Robert Vinall, what makes a good investment process?

Here you can enjoy our conversation with Rob Vinall of RV Capital. We have discussed the ingridients of a good invesstment process.

This transcript is part of a series of transcripts that I publish before the RV Capital meeting in Engelberg. Before the RV Capital meeting takes place, we want to make these great and relevant conversations also available in form of a transcript.

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We have discussed the following topics:

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Rob’s idea generation

[00:00:07] Tilman Versch: Rob, welcome back to our interview. In this episode, we want to talk about process, from the beginning, from idea generation to invest or sell at a certain point. Let’s start with idea generation. Where do you get your ideas from?

[00:00:25] Robert Vinall: Yeah, I think that’s a great question. Because if you think about it, there’s, 10000 plus public companies out there so probably the biggest single factor, what you end up ultimately investing in is which of those 10000, you actually start looking at, because they have to make it to the top of the filter, or if they’re going to make it to the bottom of the filter at some point. And my opinion, on where to start with an idea has changed quite a lot over the years. So when I started investing, I was very much sort of enamored by Ben Graham, and he took a very quantitative outlook, he’s famous for so called net-nets, companies trading at a discount to the tangible assets they had on their balance sheet. And I too, would typically do screens, looking for companies which are trading at a discount to their book value, very low PE or a 52 week, low share price, so this type of stuff.

And then over time, I realized that this was actually really the wrong way to go about things because, on average, not always, but on average companies, which are trading on big discounts to their tangible book value or other types of low metrics, kind of the low average companies, because the market is not completely stupid; if it’s saying something’s worth only four times earnings, then on average, that’s going to be a pretty crappy company.

And as a long-term investor, I don’t want to be spending my time analyzing the crappy companies in the hope that every now and again, one crops up, which isn’t. No, I want to be looking at really great companies. So I stopped screening many years ago. I was thinking about what is the single most important thing that gets me excited about an investment? And in my particular case, I’m sure for other people, it’s different, but in my particular case, it’s a very passionate, aligned entrepreneur running a business.

So given that, that’s sort of the main thing I’m looking for. It probably makes sense to use that as a as a starting point on which ideas to look at. So now, for me to get sufficiently excited to start reading the annual report for the company or trying to learn about what it does, what I like is to find is that there’s a sort of a passionate entrepreneur who’s somehow connected to the business either as a major shareholder or ideally as the CEO of the company as well. So how do you find out about that? It can be through referral. Someone else points out to you, there’s this great entrepreneur running the company, you should check it out or maybe you read an article in the newspaper. So there’s different ways you can come across it. But that’s really the trigger for me to now to actually start analyzing a company.

Filters Robert uses

[00:03:08] Tilman Versch: Maybe talk a bit also about filters. You said, the great management filter is important for you. Is there another filter to say no, maybe? If you say you don’t invest in certain countries, for instance.

[00:03:20] Robert Vinall: So what we’re talking about now is literally the first sort of five minutes of an investment analysis. So where you’re literally, somebody throws a name of a company at you, you’ve never heard of it before, you have no idea what it does. So the first filter would be, like I just said, is there someone running the business that I have the potential to trust? But there are other filters as well. The most important one is, just on a brief look at the business, do I think this is a business where I have the potential to understand it? So is the business of a nature where I think it’s going to be within my capacity to kind of build up an understanding of what it does, what the risks are going to be and stuff.

So if it’s a sort of biotech company, which has got an early stage cure for cancer, then realistically, as a non-biologist, I’m never going to be able to answer that question. So I’ll kill the idea very quickly. But you mentioned countries – that’s one thing that I’m very indifferent to. I’m not bothered about which country a company is based in or which sector or whether it’s a big company or a small company. All those things which a lot of people use as themes for their funds, that’s not something that particularly interests me. I’m perfectly happy to look at, and indeed invest in a company, whether it’s from South Africa or Germany or anywhere else for that matter.

Minimum standards Robert has on a country level

[00:04:53] Tilman Versch: So you don’t say, I don’t invest in certain countries?

[00:04:56] Robert Vinall: Obviously, the rule of law has to be upheld and property rights have to be properly protected in a country. So there are certain countries that for sure I wouldn’t invest in, but they tend to have such small capital markets anyway, that there are plenty of other opportunities out there.

Factors that make a company perfectly investible and debt or cyclical companies

[00:05:15] Tilman Versch: Let’s try to invert a bit. What makes the company perfectly investable for you?

[00:05:23] Robert Vinall: Perfectly an investable? If the CEO has changed three times in the last two years because I need a track record of a CEO to be able to judge if that’s going to be a good person or not. Typically, if there’s no major shareholder, because I think it’s important companies have owners. If there’s a business that I don’t understand or think is going to change a lot in the coming years. Those are the type of things that would make a company investable, right from the get-go.

[00:05:56] Tilman Versch: And debt for instance?

[00:05:58] Robert Vinall: Yeah, thank you. That’s a good one as well. So debt is something I’m quite allergic to. If it’s an industrial or a kind of service type company, it would typically have zero debt, and most likely a net cash balance for me to be interested in it. And if it’s a financial company, like a bank or a lending business, then of course it would have debt, but its equity ratio would be multiples higher than comparable companies in the field so that if there is a crisis in the industry, then this would be the company which is the last man standing.

[00:06:35] Tilman Versch: Cyclical companies?

[00:06:38] Robert Vinall: I have absolutely nothing against a cyclical company. From a purely personal perspective, I find them sometimes difficult to value. If a company earns kind of 100 one year 50, the next then 75 the year after that, then it’s quite difficult to form an opinion on what it’s really worth. So I struggle a little bit with cyclical companies, for that reason. But as a matter of principle, I’m perfectly happy to invest in a cyclical company.

The next steps of Rob’s investment process

[00:07:09] Tilman Versch: So a company goes through the next step, after the five minutes, you’re taking your time to look at it. What are the important numbers or metrics you’re screening for?

[00:07:22] Robert Vinall: Well I don’t really screen for numbers or metrics.

[00:07:30] Tilman Versch: What do you look at first of a company?

[00:07:32] Robert Vinall: So if a company passes that five minute test, then I’ll typically start to read about it. That would normally mean downloading the annual report. My favorite situation is if the CEO writes a long thoughtful letter about the business, because then you really get a sense of the essence of the company, but also the way the manager thinks, which are two very important factors for me. So that’s an ideal scenario. And then in the back of my mind, as I’m reading about the company, I guess there’s the hypothesis of any investment that I make, is that it’s a wonderful business, which is going to grow and flourish over the next 10 years. And by being an owner of the business, I’m going to participate in that value creation.

And of course, that’s very rare for that hypothesis to really play out. So as I read through the annual report, I’m looking for disconfirming information, which would sort of invalidate that hypothesis. So maybe there’s a market where the growth opportunity is about to be exhausted, or where there’s a very obvious competitive threat which is going to impair the business’s ability to make money. And so I’m basically looking for this disconfirming information. And as soon as I find that disconfirming information, then I’ll simply stop the analysis and move on to a different opportunity. And if I don’t find disconfirming information, I keep reading, keep learning about it. At a later point in the process, I’ll visit the company and if, right at the end of the process, I still haven’t found any reasons why that the hypothesis shouldn’t play out then I’ll probably end up investing in it.

The role of number’s in Rob’s process

[00:09:22] Tilman Versch: Maybe a question about numbers. What role does numbers playing the whole process for you?

[00:09:28] Robert Vinall: The numbers in isolation really don’t mean anything. What’s important is to understand what a business really does, how it sells, how it makes money, what the value it creates for its customers. And then the numbers or the figures that it produces should then reflect that, obviously. But the context of what brings the numbers about is infinitely more important than just what the numbers are.

[00:10:02] Tilman Versch: So you take numbers as a way to understand the play the companies in or the field company is in and how it’s performing in this metric?

[00:10:10] Robert Vinall: I guess the numbers are a little bit like the scoreboard. So if you’re watching a soccer match, then obviously, what you’re interested in is how well the players play, whether they seem better than the opponents, whether they’re well organized, whether they’re motivated, whether the team’s working together and all that kind of stuff. These are the things you would look at. And then of course, the output is then the score.

Maybe the team wins or loses or whatever. But really, what you would focus on as a fan of a football game would be actually on what’s happening on the field and not what’s happening on the scoreboard and for me it’s the same with companies.

Robert’s preferred sources to gather information about a company

[00:10:55] Tilman Versch: What are your preferred sources to get knowledge about a company besides the CEO letter.

[00:11:02] Robert Vinall: My preferred source is primary information, so, direct facts about the business on the basis of which I can then form my own opinion on what its long-term perspectives look like. The annual report is a great source of primary information, feedback from customers, or suppliers or employees are great sources of primary information. That’s really what I’m looking for, and then based on that, I kind of start to form an opinion. What I’m less interested in is other people’s opinion.

[00:11:35] Tilman Versch: Where do you get the primary information from? Do you go to fairs? Do you look at portals where employees wrote about the company?

[00:11:45] Robert Vinall: I mean, it depends on the type of the business it is. If it’s a consumer business then, I’m myself a customer, so that’s a great source of input or speaking to people like yourself. Whereas if it’s more of a kind of a B2B type company, then to get that primary information you need to speak to the business’ customers. So it really depends on the type of opportunity. But a big part as well as just sort of building out a network. So increasingly, when I visit company X, because I’m interested in company X, most likely that company X will also be a supplier of or a customer of, lots of other companies that I’ve visited with over the years, in which case is a great opportunity to not just analyze company X, but also analyze company Y, and Z.

How long Rob’s research process usually takes and two examples

[00:12:37] Tilman Versch: How long does the research process for you usually take before you invest?

[00:12:41] Robert Vinall: So in an ideal situation and of course investments don’t always work out in an ideal way. But ideally, the way a process should work is that I get to know a company on day one obviously, start to analyze it, build up hopefully quite a decent amount of knowledge about it, and then follow the company over a number of years. And only after a few years, actually end up making an investment when something happens that makes it attractive. Maybe the share price falls or having an inside in the company can be much more valuable than I initially thought. But I think time is an amazing way to find out the flaws in an investment hypothesis.

So no matter how diligent you are, if you just spend a month looking at a company, there’s almost certainly going to be risks, elements of the business, which you simply overlook, or don’t find. Whereas if you follow a company, maybe from a distance, but over a number of years, then you tend to learn a lot more about it and build up a lot higher conviction in the business. So ideally, I would follow a company for a number of years before actually making the investment.

[00:14:02] Tilman Versch: So let’s go from ideal to example. What was the fastest time period for you to invest? And what is the longest, where you’re still looking maybe at a company?

[00:14:14] Robert Vinall: So a case where the process worked really well was, for example, Grenke Leasing, which was a company I had on day one of the fund and even today is still one of the largest positions. I first met with Mr. Grenke, who’s the founder of Grenke Leasing, I think in 2005. At the time, this was a few years after the company had IPOed and the valuation was incredibly high, because rightly, the market was very optimistic about the prospects of the business. And at the time, I’d never seen a financial company before. I was super impressed by Mr. Grenke. He really sat down with me at a table like this and explained the business to me and how they could grow and I was super impressed.

But the valuation I thought was too high. But I made a mental note to myself that if ever this company were to get cheap, that I would like to buy it, and if you fast forward three years to 2008, the middle of the financial crisis, everybody was panic selling all companies with any connection to financial services. That’s when I just use the opportunity to buy Grenke, so that was really an ideal sort of situation. So a number of years past, where I was able to continue to follow the company, to learn about it and then when an opportunity presented itself, I was able to make the investment. So that would be kind of like a typical scenario.

A shorter scenario would be something like; I think for example, Trupanion, which is a pet insurance company. I think I first started studying it in the spring of 2014 or 2015, I can’t remember which. And I made the initial investment sort of around the autumn of the same year. So that’s probably about six months that went between when I first started sort of looking at it and then ended up making an investment. So I think six months is probably the absolute minimum, I wouldn’t invest in something less than that. And actually, it’s difficult in any case, just from a purely logistical perspective to do it in less than six months because, you start off by doing this, the desk research, reading through all the annual reports, building a model, and that kind of stuff.

That typically takes kind of a few weeks, then you schedule a call with the company, and normally the call gets scheduled a week or two in advance, and then to extend the call goes well, then you try to figure out an opportunity to go and visit the company, and especially if the company’s in a different continent, normally, it takes at least a month to plan that. So I think it’d be very difficult to invest in something in less with less than sort of a six months’ time period. But of course, not all of those six months are spent analyzing just that company. That’s times when you’re doing other things obviously.

Rob explains how he spends time researching companies

[00:17:13] Tilman Versch: In your research process, do you have a rough number of how many countries you visit per year?

[00:17:20] Robert Vinall: Well, I do, but I don’t think it’s a very meaningful number. So especially if I’m new to a country, what I’ll typically do is try and attend a conference there where organized by a broker or on the stock exchange, whoever it is. And typically, a conference is set up, that takes three or four days, and you get to see five or six companies a day. So five companies, times five days, you’re seeing some 25 companies in a week or whatever; so, if I’m doing that, obviously, it could potentially be hundreds of companies that I’m seeing a year. But I found, especially once I get to know countries and industries, well, that type of scattergun approach isn’t a very efficient use of my time.

And what I much prefer to do is have one or two companies that I’m super interested in, and then spend one, two, or even three days just at that one company. If I look at today, in the course of a year, I’m seeing much, much fewer companies than I was, say, five years ago, but that’s simply because I’m spending much more time at the companies I’m interested in, rather than seeing five companies a day.

Rob discusses how much detail in important for him

[00:18:34] Tilman Versch: How much detail is important for you?

[00:18:40] Robert Vinall: Yes, detail is really, absolutely crucial, because I have a very concentrated fund; there are only 10 companies in my portfolio. And that’s not 10 times 10%, some of the larger ones 20, even more than 20% of the portfolio, obviously, the smaller ones are more around the 5% mark. So I have a very concentrated portfolio. So that means I can’t afford to make too many mistakes, I really need to know the companies very well before I make an investment.

And also, what I found is the most successful investments are made when you buy a company when everyone else is sort of very pessimistic about it, and potentially even panicking. And obviously, to have the courage to buy something when everyone else is effectively saying they think it’s worthless is very difficult, intellectually, but above all, emotionally. And the only way I find I’m able to do that is if I really feel I know the company better than everyone else. Even if some of those things I know aren’t necessarily particularly relevant to the to the investment, it’s still super important to have that knowledge in order to then have the confidence to make the investment.

The relation between details, key drivers and mechanisms

[00:19:48] Tilman Versch: How do you see the relation between details and key drivers and mechanisms?

[00:19:50] Robert Vinall: It tends to be the case that there’s hundreds of different things that can seem important in a company. There’s lots of metrics you can track and calculate and follow and all of those have some kind of value. But of course, if you’re following hundreds of metrics, then one blows into the other and you quickly lose sight of where you are. So what I tend to find is that every investment tends to come down to just kind of a handful of factors or metrics, and sometimes even just one. And so the really important thing is to A. figure out what that metric is and then, of course B. to, follow it closely. So I think a big part of any analytical processes is sort of taking all that complexity and then distilling it into simplicity. And simplicity means, kind of one or two key drivers for an investment.

[00:20:58] Tilman Versch: Can you maybe name the example for the one key driver?

[00:21:05] Robert Vinall: It really depends on the company you’re talking about. One of my favorite investments is a company called Credit Acceptance, which does subprime lending for cars in the USR. And so Credit Acceptance’s, founder, Don Foss had this amazing idea, when he started the business that you could lend much more effectively to people if the dealer, the person selling the car participates in the riskiness of the loan.

And it’s kind of counterintuitive. You think well, how on earth does the dealer know whether someone’s going to repay or not? And actually, the dealer has quite a big influence because the dealer knows the quality of the car, and if the car is gonna fall to pieces a few months after it leaves the garage, then the person is not gonna be able to get to their work to go to their job. And if they can’t go to the job, they’re not going to be able to earn money. And if they can’t earn money, they’re not gonna be able to repay the loan.

So this was a genius insight that he had. But he wasn’t a mathematician. And although this insight served the company very well, over many decades, there came a point where it suddenly reached the situation where it no longer knew whether the loans that was making were profitable or not. And so it was the influence of the now CEO, Brett Roberts, who really introduced the tools to figure out okay, is the loan profitable or not? And the way he describes it is it’s difficult to know if you’re winning if you don’t know what the scoreboard is. So he created the scoreboard, and the scoreboard for Credit Acceptance is what they term the kind of the economic value added, so what is the profitability of your loan after allowing for the capital cost of that loan?

And very, very rational, they’re capitalists guess so they allocate first and the most profitable loans, and then to the less one less profitable ones, and the ones which don’t reach their profitability targets, then they leave out completely, but for them it’s the economic value added, which is the key driver.

Selling and the reasons for selling

[00:23:10] Tilman Versch: When do you sell and why?

[00:23:05] Robert Vinall: Well, by far the most important reason to sell it’s actually when you realize you’re wrong. So like I mentioned, my investment hypothesis at the start of an investment is, you know, this is a wonderful business run by a wonderful person, and it’s going to become much more valuable over time. And of course, that situation is very rare. So quite frequently, the hypothesis proves to be wrong. Maybe their growth opportunity is less than I expected, or the manager is less engaged than I hoped or whatever it might be. And whenever I realize that that hypothesis is wrong, it’s very important that I react quickly and sell the company. And whenever I’ve done that, in the past, I’ve never regretted it.

I think another reason obviously to sell is if you think something has become too expensive. And in my experience, where everything else about an investment has been 100%, what I’m looking for, but where I felt the prices got too expensive, and then I sold. That’s oftentimes turned out to be a mistake, because kind of unexpected things happen. In great businesses, the unexpected things tend to be very positive, as opposed to the bad businesses where they tend to be negative, the surprises. And so oftentimes, I’ve sold things and later regretted it if it was purely because of my assessment of the value.

[00:24:32] Tilman Versch: So how do you deal with this now?

[00:24:35] Robert Vinall: Well just by the way I’ve learned to invest and the way I continue to learn to invest is by looking at past investments, figuring out which ones did well, which did less well, and the reasons for that, and then iterating to obviously do more of the positive things and in the future and less than the negative things. Like I just described, where an investment was otherwise perfect, but I was just concerned about the price has been a source of mistakes. So on a forward looking basis, I weight my opinion on that sort of the price element of things a little bit less, because it’s proven to be less reliable, and then overweight, these other elements such as the quality of the business and the people to hopefully correct for that bias.

How Rob tracks companies he has sold

[00:25:24] Tilman Versch: How do you track the companies you’ve sold?

[00:25:27] Robert Vinall: Sometimes I sell a company but fundamentally remain interested in potentially investing again, in which case, I’ll continue to follow it quite closely, I’ll continue to visit the company from time to time, read the quarterly reports, that kind of stuff. And other companies, I’ve discovered something in it as a result of which I’ve sold and decided it’s never going to be an investment again.

So in that case, I tend not to follow it that closely in the future, but I do kind of keep an eye on them. I like to make sure that they continue to do reasonably well. I would consider it a poor reflection on my ability as an investor, if every time I sold a company, the company was a few months later gonna go down to zero, then on the one hand, it’d be nice to have sold, but on the other hand, I would wonder, how good of an analyst am I if I’m buying companies, and they end up going to zero. I do like to see that companies do reasonably well after they’ve sold. And I think generally, even for the companies that I’ve sold, most of them have continued to do reasonably well afterwards.

Robert Vinall’s insights on his watchlist

[00:26:31] Tilman Versch: And how many companies are on your watchlist?

[00:26:35] Robert Vinall: It moves around a little bit, as hopefully, companies coming in as I discover new good companies, and then sometimes others going out as I discover a reason why they no longer suit me as potential investments. But I would guess that it’s generally around somewhere between kind of 70 to 100 companies on my watchlist.

[00:26:57] Tilman Versch: Thank you very much for these great insights and this interview.

[00:27:00] Robert Vinall: Thank you. It’s a pleasure.

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