One of our key concerns when managing our portfolios is the ongoing progress of building business value, especially for our “compounder” holdings. The gradual build‐up of business value continues over most periods, regardless of stock market fluctuations. Ideally, we want to see value creation manifest itself through revenue growth, earnings momentum and smart capital allocation decisions. However, reported results do not always show up in a smooth upward progression because of business cycles, market conditions and other factors. At a minimum, we want to see solid headway relative to peers. Great companies tend to take market share from their rivals over time and frequently make their biggest gains during times of industry turmoil. Top performing managers are constantly digging a deeper “moat” (competitive advantage) around their business and seeking new opportunities for growth. These moat‐digging exercises ultimately show up in greater earnings power and higher stock prices, but require a long‐term orientation.
“Pain now, gain tomorrow”
Virtually all great businesses engage in “pain now, gain tomorrow” activities. Not surprisingly, over time those companies tend to outperform peers that are managed to optimize short‐term results (i.e. make their quarterly numbers), which often involves the opposite behaviour – “gain now, pain tomorrow”.
Some examples of “pain now, gain tomorrow” activities within Pender’s portfolio companies include:
- Panera Bread (NASD:PNRA) and its heavy upfront “2.0” investments to embrace technology and increase customer convenience;
- Syntel’s (NASD:SYNT) transformation as it makes far‐sighted digitization and IT automation investments to better serve its clients;
- Platform Specialty Products (NYSE:PAH) with its front‐end loaded expenses to build out critical infrastructure as it prepares to become a much larger enterprise in the future;
- Wynn Resorts (NASD:WYNN) and the willingness to constantly elevate and redefine the best‐inclass luxury resort guest experience with its ambitious multi‐year developments.
All four companies are led by leadership groups that have made similar “pain now, gain tomorrow” decisions in the past, and which paid off handsomely for patient investors. With much of the “pain” now behind them, our belief is that these companies are nearing an inflection point for the “gain” period of accelerating revenue and earnings momentum. Although each company is at a different stage of their journey, we anticipate that these compounder holdings will be worth substantially more over the next three to five years.
We are also increasingly vigilant about the disruptive forces from technological innovation on business models. There are a number of businesses that will not face significant disruption by technology, such as those selling household products like soap and food products (Unilever), iconic time‐tested brands (Diageo) and insurance (Markel). At the other end of the spectrum is the set of companies that are leading the disruption, like Alphabet (Google), Uber, Amazon, Tesla and Netflix. Some of these companies operate in markets with “winner‐takes‐all” (or most) characteristics. Whether they succeed or not, it is probably not a good idea to get in their way!
In between these extreme groups there are a large number of companies which are facing threats from these disruptive changes to varying degrees. Historically, it is not uncommon to find incumbent enterprises that enjoyed highly profitable businesses driven by past economic and competitive realities fade relatively quickly after the paradigm has shifted. We believe this risk has only increased.
Warren Buffett is famous for saying that he wanted to own a company so great and enduring that even a “ham sandwich” could run it. However, those days are increasingly numbered in our opinion. We believe companies that are likely to do well increasingly require superior management teams that are likely to stay superior for a long time, embrace technology for both offensive and defensive strategies and are capable of adapting to dynamic change.
When weighing decisions about how to deal with disruptive technologies, we believe investing alongside management teams with a “pain now, gain tomorrow” mindset is more critical than ever. Previously successful business models are changing rapidly. The more quickly companies can adapt to the new realities, the greater the likelihood that they will survive and thrive.
This post has been excerpted from recent quarterly commentary by PenderFund Capital Management.
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