Thomas Russo is a highly respected value investor who specializes in international investing. He recently wrote the new section on global investing in the sixth edition of Security Analysis. Here is his bio from Gurufocus.com.
Mr. Russo oversees $3 billion as general partner of the Semper Vic Partners and Semper Vic Partners (Q.P.) limited partnerships along with overseeing funds in discretionary, individually managed accounts for individuals, trusts and endowments. He is a graduate of Dartmouth College (BA, 1977) and Stanford Business and Law Schools (MBA/JD, 1984).
The following are my notes from a talk that Russo gave at Columbia University in 2006. I hope you find his remarks as instructive as I did.
- Russo learned a lot from studying Buffett’s writings and going to Berkshire Hathaway annual meetings.
- He is long only.
- He attempts to reduce risk by investing in companies with strong, predictable cash flows.
- He spends a lot of time thinking about agency costs. [Here is a definition of Agency Costs from Investopedia: “A type of internal cost that arises from, or must be paid to, an agent acting on behalf of a principal. Agency costs arise because of core problems such as conflicts of interest between shareholders and management. Shareholders wish for management to run the company in a way that increases shareholder value. But management may wish to grow the company in ways that maximize their personal power and wealth that may not be in the best interests of shareholders.”
- Russo focuses on whether management thinks about themselves first or shareholders.
- Most of his investor accounts are taxable; therefore they want long-term deferred capital gains.
- Russo believes it takes good management to hold a stock a long time.
- Russo is a global investor.
- Russo is very narrowly focused by industry. This frees up a lot of research time and allows him to very clearly define his area of expertise or, taking a page from Buffett, what he defines as his circle of competence. [This approach of defining and operating within one’s “circle of competence” is based on a very simple idea: you cannot value what you do not understand.]
- After graduate school, he trained as an investor at the Sequoia Fund. [This highly successful fund was started by Bill Ruane in 1970 to manage money for many of Buffett’s partners when Buffett closed his partnership in 1969.]
- Russo focuses on food, tobacco, media, and beverage companies.
a. They have powerful brands.
b. Their products provide a “sense of lack of substitutes”, that is a reluctance to switch.
c. Cash flows in these businesses tend to be more predictable.
d. They tend to have pricing power; this is important in an inflationary environment.
e. This is his natural comfort zone.
- Russo bought Heineken in 1987, which he continues to hold.
a. Global beer brand
b. Attractively priced
- A global investor can compare businesses around the world.
- His training was focused by industry.
a. This gives extraordinary insights by comparing companies around the world.
b. Some industries are better than others; why not pick ones with superior economics?
- He also owned Miller and Guinness.
- He remains focused today.
- Russo finds that you pay more attention to businesses you are interested in and they are easier to track.
a. For example, Russo can track Heineken by talking to bar tenders.
- There was no sell side research [research from the research department of retail brokers often thought to be compromised by a conflict of interest] at Sequoia; Russo does his own research.
a. Sell side research is short term oriented.
b. Russo looks out 5-10 years.
- Russo is very research focused.
- Valuation process
a. Russo uses EBITDA, even though many scoff at it because it does not capture the true cost of running the business.
c. Allows Russo to compare businesses globally (depreciation numbers can vary).
- Russo invests based on the ratio of Enterprise Value to EBITDA
a. He wants to pay a modest multiple. 8x EBITDA is a general rule of thumb but it varies by company.
b. Even though he purchases undervalued securities, because of his long holding periods, most of his returns have come from growth, as opposed to the gains from the stock closing its initial valuation gap.
c. He wants the companies in his portfolio to be growing, that is, he does not want a stale basket of assets which lowers his IRR.
- Heineken’s growth has come from exploring new markets and from acquisitions.
a. They buy new businesses in foreign markets and then, when integrated, drive the newly acquired premium products through their global distribution and sales platform.
- For Russo, it all comes back to reinvestment – how is the cash reinvested?
- Agency costs are critical.
a. What are the incentives?
b. What is the culture?
c. What do they do with the cash?
d. Are they short-term oriented are operating on behalf of the shareholder?
- Russo has made money paying attention to agency issues.
a. Russo’s solution is focusing on family controlled businesses.
i. He likes when the family still controls the board.
ii. The risk is that the family is corrupt.
iii. You can find good family management teams by looking at their deeds and writings, where they express a care about the long term growth of the business.
- Lots of options are a red flag.
a. A controlling family may shoot down a management team that wants excessive options.
b. This stems dilution.
- Another risk is when management risks the business; they risk want they need for what they don’t need.
a. For example, a large transaction that promises a poor return on capital.
b. A controlling family may be more inclined to stop such a transaction.
c. A management incented by options has an interest in doing the “big deal”.
d. A family may hinder corrupt accounting because they are more intimate in what is going on.
- If a family is in control of a business over many generations it is a good sign that the business is self-funding. It has attractive cash flow characteristics.
- He likes beverage companies because once a still is built, you don’t need to replace it – you actually like the character imparted by the still.
- He has “hidden under the skirts” of controlling families.
- The businesses he invests in are largely out of the funding universe.
a. For example, in tobacco, you don’t need to borrow to purchase the product.
b. They tend to be consumer non-durable.
- You must be able to sustain under performance to have good long-term performance.
- He made good money in 2002 and 2003 because he was outside the Internet contagion and therefore did not lose money.
- There is a “you stupid idiot” phenomena that surfaces from clients when things are not working.
a. Tobacco has been very reviled in the last 10 years .
b. Huge awards have been awarded.
c. This shook investor confidence.
d. He took calls from investors who thought he was a nut to be in tobacco.
e. An investor needs to fight against this.
f. In 2006, he was fighting this because he owns newspapers which are totally out of favor and thought to be going out of business. Everyone thinks Google is going to make them all go away.
g. He believes that newspapers are far “less good” than they were a decade ago but better than the market perceives.
h. They trade at a low enough multiple to make money.
- Global returns have smoothed his overall returns. Currency fluctuations tend to balance out over time.
- Most of Russo’s investors get a monthly statement, so the holdings are highly visible.
a. This can cause a strong client reaction when the volatility is high.
- A lack of liquidity in a stock can cause a discount because there may not be enough shares for Wall Street to make money.
Here is an SEC filing of their latest holdings.