SUCCESSFUL LONG-TERM INVESTING WITH HIGH-QUALITY STOCKS FEBRUARY - - PowerPoint PPT Presentation

SUCCESSFUL LONG-TERM INVESTING WITH HIGH-QUALITY STOCKS

FEBRUARY 15, 2020

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Susan Christ, CFA Senior Vice President - Investments Hendershot Investments, Inc.

We seek to buy:

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INVESTMENT PHILOSOPHY

• HI-quality businesses
• Reasonable valuations
• To hold for the long term

What is long term?

• High-frequency trader = Nanosecond
• Day-trader = Between Lunch and dinner
• Uncle Sam = One year
• Hendershot Investments > Decade

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Our favorite holding period is forever. Only buy something that you would be perfectly happy to hold if the market shut down for 10 years.

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HI-QUALITY COMPANY CRITERIA

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• Durable competitive advantage
• Strong balance sheet
• Predictable growth
• Robust free cash flow

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COMPETITIVE ADVANTAGES = MOATS Durable Competitive Advantage

• Evidenced by consistently high ROEs
• Opportunities for market expansion
• Pricing power

• In

Inta tangibl ibles s

• Cost

t Advantag tages es

• Hig

igh Swi witchin tching g Costs ts

• Netw

twork

• rking

ing Eff ffect Moats or Durable Competitive Advantages:

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Patent nts s - Johnson son & Jo Johnson son Propri roprietary etary Techno nolog

• gy

y – Apple Strong Strong Br Brand d – Di Disney & & Pe Pepsico ico

In Intang tangibles ibles

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GE GEIC ICO

Cost Advantages

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UPS

High gh Swit itching ching Costs sts

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Networ tworking king Eff ffect ct

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“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.”

Warren Buffett

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HI-QUALITY COMPANY CRITERIA

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• Durable competitive advantage
• Strong balance sheet

with little or no long-term debt.

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The more cash and the less debt on the balance sheet, the better we like the business. Debt-free companies don’t go bankrupt!

Strong balance sheets

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“Companies with large debts often assume that these obligations can be refinanced as they mature. That assumption is usually valid. Occasionally, though, either because of company-specific problems or a worldwide shortage of credit, maturities must actually be met by payment. For that, only cash will do the job. Borrowers then learn that credit is like oxygen. When either is abundant, its presence goes unnoticed. When either is missing, that’s all that is noticed."

Warren Buffett on debt…

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Strong Balance Sheets

Company Cash & Investments Long-term Debt Shareholders' Equity Apple $207.1 billion $93.1 billion $89.5 billion Booking Holdings $11.8 billion $7.5 billion $6.0 billion Facebook $54.9 billion

• $101.1 billion

Genuine Parts $451 million $2.8 billion $3.7 billion UnitedHealthcare $51.5 billion $36.8 billion $60.4 billion

HI-QUALITY COMPANY CRITERIA

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• Durable competitive advantage
• Strong balance sheet
• Predictable growth

• Sales

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Predictable growth

• Earnings
• Dividends

HI-QUALITY COMPANY CRITERIA

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• Durable competitive advantage
• Strong balance sheet
• Predictable growth
• Robust free cash flow

Cash flow a business generates from its

• perations

less Capital expenditures to maintain and grow the business

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Free cash flow =

Robust free cash flow

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Seek intelligent capital allocation by managers who use cash flow to build value for shareholders

• Grow the business through strategic acquisitions
• Pay dividends
• Buy back shares at reasonable valuations

We seek companies with the ability to do all three!

Focus on Free Cash Flow

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Free Cash Flow Yield = Free Cash Flow per Share Stock Price Compare Free Cash Flow Yield to Alternative Investments

Focus on Free Cash Flow Yield

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Company Projected Free Cash Flow Yield

Apple 5.7% Booking Holdings 8.6% Facebook 7.6% Genuine Parts 6.9% UnitedHealthcare 6.3%

Focus on Free Cash Flow

Apple designs, manufactures and markets smartphones, personal computers, tablets, wearables and accessories. It also sells operating systems, services

like iCloud storage and Apple Pay, and a host of digital content from the popular iTunes store and other portals. Fiscal Year – Sept. 30 (000,000) 2019 2018 2017 2016 2015 Operating Cash Flow $69,391 $77,434 $64,225 $65,824 $81,266 Capital Expenditures (10,495) (13,313) (12,451) (12,734) (11,247) Free Cash Flow 58,896 64,121 51,774 53,090 70,019 Acquisitions (624) (721) (329) (297) (343) Dividends (14,119) (13,712) (12,769) (12,150) (11,561) Share Buybacks (66,897) (72,738) (32,900) (29,722) (35,253)

Booking Holdings is the world leader in online travel and related services, provided to consumers and partners in over 230 countries and territories through six primary brands-Booking.com, KAYAK, priceline, agoda.com, Rentalcars.com and OpenTable.

Fiscal Year – Dec. (000,000) 2018 2017 2016 2015 2014 Operating Cash Flow $5,338 $4,662 $3,984 $3,102 $2,914 Capital Expenditures (442) (288) (220) (174) (132) Free Cash Flow 4,896 4,374 3,764 2,928 2,782 Acquisitions (273) (553) (1) (140) (2,496) Dividends

• Share Buybacks

(5,971) (1,828) (1,012) (3,089) (750)

Fiscal Year - Dec. (000,000) 2019 2018 2017 2016 2015 Operating Cash Flow $36,314 $29,274 $24,216 $16,108 $10,320 Capital Expenditures (15,102) (13,915) (6,733) (4,491) (2,523) Free Cash Flow 21,212 15,359 17,483 11,617 7,795 Acquisitions (508) (137) (122) (123) (313) Dividends Share Buybacks (4,202) (12,879) (1,976) Facebook, Inc. operates the world’s leading social networking service through its flagship Web site, Instagram, WhatsApp and Messenger. The company’s Web-based tools allow users to connect and communicate with each other. The company had about 2.45 billion monthly active users at 9/30/19 and generates substantially all its revenue from selling advertising placements to marketers.

Fiscal Year – Dec. (000,000) 2018 2017 2016 2015 2014 Operating Cash Flow $1,145 $815 $946 $1,159 $790 Capital Expenditures (232) (157) (161) (110) (108) Free Cash Flow 867 658 785 1,049 682 Acquisitions (462) (1,495) (462) (163) (288) Dividends (387) (395) (387) (368) (347) Share Buybacks (181) (174) (181) (292) (96) Genuine Parts Company is a distributor of automotive replacement parts in the U.S., Canada, Mexico, Australasia, France, the U.K., Germany, Poland, the Netherlands and Belgium. The Company also distributes industrial replacement parts in the U.S., Canada, Mexico and Australasia through its Industrial Parts

• Group. S.P

. Richards Company, the Business Products Group, distributes a variety of business products in the U.S.

Fiscal Year - Dec (000,000) 2019 2018 2017 2016 2015 Operating Cash Flow $18,463 $15,713 $13,596 $9,795 $9,740 Capital Expenditures ($2,071) (2,063) (2,023) (1,705) (1,556) Free Cash Flow 16,392 13,650 11,573 8,090 8,184 Acquisitions (8,343) (5,997) (2,131) (1,760) (16,164) Dividends (3,932) (3,320) (2,773) (2,261) (1,786) Share Buybacks (5,500) (4,500) (1,500) (1,280) (1,200) UnitedHealth Group offers a broad spectrum of products and services through two distinct platforms: UnitedHealthcare, which provides health care coverage and benefits services; and Optum, which provides information and technology-enabled health services.

We seek to buy:

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INVESTMENT PHILOSOPHY

• HI-quality businesses
• Reasonable valuations

If you pay too high a price, even for a great company, your returns won’t be so great.

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After identifying a HI-quality company, the most important part of the investment equation is to only buy it at a Reasonable Price... as the price you pay will determine your return.

Reasonable Valuation

Intrinsic value = present value of the future discounted cash flows that can be taken out of the business over its lifetime.

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Reasonable Valuation

We’d rather buy a great business at a fair value, rather than a fair business at a great value

The three most important investing lessons are:

• 1. Think of a stock as part of

business and seek to own a group

• f high-quality businesses.
• 2. Use the stock market to serve

you, not to instruct you.

• 3. Always buy with a margin of

safety.

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Wisdom of Great Investors

Benjamin Graham

The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to

• ptimists and buys from pessimists.

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Wisdom of Great Investors

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• Mr. Market’s emotional roller-coaster

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Be Be fearfu rful l wh when others ers are greedy dy. . Be Be greedy dy when other ers s are fearfu rful. l.

Wisdom of Great Investors

Warren Buffett

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The investor’s chief proble lem—an and d his worst st enemy—is is likel ely y to be himself

• elf. In the end,

, how w your r inves estmen ents ts behave ve is much less s importa rtant nt than n how w you behave ve

Wisdom of Great Investors

Benjamin Graham

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A l A lot of people le wi with high h IQs Qs are terrib rible e inves estors rs becau ause se they y have terrib rible e temper eram amen ents

• ts. Yo

You need to keep p raw, irrati ation

• nal

al emotio ion n under r contro trol. l.

Wisdom of Great Investors

Charlie Munger

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Neuroeconomic Insights

• Uneasy coexistence

between our primitive brain and advanced neural systems

• Adrenal glands v. Neocortex

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Know your emotional triggers…

then understand rather than follow your emotions.

Fear v. Greed

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Understand rather than follow your emotions.

Price e fluctu ctuat ations ns have only one signifi ficant cant meaning ng for r the true ue in investor.

• stor. They provide
• vide him

im wit ith the

• pport

rtun unity ity to buy wisely when prices s fall sharply ply and to sell wisely when they y advance ce a gr great at deal. . Ben Graham

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Wisdom of Great Investors

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The he be best t way ay to to me meas asure ure you

• ur

in inves esting ting suc uccess cess is is no not by t by whether you’re beating the market but by whether you’ve pu put int t into

• pl

plac ace e a f a fin inan ancial cial pl plan an an and a d a be beha havio iora ral l di discip ciplin line e th that at ar are e li likely ely to to ge get t you

• u whe

here e you

• u wan

ant t to to go. go.

Wisdom of Great Investors

Benjamin Graham

In the short rt run, the market et is a votin ing g machin ine, e, but in the long run it is a weighi hing g machin ine.

Ben Graham

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Wisdom of Great Investors

The he th three ee mo most t im impo portant tant wor

• rds

ds in in in inves esting: ting: “Margin of Safety”

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Wisdom of Great Investors

Rul ule e #1 #1: Nev ever er lo lose e mo mone ney. Rul ule e #2 #2: Nev ever er for

• rge

get t Rul ule e #1 #1.

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Wisdom of Great Investors

1. 1. If f the business ss funda damental mentals s deteri eriorate

• rate and the

problem doesn’t appear temporary. 2. 2. If f the stock ck price e moves s signifi ficantl cantly y ahead of underl rlyi ying g business ss value, e, trim im the positi ition. n. 3. 3. If f we we see a su substanti stantiall ally y better ter investment stment

• pport

rtun unity. ity.

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Selling Criteria

“If the job has been done corr rrectly ctly when a c common n sto tock k is purc rchased, sed, th the ti time me to sell is almost never.”

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Wisdom of Great Investors

With HI-quality stocks sporting free cash flow yields significantly higher than low-yielding bonds, investors should follow the cash to build an investment stash!

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