“Every pool in the United States is an annuity for Pool Corp”.

These twelve words, taken from a recent interview with investor Peter Keefe¹, can explain much of the 20x share price increase and billions of dollars of value creation by listed pool equipment supplier Pool Corp over the past two decades.

The obvious question that follows is how twelve simple words can be worth billions of dollars.

The answer lies in the power of big insights – an often-underappreciated element of long-term compounding in a world increasingly obsessed with the latest real-time data point.

Most aspiring young investors follow a well-trodden path. Get good grades in high school; earn your way into a well-regarded university; study finance, accounting or any other business discipline; do an internship at an investment bank or related financial institution; take a graduate job at said firm. This is all with the intent to leverage this into a lucrative investment career on the ‘buy side’ – the irony of my own career path following this is not lost on me!

The problem with this is that it instils the idea that investment success is largely a product of analytical prowess. The more precise your DCF model, the more accurate your valuation multiple, the better your ability to read a balance sheet will all add up to making you a better investor.

Those who make it past the first few crucial years as an investor quickly learn that this is not the case. It’s hard to be a good investor without these skills – they are necessary and crucial foundational skills – but investing is a multi-layered, multi-faceted discipline that cannot be reduced to a formula. We believe those that understand this are the ones who make the leap from great analyst to great investor.

Does this makes detailed analysis redundant? Absolutely not. Big insights are rare and often only come after deep analysis of a business or industry. The paradox being big insights are often a prerequisite for ‘multi-bagger’ outcomes, but they only come from the amalgamation of many smaller insights over a long period of time.

Warren Buffett once quipped that his best ideas have come when he is in the bathtub. Despite it not being a magical bathtub (although that would explain a lot), you can imagine it acts as the melting pot for the thousands of small ideas that Buffett has accumulated from his deep study of many businesses and industries over many years to come together as bigger insights.

Big Insights Shared

The Nomad Partnership letters from Nick Sleep and Qais Zakaria have been a big inspiration over the years and in particular their prodigious study of the scale economies shared business model that they successfully (and very profitably) applied to CostCo and then Amazon, the latter as early as 2004. This quote from the interim 2007 Nomad Partnership letter captures their big insight well.

“Nomad has an investment in Amazon for more reasons than the firm’s simplicity of operations. But when this basic building block is combined with the scale efficiencies shared model (which increases the moat as the firm grows), customer centric orientation of the firm’s founder, as well as his healthy disdain for Wall Street, this combination makes us think that we may have a mouse that can turn into an elephant. To those who argue Amazon is large already we ask two questions: what do you think e-commerce will be as a proportion of US retailing in ten-years’ time, and what do you think it was last year? Write both numbers down and turn to the end of this letter for the answer to the second question.” 

Nomad Partnership letter, 30 June 2007

At the time of this comment Amazon had a market capitalisation of approximately $30bn. Today it is over $2trn.

An obvious retort is that these insights could have been applied to a multitude of businesses at the time and they just got lucky picking Amazon, the one that worked.

This might be true – indeed luck plays a role in almost every successful outcome in life – but it misses the point. Sleep and Zakaria spent many years studying a wide variety of businesses and from this came up with a very small number of business models that they believed had the potential to unlock significant value over time. This meant that when they came across Amazon, their arms were outstretched wide, waiting.

The same can be said of Li Lu, the legendary investor endearingly referred to as the “Chinese Warren Buffett”, who had the privilege of being the only outside money manager that Charlie Munger allocated capital to. Lu is renowned (at least in value investor circles) for his multi-disciplinary thinking and deep (deep) research. In a speech given at Columbia Business School in 2006 Lu speaks about the power of big insights, but only after extensive work has been done.

“In your life you probably won’t have more than five or ten insights, and you will develop them over years of study. 15 years ago I studied American companies, and now I find the Asian counterpart. Only by studying the company and industry for 15 years can I be sure to invest in them. If you have the insight, then you need to act with conviction”.

Li Lu, Colombia Business School speech, 2006

A small insight isn’t going to make you any money. A big insight on its own might – but it’s also known as a guess. Only a big insight built on top of thousands of smaller insights gives you a real fighting chance of being right and generating outsized returns.

The Big Insights at TDM

We’ve spoken about big money-making insights from other investors but what about TDM? Having compounded our client’s capital at c.25% p.a. for almost 20 years, we must have had at least one or two big, successful insights along the way.

One of our earlier successes was our investment in Baby Bunting, now Australia’s largest specialty retailer of baby goods. TDM invested in Baby Bunting in 2007 when it was a small family-owned retail business with 5 stores and under $30m in sales. We helped take the business public on the ASX in 2015 with 33 stores, $180m in revenue and a $250m market cap. Today it has 70 locations and generates approximately $500m in revenue (note TDM exited the investment in 2018).

What was the big insight that compelled us to invest in Baby Bunting? It came down to three things:

1. Our multi-year study of leading specialty retailers in both the US and Australia highlighted the opportunity for “category-killers” in specific verticals such as baby goods;
   
2. Unlike the US, there wasn’t yet a category-killing baby goods retailer in Australia and;
   
3. Baby Bunting had all the elements to be the category-killer in Australia.

Quoting one of our original investment memos:

Sam Walton said it best: “The secret of successful retailing is to give your customers what they want. And really, if you think about it from the point of view of the customer, you want everything: a wide assortment of good quality merchandise; the lowest possible prices; guaranteed satisfaction with what you buy; friendly, knowledgeable service; convenient hours; free parking; a pleasant shopping experience.”

The Baby Bunting offering nails every one of these key ‘category killing’ tenets. Whilst the formula sounds simple, the Baby Bunting offering has been developed over thirty years and is far superior to any of its competitors. This superiority continues to be demonstrated by consistent market share gains in its core Melbourne market, growing sales by 20% through a tough retailing period over the last twelve months.

This was a very profitable insight that allowed for one of TDM’s most successful investments.

But more than this, the experience gained from our involvement with Baby Bunting (among others) has proven pivotal in our more recent investment in Mexican-inspired QSR business Guzman Y Gomez (“GYG”). While our journey with GYG is far from over, it has been a highly successful investment to date – growing in value from c.$150m when we invested in 2018 to approximately $4bn today.

Having experienced first-hand the many challenges scaling a fast-growing retail business, we were in a strong position to identify the gaps and opportunities for GYG when the business first came to us. Not to mention the ability to leverage extensive relationships built across the Australian retail landscape.

At the time of making our initial investment in 2018 we said the following in a document shared with our clients.

GYG has many things we look for in an attractive investment opportunity:

• A business model that is potentially so robust and unique that it can disrupt an industry on a global basis;
• A global growth opportunity in the business’ core market which is so large that the business can grow at a high rate for at least 10 years; and
• A world class-management team and culture lead by co-founder and global CEO Steven Marks with significant ex-McDonald’s and other QSR experience.

We certainly did the in-depth analysis to accompany these insights – dissecting the unit economics, benchmarking to peers, evaluating penetration across markets, talking to franchisees, employees etc. However, none of this would have told us that the average GYG restaurant would go from making $2m in annual sales to >$5.5m (and growing) today or that the drive-thru format would be so successful (they had less than 10 at the time). This was a combination of 1) the big insights above; 2) strong execution (itself a factor of the management team and culture) and 3) some plain old luck.

Limitations of the Big Ideas Model

The main limitation of the “big insights” idea, and an extension of the “it’s all luck” retort, is that it can be used to justify anything. “Web 3.0 is going to take over the world” is indeed a big insight that has, at least to date, failed to play out. It is a truism that for a big insight to be a profitable one, the insight must be right. But this is unhelpful. How does one ensure that they are right?

In the complex world that we live in, this is an impossible question to answer. The better question to ask is borrowed from Jeff Bezos:

“I very frequently get the question, “What’s going to change in the next ten years?” And that is a very interesting question; it’s a very common one. I almost never get the question, “What’s not going to change in the next ten years?” And I submit to you that the second question is actually the more important of the two, because you can build a business strategy around the things that are stable in time.”

Perhaps this is the closest thing to a full proof prediction in our complex world today.

Alternatively, one can apply Charlie Munger’s inversion principle and ask “what are some big things being said today that have the potential to be just plain wrong?” This is an application of Mark Twain’s famous quote (a favourite of Howard Marks) “it ain’t what you don’t know that gets you in trouble. It’s what you know for sure that just ain’t so”.  

Finding things that the market “knows for sure that just ain’t so” could indeed be a fertile hunting ground for mispriced opportunities on both the long and short side. ²

This is a good segue into hype cycles, a term popularised by technology research firm Gartner. Gartner categorises the hype cycle across five phases: 1) technology trigger; 2) peak of inflated expectations; 3) trough of disillusionment; 4) slope of enlightenment and 5) plateau of productivity.

Phases 1) and 2) often involve big ideas and insights. Indeed, it is hard to reach a ‘peak of inflated expectations’ without these. The problem is that these big insights are likely already incorporated, often excessively so, into today’s security prices and therefore less likely to be profitable on their own.

Valuation Matters

A big insight is not a profitable insight if it is already priced into the stock. This is another way of saying that valuation matters. It always does.

One should not need a big insight to be 100% correct for an investment to pay-off. If this is the case, a sufficient margin of safety does not exist. Rather, we should be looking for situations where the risk of a permanent loss of capital is low even if the big insight does not play out as expected.

Granted there is some circularity in this argument as accurate big insights should improve the ability to assess the risk-reward profile of a business. But no one said this was supposed to be easy.

Apply this Today

So where might a big insight be today?

“AI will take over the world and touch every aspect of our lives” is a big insight. But it is also a widely known and accepted one. That’s not to say money can’t be made investing behind this thematic. But rather that this insight on its own is unlikely to be a profitable one and careful individual stock selection is required (it always is). I will reserve judgment on whether we are at a peak of inflated expectations with AI – the truth is, I have no idea.

At the risk of coming across as providing a non-answer answer, I will mention something that has recently caught my attention.

Our history with the GYG investment has given us both the need and the vantage point to closely evaluate the food delivery sector. The sector continues to attract debate as to both the sustainable level of growth in a more normalised, post-covid world and with this, the steady-state unit economics.

A recent quote from an analyst at brokerage firm Redburn in a report about Doordash caught my attention. He said (my emphasis):

“…we continue to face investors choosing to ignore the stock or responding with immediate retorts like “I don’t do delivery”. The sentiment reminds us of Uber over a year ago, with investors needing the ride hailing giant to prove its business model, only to now be viewing the stock as a utility like consumer bellwether with profits and strong FCF generation prospects.“

Doordash as a ‘consumer utility’ is a big insight that, if correct, has the potential to be a very profitable one. But will it prove to be correct? I have no idea and like all things predictive, that assessment is best left to the reader.

Footnotes:

1. Masters Invest – Learning from Peter Keefe ↩︎
2. TDM has not to date, nor does it intend to, engage in any form of short selling. ↩︎