TIP608: Long-Term Compounding w/ Chris Mayer

Chris Mayer, the author of "100 Baggers" and the co-founder and portfolio manager of Woodlock House family capital, emphasizes the power of long-term compounding through investing in high-quality businesses. During the episode, he discussed his fund's impressive 45% annual return before fees in 2023, which outperformed the market significantly. Mayer also highlighted his investments in Constellation Software, Topikis.com, and Lumine, and shared insights into their growth strategies and performance. Constellation Software, a conglomerate acquiring small software businesses, has been a 200-bagger since its IPO in 2006, with a consistent 25% return on invested capital. Topikis is targeting higher organic growth rates through its subsidiaries, while Lumine's spin-offs have contributed to its success. Mayer's approach to investing allows for long-term commitment to great businesses and the ability to monitor their performance over time. The Investors Podcast Network, which recently started a mastermind community, has seen a growing number of investors resonating with this approach.

Even in a volatile market year like 2023, where macro forecasting proved challenging and the difference between highs and lows was significant, individual companies with strong fundamentals can deliver impressive returns. The investor discussed adding to Lumine and Technion, both of which had significant positive impacts on his portfolio. He also highlighted the importance of staying patient and not being swayed by market noise or narratives, such as the belief that the Fed drives the market or that owning specific tech stocks is necessary for success. Despite concerns about market corrections and rate hikes, companies with solid business performance continued to reward patient investors handsomely, as shown by the investor's experience with Technion. The lesson learned is to focus on individual companies and their underlying business strengths, rather than being overly influenced by macroeconomic variables or market narratives.

Successful investing involves focusing on the essentials of individual businesses and filtering out the noise of external market fluctuations and macroeconomic predictions. The speaker emphasizes the importance of guarding attention carefully and spending time on understanding the critical success factors for businesses over the long term. He also advises against checking stock prices frequently and mentions the importance of diversification within the market, as there are significant variations even within the S&P 500. The speaker shares examples of companies that have performed well despite being overlooked, such as Copart and Monster Beverage, highlighting the importance of looking beyond popular narratives and focusing on the fundamentals of individual businesses.

Constellation Software, a company that was once overlooked due to biases against software buyers, has shown impressive growth over the past few years. The market has come to recognize Constellation's ability to deploy large amounts of capital, leading to significant growth in free cash flow. This shift in perception, along with Constellation's successful acquisition of Optimal Blue for $700 million, has contributed to the company's recent run-up in share prices. Despite the high growth rates, Constellation continues to compound at around 25% consistently. The company's ability to identify and acquire attractive software businesses has proven to be a winning strategy, and investors are now recognizing the long-term potential of this humble business.

Constellation Software, a leading software company, has continued to demonstrate strong organic growth and has capital to deploy, as evidenced by their recent acquisition of Optimal Blue for $700 million, despite putting down only $200 million. This deal, which is expected to generate significant returns, comes amidst increased competition in the market, but Constellation's niche focus on smaller acquisitions with minimal organic growth sets them apart. Companies may choose to sell to Constellation due to their attractive purchase prices and proven track record of success. Additionally, Constellation's organic growth rate, running at around 5-6%, has surprised many and sets the stage for further growth. Overall, Constellation's strategic acquisitions and strong organic growth position them well for continued success.

When it comes to selling a business, there are different motivations and considerations for business owners. While getting the highest sale price may be a priority for some, others may value having a permanent home for their business, even if it means a lower sale price. Consolation may be a better option for those in industries with little competition or organic growth. Additionally, there are tools like Monarch Money to help manage personal finances and make tracking expenses and investments seamless. The Holy Grail of Investing by Tony Robbins offers insights into alternative investments and strategies for maximizing returns.

Constellation Software's decentralized business model allows for scalable acquisitions and autonomy for each business, but it also presents challenges such as potential difficulties in retaining talent and maintaining a closely knit team. As the company grows, senior managers may have less impact on overall performance and may face compensation concerns. Constellation addresses these challenges through incentives, such as requiring senior managers to invest in company shares, and experimenting with spin-offs. However, as the share price increases, some managers may be hesitant to invest a significant portion of their income in Constellation stock. The decentralized model, while effective, requires constant attention to ensure teams remain motivated and incentivized as the company continues to grow.

Constellation Software, under Mark Leonard's leadership, is exploring new avenues for growth beyond its traditional vertical market software (VMS) deals. This shift, which some call Constellation 2.0, includes pursuing larger and more complex deals and venturing into new industries. Constellation's vast potential deal pool, estimated to be around 100,000 companies, is a result of the numerous software solutions created for various businesses and the constant emergence of new software companies. Despite the large number, it's a realistic goal given the vast market and the company's successful track record in thoughtful capital allocation. Shareholders should be prepared for this potential drift outside of VMS and embrace the company's continued growth and innovation.

Constellation Technologies, a holding in your fund, has spun off two businesses, Topikis and Lumine, into public companies. This dynamic as a Constellation shareholder means new companies were deposited into your account. The reasons for these spin-offs include experiments with incentives, natural fit for the businesses, and allowing the CEO of Lumine to run his own thing. Topikas, which is more confined to Europe, and Lumine, which is tied to one vertical but can go anywhere, offer different advantages and challenges. Constellation still owns a portion of both spin-offs and they serve as a tool for Constellation in special situations. These spin-offs are not a strategic play but rather a special situation type deal. It is expected that there will be more spin-offs in the future, likely as part of larger deals.

The spin-off of a company like Lumine from a larger conglomerate, such as Constellation, can present significant investment opportunities for long-term investors. This is due to the fact that institutions that own the parent company may be required to sell their shares of the spun-off entity, leading to an oversupply of shares and a potential drop in price. This can create a favorable entry point for investors. Another interesting point discussed was the different dynamics between the spin-offs of Topic and Lumine. While Topic, which spun off in 2021, saw a lot of its shares being held by investors due to its size and the market conditions at the time, Lumine, which spun off with a smaller market capitalization, saw a significant amount of its shares being sold in the initial days of trading. The speaker also highlighted the potential of investing in a spun-off entity like Lumine, which he believed was the European version of Constellation and had a large and fragmented market in Europe to deploy capital. The company was expected to grow at least 25% a year and was reinvesting all its earnings, making it an attractive investment opportunity. Overall, the discussion emphasized the potential investment opportunities that can arise from the spin-off of a company and the importance of considering the specific dynamics of each situation.

Topicis is an attractive investment opportunity due to its consistent free cash flow growth, stable business without leverage or cyclical risks, and potential for greater runway in Europe's less developed private equity market. The company's complex structure, limited communication from management, and lack of traditional investor relations efforts may present hurdles for some investors, but these challenges also help attract a certain type of shareholder who is committed to understanding the business. Overall, Topicis' strong fundamentals and potential for long-term growth make it an intriguing investment option.

Companies with strong organic growth, like Topicus, are attractive acquisition targets for larger firms looking to expand their portfolios. The Fundrise Flagship Fund, for example, is planning to buy more assets with higher organic growth rates, such as Topicus. Shopify, a global commerce platform, is another example of a business that has achieved significant organic growth and provides entrepreneurs with the tools they need to succeed. Shopify powers 10% of all e-commerce in the US and offers a $1 per month trial period for businesses at any stage. The appeal of companies with high organic growth lies in the easier compounding of assets and the focus on growth. Constellation Software, which owns the Fundrise Flagship Fund, has also seen strong organic growth in recent quarters. Luma, another acquisition target, is doing larger deals in the media and communications vertical and has fewer acquisitions but a focused approach. The ability to generate organic growth is a valuable asset for businesses and can make them more attractive to potential acquirers.

Loomine, a recent spin-off from Constellation Software, stands out due to its focus on larger carve-out deals from larger companies. This approach offers less competition and the potential for high returns, as demonstrated by their successful acquisition of Nokia's subsidiary. With a large vertical market and significant growth potential, Loomine's pipeline includes deals in the low thousands, making it an attractive investment opportunity. The acquisition of Wide Orbit, a business with strong pricing power and stickiness, was a good deal despite the higher-than-average multiple paid. Synergies within the subsidiaries and the potential to redeploy cash flows from older, stagnant media communications companies add to Loomine's appeal.

Lumine, a company sourcing their own deals with a talented team, is expected to deliver similar or even better returns on capital compared to Constellation and Topicus, despite dealing with larger deals that typically have lower Internal Rate of Return (IRR). The alignment of incentives through stock ownership and vesting periods is a significant appeal, as it mirrors Constellation's successful structure. The current valuations, with Constellation trading at a premium, might seem counterintuitive, but long-term investors should focus on the potential for significant earnings growth over the next decade, rather than the exact multiple. Even if valuations fluctuate, opportunities for investment will arise.

Investing in high-quality companies with a long-term perspective can lead to significant returns, even if it means paying a higher multiple upfront. By forecasting a company's earnings potential over a 10-year period and applying a reasonable multiple, investors can find attractive opportunities that may seem expensive at first but could yield impressive returns. For instance, a company with a consistent 25% earnings growth over 10 years would represent a 9x earnings multiple. However, some investors may find it more palatable to break it down into smaller time frames or assume higher returns and terminal multiples. Regardless, the power of compounding in long-term investing is undeniable. It's essential to remember that paying high multiples without proper research and conviction can be risky. Instead, thoroughly analyze a company's business model, financials, and growth prospects before making an investment decision.

Building a successful investment portfolio involves making multiple informed bets and allowing them to compound over time. It's not necessary to put all your eggs in one basket, but rather, diversify your holdings and let the winners run. Position sizing is an important consideration, as is identifying attractive opportunities that align with your investment thesis. It's also crucial to avoid chasing trends or overpaying for quality, as markets can be volatile and prices can fluctuate significantly even for high-quality companies. When considering new investments, consider position sizing and the attractiveness of opportunities based on a long-term perspective. Trimming positions is generally not advised, unless there are compelling reasons to do so or other attractive opportunities present. Ultimately, the key to outperforming the market is maintaining a disciplined approach and being willing to let your winners grow.

Investing in a few high-performing companies, which can make up a significant portion of your portfolio, can lead to substantial returns. Chris Rokos, a value investor, shared his experience of having some investments increase 20x, making up a large portion of his portfolio. He emphasized the importance of holding onto these winners rather than selling them. Chris also discussed his focus on serial acquirers, companies that make strategic acquisitions to grow their business. For those interested in learning more about this investment strategy, Chris recommended checking out his conversation with Kyle Greve on "Our Millennial Investing Show," as well as resources like Impractical's research on serial acquirers and Acquires.com's free book on the topic. Lastly, Chris mentioned that those looking to learn more about him and his firm, Family Capital, can find him on LinkedIn or his occasional blog. Overall, the conversation highlighted the potential for significant returns from focusing on a few high-performing companies and the importance of staying informed about investment strategies like serial acquirers.