. Additionally, in the investing world, Elliot emphasized the value of former employees and customers' opinions in building a deep understanding of a business. These perspectives, along with extensive research and background work, help investors form a more comprehensive view and make informed decisions. Overall, the conversation highlighted the importance of love and support in personal life and the significance of diverse perspectives in the investment process.

• Speaking with former employees for valuable insights: Former employees' perspectives can reveal a company's focus on customers, fair treatment of stakeholders, and essential product insights.

  When analyzing a company's resource allocation and stakeholder treatment, speaking with former employees can provide valuable insights. These conversations can help determine if a company is customer-centric or if they prioritize squeezing every last penny from customers or suppliers. Understanding how a company treats its employees is also crucial, as it can be a red flag if they are not treated fairly. For areas where an analyst doesn't have a natural intimacy with the product, speaking to those who do can provide essential perspectives. Overall, these conversations can inform decisions on the benefits of scale, customer satisfaction, and stakeholder treatment in smaller companies. If you're interested in learning more, visit joincolossus.com for podcast episodes, transcripts, show notes, and weekly newsletters condensing the big ideas and best content on the internet.