TIP680: Investing in Exceptional Businesses for the Long Run w/ Dev Kantesaria
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You're listening to TIP. On today's episode, I'm joined by Dev Kansasaria. Dev is the founder and portfolio manager at Valley Forge Capital Management. The firm has been highly successful since its inception in 2007, as it's outperformed the S&P 500 by a wide margin and has over $4 billion in assets under management.

During this episode, we covered Dev's view on the current market environment and the recent stock market rally, how Valley Forge adopted Warren Buffett and Charlie Munger's investment approach, why predictability and pricing power are essential parts of his long-term approach to investing, why Dev has decided not to invest in any big tech companies as of the time of recording, and why he'll continue to invest in US large cap companies despite the optically higher valuations relative to their international counterparts,

why Dev loves compounding machines that allocate capital to share repurchases, and so much more. Dev is extremely thoughtful and is truly passionate about educating people on how to be a great investor. So with that, I hope you enjoy today's discussion with Dev Kansasaria.

Celebrating 10 years and more than 150 million downloads. You are listening to the Investors Podcast Network. Since 2014, we studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now, for your host, Clay Fink.

Welcome to the Investors Podcast. I'm your host, Clay Fink. And today we have a very special guest for our listeners, Dev Kantasaria from Valley Forge Capital Management. Dev, welcome back to the show. Thank you. Happy to be here.

Robert Leonard : So I've wanted to bring you back onto the podcast for quite some time. You started your firm in 2007, and you've outperformed the S&P 500 by quite a wide margin since inception. In preparation for this interview, I heard you state two years ago that during the most recent bear market, you were on record for saying that quality, predictable businesses will be prized again. And here we are with many of your holdings performing exceptionally well, most notably

FICO, which is a top holding according to your most recent 13F, and it's up over 100% in the past year. But markets overall, they feel like they can go nowhere but up. The S&P 500 last year rose by 24%. And year to date, as of the time of recording, we're up another 24%. So what are some of your general thoughts on today's market? And are you able to find opportunities to deploy capital?

Although there's a lot of different things people discuss, that's moving markets, elections, GDP growth, Federal Reserve policy. I think that what's been the driver over the last couple of years is having more clarity around inflation and interest rates. And I think we can confidently say that we have passed the peak. We're on the downtrend. We don't know the timing of when interest rates will decline further, but it's our strong view that that'll be the direction of interest rates.

in future Federal Reserve policy, in central banks actually around the world. If you put interest rates into perspective, you're too young, but you go back to the early '80s, mortgages were 18%, 20% a year. So people often get worked up about whether interest rates are 5% or 4.5% or 3.5%. The way we look at things is that we're in a low range and we expect that range to go even lower. When interest rates are low,

That means that the interest that you earn from your cash, from your bonds, is less competitive with equity earnings yields. And so equities look more attractive in comparison. That's really been, I think, the story with equities around the world. And we should expect to see more of that. So I think the backdrop for equities, particularly those that provide strong organic growth over the next five to 10 years, is extremely attractive.

And we've seen things like Buffett selling down his Apple stakes, selling down stakes like Bank of America. Given what you're seeing in the market, maybe some frothier areas, is this a time where you're looking to potentially build more cash or do you just take timing largely out of the equation? For us, market timing has been a poor way to generate returns over the long term. Generally, U.S. equities trade in a range of reasonableness.

I have to go back to 1999-2000, the dot-com bubble when things got extremely out of hand. Getting worked up about whether a company has a PE of 24, 28 or 32 is far less important than making the right decisions about what companies you buy. And if you buy a great compounding machine,

Over the long term, that type of intrinsic value growth overcomes whether you've overpaid by 10% or 15% on the positions that you're buying. So this idea of bringing great precision to valuation, I think is a silly exercise because at the end of the day, we're trying to predict the future. And that's an inexact science.

Yeah. I think it was Buffett who actually said, I can't remember exactly who stated it, that it's better to be more broadly right than precisely wrong, especially when it comes to things like valuation. And during your previous discussion on our show here a few years ago, much of the discussion revolved around Buffett and you're a huge Buffett fan yourself. And I can't help but kind of compare your investment approach to someone like Buffett and notice

just how valuation-oriented he can be, at least relative to current earnings. So he paid around 11 times earnings for Apple in 2016. And he seems to really hone in on securities that are really out of favor. So you look at the basket of Japanese stocks he bought, Occidental Petroleum or Chevron. I'm curious if you would agree that he might be more valuation-oriented when looking at current year's earnings, and maybe if there's any other key differences that you might highlight when comparing your approach to his.

Sure. So my inspiration, the playbook that we employ at ValueForge all derives from Buffett Munder. I've been studying public equity since I was eight years old. So that's a very long time at this point. And I wish there were easier ways to make money. I wish I could trade gold bars. I wish I could predict where the price of oil was going to go. I wish I could invest in Bitcoin at the right time or just ride a momentum stock. But as you look over time, what works and also what's tax efficient, which matters in long-term investing,

There's no playbook better than the Buffett Munger playbook. And that playbook is quite simple to describe. You own very high quality businesses. We define quality as finding the perfect intersection between growth and predictability. You can have companies that are growing very fast, like a young software company, but you're not sure where it's going to be in five or 10 years in terms of market share or industry dynamics, or you can find a company that's extremely predictable, like Nestle or Hershey or

but they're growing organically at only 2% or 3% a year. In neither one of those situations, deliver strong returns over the long term. If you could find companies that are growing at a much higher rate, but predictable, those are the types of compounding machines that you want to own. One of the favorite things that I own is an annual report from Coca-Cola from 1928. That report I like in particular because it has a lot of graphics and it shows the vine growth of Coca-Cola from when the company started through 1928

and just unbelievable growth. They also show per capita consumption of Coca-Cola. So in only six years, the amount of Coca-Cola per capita in the US consumption doubled. And I can't think of a product where in six years it's used twice as much as it was than before. And so you look at what Coca-Cola represented in 1928, it was obvious for everybody to see why were people not piling into Coca-Cola? Was it valuation? Did they feel like it had saturated its market? But

but what Coca-Cola had was another 50 great years ahead of it. We're trying to build a portfolio that on a weighted average basis can grow in the high teens to low 20s over the next decade, but can do it in a very predictable way. If you look at the average, the median S&P 500 company for the next 10 years, it's going to grow in the low single digits organically. We have a portfolio that we think can grow four times as fast

but to do it in a very predictable manner. And so finding that type of work and growth is, again, we're trying to predict the future. And so it's great if others don't agree with us because we're not trying to figure out the best way to make money over the next year or two. We're trying to find the best way to make money over the next five to 10 years. Things that Buffett has bought more recently are not attractive to us.

Just because we share the same playbook doesn't mean we necessarily agree on the companies that we buy, like an oil company or a bank or Apple are not attractive to us today. But he has different problems than we do. He has to put a lot of money to work.

So he's looking at mega cap companies. But we're also looking at generally large US cap companies. And that's because those are generally very dominant businesses. They're monopolies or duopolies in their respective industries. So that generally means that they're mid cap to large cap. So it's difficult to say what he likes at the moment or why he's raising cash, but we're using his playbook, but we're employing it with a different set of names.

Robert Leonard : The two words you mentioned there at the start were predictability and organic growth, and then there's plenty of what ties into that. So what sticks out to me is just this very long-term focus. And predictability is something that only a few investors probably put as much of an emphasis on as much as you do, is what I would say. So could you talk more about why predictability is such an essential part of your investment process and how you came to this critical realization?

Simply stated, we hate to lose money. It pains me to lose a single dollar and of course, we can't always be right. But if you buy in with this concept of margin of safety, it means that even if your assumptions aren't exactly right, that you can still get your money back, you can walk away with a small profit. So predictability is not something that we sacrifice at Dollar Forge.

We're happy to give up some growth in exchange for predictability, but the idea of us investing in something that could go down 90% tomorrow, that's just not our fishing pot. Those are not the types of businesses we own. We'd like to buy things where the industry dynamics and the business model has already been successful over decades. That's not the case with every company we own. And then when we enter the business,

I would say one third of the time, it's because the stock has significantly dropped and there's a misunderstanding about an issue and we disagree with how the rest of the world is thinking about the company. Two thirds of the time, surprisingly, the opportunities we find are what I call market neglect. And this happened with FICO six years ago. It's sitting there in plain sight. No one is paying attention. It might sound outrageous to think that these mid and large cap companies are just given how many people are trying to work in public equities today.

things are just sitting there in plain sight to be taken advantage of. But that was the case with FICO six years ago. And it happens quite often where we see something, a change in pricing power, an improvement in intrinsic value, that even a business that's been around for 50 years, they morph over time. They're not always the same. Business quality can get better or worse. So we continue to find these disconnects. There's no dearth of opportunities. And we want to own our eight to 12 best ideas. As I've said many times before, by the time we get out to our 17th best idea, we're not

We're not very happy with the risk-reward proposition. Tying into predictability still here, a lot of eyes are on AI and how AI is going to change the world. Who's going to be the winners? How is that going to affect all these big tech companies? Everyone knows these big tech companies are extremely dominant. They seem to only get bigger and bigger. And it's hard to argue against the investment case for many of them, just looking at the business quality, for example. What are your thoughts on big tech, AI, etc.?

Big tech, they're above quality business models, right? Google search is an amazing business model. And AI has given the big tech companies another growth driver for the next few years. So I expect the NVIDIAs and the Googles and the Microsofts and the Amazons of the world to do well for the next few years. The concern that I have is what happens after that. And it's our view that AI becomes commoditized. And then it becomes difficult for these companies to monetize their AI offerings. We

We can see today that in terms of R&D expenses and capital expenditures,

that those are going up exponentially because these companies are fighting each other ruthlessly to stay ahead of the others. So a few years out, if an off-the-shelf AI program can do 98% of all the tasks, the human tasks in the world, how do you differentiate yourself? How do you monetize that? And so as we look out five years from now, seven years from now, 10 years from now, it's very difficult to know who the winners will be in AI.

From both the hardware perspective and the software perspective. So we can't argue with what they've been able to deliver and the earnings they've been able to produce. And I think that Cardi continues for a few years, but I think it will have a bad ending for most people because it's very hard to predict the one or two companies that are the real winners here.

In one of your previous shareholder letters, you outlined the essential qualities of a great equity investor. Our listeners who were born here in the US, like myself, they might have heard a similar story to me growing up where we were told if we work hard, go to school, get good grades, find the right mentors, then we can succeed in life. However, when it comes to investing, you actually argue that this simply isn't the case.

you even made the bold claim that 99.9% of the active management industry adds zero value. So talk more about why being a great investor isn't as simple as maybe some make it out to be.

Yeah. So I know this is a provocative statement, but it is my belief that the vast majority of the public equity management industry is simply random statistical noise minus fees. And that's a real disservice to underlying investors and allocators. In terms of people that can add true value in public equities, I don't know the exact number, but it could be less than 15, less than 12, maybe even less than five.

that over a 20 or 30 year period had true alpha. And so it is an interesting question because I think every, I like to call them dads, every dad in the world has their own stock portfolio, including my dad in the past, and public equity investing is readily accessible. Today, anyone can open up a brokerage account, commissions are nil. And so it's very easy for anyone to become a public equity investor. Preston Pysh :

But as I stated in that letter, very, very few on the planet can outperform. And what are some of the reasons for that? And that's what I was trying to get. I don't have the perfect answer.

but a lot of it goes to how you're constructed in terms of your emotional intelligence, your personality, certainly some of the things as it relates to how you grew up. What common theme I find with great value investors is many of them have grown up in frugal environments. So on Saturdays, if you're going out to look at your Ferrari collection in your garage, that probably doesn't match up well with someone that's trying to find deep value

Monday through Friday in their day job. Yes, we have summer interns from the top universities in the country. It's the first question I asked them is that 99.9% of your peers, you all have close to perfect GPAs, you have close to perfect essay key scores. I know that all of you work very hard, but why is it that 99.9% of your peers will end up being mediocre public equity investors? So there's a lot of themes that go into it. I think a very important part of this is having the right mentor

Buffett talks a lot about Graham as someone early on that had an influence on him. So I think learning from the right mentor, I think could be very important. I think how you grew up, I think just genetically how you're engineered, you need extreme delayed gratification.

So when they do the marshmallow test with like three to five-year-olds, that's like 15 minutes of delayed gratification. I'm talking about delayed gratification that is potentially decades. When you're in the first grade working hard in school, it's tough to talk to a little kid and convince them to work hard on their homework every night because you're working on something that isn't immediately tangible, right? What job you're going to get when you're 22 years old

try to explain that to a six-year-old. In public equity investing, to be successful, you really have to have these sort of long timeframes. Because if you focus on the near term, you will have a lot of information that points you in the wrong direction. The decisions that you will make will be wrong if you don't have the right time horizon. With my personality, I don't get happy when the market goes up. I don't get sad when it goes down.

I can be unemotional, disciplined, take advantage of fear. And so it's a very rare personality type. I think it's potentially one out of 5,000, one out of 10,000. I don't run it to a lot of folks that like to watch paint dry on a wall. I actually do. And I get great satisfaction from knowing that we're making decisions that may not pay off for five plus years.

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All right, back to the show. So I've been an avid listener of this show since 2016, 2017. I've been a host for a few years now. And just looking at my own experience, it almost feels like getting a lot of these basics down can be learned. Things like delayed gratification, patience, discipline, just some of these basic traits. But then you talk to a lot of people in your day-to-day life, and you can just tell that a lot of people are just

wired differently. No matter how many times you say something where you're not thinking about taking a short-term game, you're thinking 10 plus years out. And it's just like, no matter how many times you say that, it just doesn't get through to people. So you built this team at Valley Forge and have been quite disciplined, I'm sure, in who you led on board and

After talking with so many investors, there's so many of them that can talk the talk, but they can't necessarily walk the walk. So it can be sort of hard to see through who truly is or has the capability of being a great investor. So how do you identify the right traits when you're hiring? It's extremely hard. The interview process is always short. So you might be able to meet someone three, four, or five times. They don't want to meet with you 10 times. So you have a limited amount of time to get to know someone. You

You sort of see really what attracts them. If they like trading cryptocurrencies on the weekend, they like biotech stocks, they like quick gain. If that's something that makes you happy, I feel a bit guilty about making quick gains. Now with FICO, that's a problem because I was up 100% last year and 100% this year. I feel a bit guilty about it. The company deserves it, but I would much rather be the turtle in the race. So I'll take it when I can get it. But

It's extremely difficult. It's like finding a needle in a haystack and

I'm sure Buffett and Munger have struggled with that as well. I think that you want to find someone that has a personality that want to be mentored, where they're still pliable. And again, you could teach them all of the right lessons, but if they're wired to enjoy short-term gains and don't have that delayed gratification, they're just going to go back to day trading biotech stocks. So there's no magic formula. But yeah, finding someone with the right temperament, patience, outlook,

it's extremely difficult. And I think with young people today, I sound like an old person, you know, kids are very short-term in their thinking. I'm based in Miami and I'm going to be speaking at the University of Miami and they were saying that how difficult it is to even get 150 kids to show up for an event. I mean, putting aside me, I mean, they've had really famous people come and they can't, you know, unless you're like an Instagram influencer with 10 million followers or a famous sports star or something, you can't even get the attention of kids today on

just talking about serious intellectual matters. So I don't know, but every generation will have its set of new investors. I think the key, even as you get older in the business, is you have to learn from your mistakes and you have to be open to constantly taking in new information and evolving. AI, although it'll be difficult to pick the winners in AI, it is a game changer for society and for business.

And to simply put your head in the sand and say, well, I don't understand technology and I just, I can't factor it into my thinking. I think that could be a dangerous way to move forward. So we have to take into account always how the world is changing around us.

Your comments around temperament reminded me of one of your points in your letter you wrote, although we can suppress for a time our natural inclinations, we usually revert to them when given the opportunity and setting. For maybe some of our newer listeners of our show, they might feel like they know what temperament is, but it hasn't been discussed in depth here on the show. How would you define temperament and what makes for a quality investment temperament if there is such a thing?

Yeah, I think anyone who has kids and maybe a lot of kids, so they have a big sample set, they'll know that even from an early age, they have a personality. And that personality doesn't change very much. With my kids, the personalities that they had when they were six months old, two years old, four years old, eight years old, ten years old, it really hasn't changed at its core. Yes, they're going to have life experiences that will alter them but I don't really know how much is genetic. I don't have a mathematical ratio.

But certain people are just wired the way they are, observing how their parents think about money, how they think about investing, the environment they grew up in, whether it was a liberal spending environment or a very shrewd spending environment. They all factor in. People can have life-changing moments. And one time I was...

stuck in the library at MIT between classes and just going through the book stacks. And I came up on a whole section on Mahatma Gandhi. And for me, that was a life-changing moment, both in terms of outlook and personality and a lot of things. So, certainly open to the idea of people evolving and changing and having these sort of great realizations. But a temperament is probably largely, by a certain age, really largely set. And it's

You know, when you're at the dinner table and you're not supposed to chew with your mouth open and you're supposed to not be loud, those are sort of suppressed learnings that you have from society, from your parents and your peers. But that may not be your natural inclination. Your natural inclination may be loud and boisterous at a dinner table. So I think often at companies and large group settings, people's natural inclinations are not evident. They're suppressed because they're told how they should act or how they should be. But when they're left to their own devices, they

They do revert to their natural personality. And that's what's interesting about our business is that you often hear about somebody working with another investor, a famous investor, and then they go out on their own and try to open up their own shop. I'm not sure that that track record is very good for people that go out and try to start their own thing.

Certainly, I think people are expecting more of the same, but in a group dynamic, people are a bit different than when they're on their own. So I don't think that's a satisfying answer for what you're asking, because I think we want a badly engineered temperament to be more successful in public equity investing. But that's why index funds are amazing. I used to live in Nauvart, Pennsylvania, the home of Vanguard.

And for 99% of people, an index fund is a beautiful thing. It takes out the emotions. It's tax efficient. It forces the behavior that most people don't have. And I think that's why index funds continue to gain traction over time. But there is a subset of people that I think can add tremendous value in public equities. And if you could find those people like a Buffett from 50 years ago, I mean, what a great ride that would have been.

Tying back to what you would look for in an analyst, I'm sure you probably ask them about some of their early experiences and what they were drawn to. So you talked about in your letters how when you were a child, you were just engrossed by the workings of each business you encountered, the local newspaper, community bank, the local restaurants, bowling alley, you name it. So can you talk more about how your early experience and that deep interest in business has helped carry you forward to being a successful investor?

One of the errors that I see in public equity investing is that people have already decided where they want to invest, what they find attractive, and they focus all of their energy and time on just those specific areas. I think to be a great public equity investor, you have to love business in general. Just because you believe that pizza shops are not a good business, you should love thinking about a pizza shop.

It's cost of goods, it's labor costs, it's rent, the competition, what it costs to deliver the pizza, the price of gas. I've loved since I was a little kid, every type of business. FICO is fun for me to analyze, but I would have just as much fun analyzing Nestle or Pfizer or chemicals company or an energy company. I love all types of businesses and wherever I go in life,

I'm constantly thinking about it. It just envelops me. For me, it's fun. It's an interesting mental exercise. I quiz my kids about it. And I think Buffett is like this. I believe he reads about hundreds of companies that he knows that he probably will never invest in. But for him, it's fun and it educates him about business in general, about what not to do, what characteristics are negative for a great business long term. And so, I think a mistake that I see with a lot of young kids at universities,

universities, they're involved in these business plan competitions. They find a few companies they like, and then they already have a preset notion of what industries are great. And I think that's absolutely the wrong way to grow and develop as an investor. You should want to get your hands and learn about every single business on the planet, whatever you could get your hands on. So I get as much joy and fun out of reading about any business or any industry on the planet.

Robert Leonard : Yeah. I mean, certainly a hallmark of a passion for investing and studying businesses. A bit earlier, you mentioned that you hated losing money. And if we look at sort of at a high level, the two ways an investor can make a mistake, we can characterize them as type one versus type two errors. So type one errors are those where you make an investment that you thought was good, that turns out bad.

Or a type two error is those in which you don't make an investment and it ends up being a mistake not to own it. And Buffett refers to these as mistakes of omission. And I think many newer investors fear missing out on the next NVIDIA, the next Tesla, the new AI or EV IPO. But after speaking with so many successful investors here on the show, it's pretty clear that the focus on not losing money is essential instead of worrying about how one can get the biggest upside. Robert Leonard

I was curious if you could speak more to this because it seems fundamental to your approach. Yes, I would say in a type one category, you know, I think people take away the wrong lessons from their mistakes. They might have been in the Great Depression. I've never experienced something that harsh, so it's easy for me to say. But you might have taken the stock market crash from the 1920s or the decade that followed

as a learning lesson and then you decided that you're just simply going to keep all of your money in cash under your mattress for the rest of your life. And that would have been a bad lesson or the wrong interpretation of the mistake. And so, I have seen many times where somebody loses money on a company, they make the wrong bet on an industry and then they make these very blanket conclusions.

I'm never going to touch that industry again or I'm never going to do that again. Usually, the learning lessons are far more nuanced. So you have to be very careful about your mistakes and the lessons that you draw from them because you may over interpret what has happened. In the second category, generally, the mistakes of omission have far higher magnitude than the type one mistakes. If you miss a great compounding machine, maybe you thought at the Microsoft IPO that you

that a PE of 35 is too expensive and you'd rather buy the company that makes washing machines at a PE of 12. What a tragic mistake that was, right? So, the mistakes of omission are always in terms of magnitude and impact always a lot worse. But there again, you have to take a time machine back to that point in time and understand why was it? Was there a risk that doesn't exist today?

was there an environment that made the opportunity less obvious. But I go back to 1928 Coca-Cola annual report and I don't know why every single person on the planet didn't own Coca-Cola stock at that time. Maybe you could have somebody call in that lived in 1928, they'd be pretty old at this point but you see it over and over again where there's things that are obvious

For me, a big omission was the big tech companies. I knew that Google search was a powerful business model. I knew that the Apple iPhone or the Microsoft Windows and Office Suite were powerful. These companies generally were poor capital allocators. There was no predictability around their capital allocation. There was often dual class stock structures where the businesses weren't necessarily being run to maximize shareholder value. But these business models were so strong that they overcame some of the sins.

that kept me from these businesses. But not owning these big tech companies 10, 15 years ago, that's certainly a big omission for me.

You mentioned, say, the Microsoft IPO as an example and highlighted how expensive-looking companies can still make exceptional investments over very long time periods. When you're looking to enter a position, typically, how far out are you typically looking just to sort of get a sense of, A, just how predictable is the future? Looking out 10 plus years can be very difficult for the vast majority of businesses. And yeah, I'd just be curious to get your thoughts on when looking at these great, great companies,

How far out is a reasonable time period in doing some of your modeling work? Yeah, for me, it's 10 plus years. So as Buffett describes, if the stock market were closed for 10 years, and I come from a venture capital background, I understand what's involved in owning a private company.

But if the stock market were closed for 10 years, there was no way for somebody to tell you what they're willing to pay for your business. Are you confident with your analysis of intrinsic value? Are you comfortable that you're making, you're interpreting the information the right way? But I don't need a traded share price every day. I don't need it every few years. I don't need it every five years. So I'm very much a purist. But if I'm not comfortable with the industry dynamic and the company remaining in a dominant position for at least the next 10 years...

it doesn't meet our bar for predictability. Robert Leonard If I were to put myself in the shoes of many of your investors, I'm sure you've gotten countless questions about valuation, what you do when the market realizes just how great some of these businesses are. Of course, FICO is one example, and we could probably point to a couple others in the portfolio. How do you think about when the market within that first 10-year time period, say, for example, really marks up the prices and bakes in some generous expectations? Robert Leonard

Most of the time, our businesses trade at a rate of reasonable risk. And if you believe this is a combining machine that will

generate phenomenal intrinsic value for you for the next 10, 20 years, you wouldn't sell it because it moved from a PE of 26 to a PE of 29. I think the mistake that a lot of people make is they fire up their Yahoo Finance or Bloomberg machines and they look at forward multiples. And for businesses that are very predictable, that are low growth, those forward multiples are pretty accurate. So the forward multiples for a candy company or a Nestle consumer goods are

Procter & Gamble, those four multiples are fairly accurate. But when you're dealing with high organic growth companies on a forward basis or special situations that are happening, the four multiple is inaccurate. And if people are using these four multiples to make decisions, they may think something is too expensive. Without getting into a lot of detail, the FICO four multiple is high. But what they're missing there is the operating earnings power from the mortgage scores business.

And we know that mortgage scores volume has been down for the last few years. But if mortgage scores volume returns to previous levels, which it will, we don't know the timing, and you factor in the recent price increases that they've made to mortgage scores, which was 100% last year, another over 40% this year, and you just do some simple math, that's massively accretive to their bottom line.

And so the multiple that exists today that the analysts are putting out there doesn't factor in these special price increases, doesn't factor in then this mortgage volume returning. They add those things when these things actually happen. They don't take a lot of risk with predicting these factors. So you have to be very careful with using Ford multiples for the next year or two to determine whether something is expensive or cheap.

Robert Leonard : I'm reminded of Mark Leonard's letters from Constellation Software. To figure out the change in the intrinsic value, he would take the return on capital and add in inorganic growth, or in many cases, just price increases. So that's another thing that sticks out to me about your approach is just pricing power. Pricing power is the hallmark of a great business, is I believe what you've stated before. So

So maybe you could talk more about that because pricing power just from an intuitive level of Coca-Cola or whatever business can simply just take up prices. And a lot of that flows down to the bottom line. That's an infinite return on capital. So maybe you could shed more light on that.

If you're providing an essential product or service, you should be able to raise your prices above the rate of inflation. As it relates to protecting yourself from inflation, which was a big concern over the last year or two, the best way to do that is to own a company with pricing power. So if inflation goes to 10%, you want a company that can raise its prices 13%. You also want a company that has very little in the way of reinvestment needs, which is also our strong preference when owning a great business. But pricing solves a lot of problems.

You may have some softness in volumes during a recession.

There may be some short-term headwinds, different kinds, but if you have control over your pricing, that is an amazing tool to have as a company. It can be overused. So if you're having problems with secular volume growth in your industry, and you're simply trying to overcome that with pricing too aggressively, that can backfire. But generally speaking, a great business should be able to raise its prices a few percent above the rate of inflation for a decade plus, preferably 20 or 30 years.

And that's an amazing contributor to compounding intrinsic value year after year.

So, we look for that but not every company has the same level of pricing power. They always talk about Coca-Cola as an example of price. If they just raise the price of syrup by any, my God, think of how much profits would drop to the bottom line. Coca-Cola has raised prices over time but it's not been that consistent or that aggressive. It's good to know that there's this latent pricing power that they have but sure, at a certain point, if they raise prices too much, people would switch to Pepsi or Seacole. I don't know if Seacole even exists anymore.

But we like to buy businesses where the service or product that's being offered is already to begin with low in price and is essential so that when they're raising prices, it's still relative to the benefit it provides, the price is still minimal.

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Another key characteristic when I look at your portfolio is I see a lot of monopolies and duopolies, which certainly helps when it comes to pricing power because new entrants aren't able to enter at a lower price. I'm curious when it comes to duopolies, what is it that keeps this homeostasis where each of the players is both happy, but also getting marginal benefits with these pricing increases and such? And how can they continue to innovate and just continue to grow market share without

like going after the other player.

Yeah, so it's interesting. You would think that if you simply bought a duopoly or oligopoly that profits would just rain down from the sky. Even monopolies, there's a company like Broadridge that has control of almost all proxy voting and they're an above average business, but not a great compounder of intrinsic value long-term. I've written about this in letters, but you could have Boeing and Airbus, a nice duopoly, but there's a lot of issues with the businesses that keep them from being great compounders.

There's a lot more at de-risk, it's capital intensive.

They have labor issues, they have government subsidies. You have in the US here, UPS and FedEx. You would think that with e-commerce package delivery increasing every year, that that would be an obvious duopoly. And those are above average companies. We in the past, we own Nike, we own Monster Beverage. Monster Beverage and Red Bull had a very nice duopoly. It's still relatively a rational oligopoly, but they don't follow each other on price-wise.

like they have in the past. Nike, Under Armour, Adidas, that could have been a nice oligopoly, but they got aggressive in fighting for market share. So it's not as simple as just going out and fighting a duopoly or an oligopoly. I wrote in the past about the potash market, which was a very nice sort of cartel. I won't call it an oligopoly. It was really like a cartel. And one member had irrational behavior and sort of ruined the potash market for a while.

I think that dynamic has improved. There's just no easy way to just have rules around what is investable and what is not. What do you think is the most underrated aspect of your investment approach besides just this long-term view and focus on exceptional companies? What do investors get wrong when thinking about your approach of buying and holding these compounding machines?

Well, I think the complexity of the decisions that we make is far greater than what it would appear to an outsider. If you have a company that you've owned for 15 years, the assumption is that's a static situation, that you're not really following it. But there's this idea that there's maybe some complacency around it. We think about our companies every day, even the ones that we've held for 15 or 17 years, about subtle changes to business quality, both up or down,

They compete with the other companies in the portfolio, how they compete with things that are short list. We're very aggressive about the expectations we have for the companies that we own. So people should not misinterpret low activity with complacency because we're big animals. We're sort of vicious in how we think about companies. There's no emotional attachment.

I would also say the complexity that goes into the decisions that we make on a going forward basis. So do we want to buy more of something that we already own? Do we want to add something to the portfolio? Dozens of risk factors that go into a risk reward decision. Those are all in the future. So there's no nice spreadsheet you can make as to how those factors are weighted and what matters the most. But

I think we are good at when you have a large set of information. And today, I would argue there's too much information. I think we are good about honing in on the two, three, four things that truly matter for the next 10 or 20 years. And do not get distracted by short-term events that a lot of other people get caught up with.

Robert Leonard : You mentioned thinking about your holdings, even if you've held them since the inception of your fund, even 17 years ago. How much time are you spending on your current names relative to reading up on other companies?

I don't have a specific number for you. Obviously, the companies that are in the portfolio and the ones that are on the short list, we are following extremely closely. Great business models don't get created very often. About more than 2,000 companies came to market with the IPO SPAC craze a couple of years ago. And our hope was that that would bring a lot of interesting new business models to the market.

A lot of those companies were young. They probably shouldn't have gone public in the first place. But as you look through that listing, we tried to look through as many as we could. There's not a single business model in there that holds a candle to something like the FICO, Consumer Credit Score business. That's been around for 50 years. So great new business models are extremely rare. So yes, we try to look at a lot of things. We don't spend a lot of time looking at things that we know inherently lack the predictability we want. So if you're developing a new drug,

and you're at clinical trials and there's regulatory issues and competitive issues and patent issues. We don't spend time reviewing biotech companies or drug development companies. They just inherently lack the predictability that we need to see. And so, yeah, it allows us to be a bit more focused in what we want to do. I'll do that for fun because again, I just like reading about companies for fun, but it's not part of what we do every day at Valley Forge.

You mentioned owning a business for 10, 15 or more years. And since your fund's inception in 2007, you've owned S&P Global. And many people talk about buying and holding great businesses for long periods of time, but very few can actually speak to that experience. And you've even added to S&P Global as recently as Q2 2023 as of the 13F filings. So what are some of the key learnings from owning a stock like this over a 17-year time period looking back today? Robert Leonard

Well, I'm fortunate to have been at the right age to see both the dot-com bubble of 1999 and 2000 and the financial crisis. I think that every great investor should go through a few of those periods. The debt rating agencies, there was just nothing positive you could say about them in March 2009. They were being sued, Congress hated them, they were front page of the Wall Street Journal every day, be blamed for the financial crisis. Debt issuance had plummeted

If you brought up Moody's or S&P over dinner, I mean, people just rolled their eyes. I talked about some of the greatest trades of my life. I would say that one of those was buying S&P Global at $17.50. And I remember where I was when that happened. I was on my honeymoon and I was sitting in a hotel lobby in Mexico. Like most days back then, futures were down, the market was plummeting.

and took a lot of conviction to buy any US public equity at that time, but buying something like S&P Global, which looked very scary back then, but today S&P Global is over $500. In that type of compounding over time, I never could have factored that into my expectations, but I knew that Rayleigh's business was one of the strongest business models in the world. Moody's and S&P are toll collectors on all the debt issuance that happens. There's some cyclicality to those businesses when debt issuance happens.

goes up and down. And during 2020, it was an amazing year for debt issuance. The years that followed were a bit more modest. That type of cyclicality doesn't bother me because I'm focused on the long-term earnings power of these businesses. But yeah, we bought S&P Global for its core ratings business. Back then, it had a lot of things that people don't remember. It used to sell textbooks and it had JD Power Associates and sold a lot of those assets. So today, it's more of a provider of data, a toll collector in a few different industries.

but a great example of thinking differently than market, having a long-term view. And it's difficult to describe. When I'm buying a great business, there's a joy that comes with what I'm buying. Buying S&P Global at $17,050, no matter all the scary things that were going on at the time, there was like an inherent, more of a contentness. I felt a great feeling of content that I was buying something really truly amazing that very few other people agreed with me on or were paying attention to.

Robert Leonard : You pointed to the cyclicality of these businesses since they're, of course, exposed to the credit cycle and pockets of the economy like residential real estate, for example, has slowed significantly in light of higher interest rates. So what's allowed these businesses to continue to grow in light of higher interest rates?

Yeah, a number of our holdings have simplicality. So the payments companies, if you go into a recession, people are going to swipe their credit card less often. If you look at FICO, mortgages, autos, mortgages have been low over the last few years. So that certainly has hurt FICO's business. The debt ratings businesses will also have

cyclicality relating to the economy and interest rates. The term cyclicality we're talking about doesn't bother us. It often gives us a buying opportunity to buy more into these businesses because most people are very short-term focused. And if they look at Moody's debt issuance and they think it's going to be down for the next couple of years, stock price may remain. There might be a cloud hanging over the stock for a couple of years, but that doesn't bother us in the least. These companies are highly cashflow generative. They can play offense. They

during those periods, they can buy back a lot of their stock. They're obviously raising prices during that interim so that when volumes do come back, they're just earning more on the debt that was delayed in being issued. So, I probably have overused this analogy, but I think of Moody's and S&P being toll collectors on a highway. And sometimes the toll collectors go out to lunch and the cars are just backing up on the highway and we don't care because we need

We know that all of those cars on the highway have to get to the other side. They're all going to have to go through that toll. And so maybe when the toll collectors come back after lunch, they've raised the price on the toll in the meantime. But we take comfort in owning companies and industries where we know that the volume drop is temporary.

Robert Leonard : There's a lot of talk now on US markets more broadly being expensive relative to some of the other countries. And pre-recording here, you mentioned that you're going to continue to focus on US companies and large cap companies. The US over the past 15 years has largely been the place to be for a lot of investors. And despite higher valuations more broadly, it just continues to seem to be that way. So

What are some of the key ingredients that enable the US specifically to continue to be an attractive place for you in 2024? David Schawel : At ValueForge, we're bottom-up fundamental investors. So we're not trying to pick macroeconomic trends. We're not trying to pick what country may be a better environment.

We simply are looking for the best business models. And fortunately for us, they happen to almost entirely be in the US. Of the 50 or 60 companies that we track on our shortlist, maybe five to seven of them are foreign. The remainder are in the US. And so anyone that is looking for strong compounding, strong organic growth, putting aside patriotism and a lot of other things that go into picking where you want to invest,

A lot of those great business models reside in the large cap area, but some in the mid cap as well.

They're just, from a 20 to 30-year perspective, absolutely the best place to be putting your money. Again, finding that perfect intersection between growth and predictability. I don't believe it's in the US small cap. I don't believe it's in Europe. I don't believe it's in Asia. I don't believe it's in India. On a risk-reward basis, the best place to make money on the planet for the coming decades is right here in the US. Again, that doesn't come from any other call than us trying to find the best business models.

Robert Leonard : Couldn't some of these business models theoretically be in these growing markets like say India, China or whatnot? Or do you even look in those markets?

There's something about our system here in the US that just generates entrepreneurs that create business models with lasting potential. And obviously, there's brilliant people everywhere in the world. But there's something about our environment that allows entrepreneurs really to prosper. And you need that type of environment to create the next generation of great business models. So if you go to places like India, great GDP growth. Obviously,

Obviously, they have a huge young population, but the business models are almost entirely commoditized. If you're building residential office buildings, you're an industrial manufacturer, maybe you're selling consumer goods, you're selling diapers or infant formula or something like that. Obviously, those businesses have a green tailwind, but that doesn't fundamentally make those great business models.

So I think the correlation between GDP growth and performance of the stock market, I think it's been known for quite a while that there's no direct correlation between those two.

So simply investing in the fastest growing countries from a GDP perspective is not going to create better stock market returns. Most of our companies are multinationals. So they have the exposure around the world, but in the US, we benefited from our reporting standards. We benefit from our audit standards. We benefit from our capital allocation thinking, which I think is better than most places in the world.

So we have management teams that might be more focused on shareholder value creation than other parts of the world. So it's an interesting phenomenon, but I'm a great believer in the future of the US relative to other economies.

Robert Leonard : If we cross the border up north to Canada, I've interviewed a surprising number of quality-oriented investors here on the show and studied a number of investors that you'd be largely familiar with that own Constellation Software as one of their top holdings. And you've stated that you prefer not to own highly acquisitive companies. I was curious if Constellation was ever in your investable universe or on your list of companies you were following. And if you have any comments on the

these sort of unique serial acquirers that have just managed to be compounding machines, to put it simply.

This goes back to our view of predictability. So I think Valiant, which was in the end of failure, you know, those buying pharmaceutical companies immediately raising prices on those pharmaceuticals. That was a grow by acquisition strategy. You have that today with Transtein, which is absolutely an above average business. Constellation is an above average business. We just don't like companies that need acquisitions as part of their long-term strategies.

We think that at some point, you're overpaying for businesses, there's integration risk, benefits may be more short-lived. Pharma companies do this quite often, they rationalize manufacturing. You get these very short-term benefits, but not these benefits that we're looking at at Valley Forge. We want serious cost and revenue synergies that go up 10 plus years. So there are some very nice businesses that exist that continue to grow by acquisition. We just at Valley Forge want a straighter path.

that to us as an element of risk that we are generally not willing to take. Robert Leonard : Some companies, they grow organically for some time, then they sort of venture into this acquisition to continue to grow market share. Would that be sort of a sell signal for a lot of your companies? David Collum : Yes. I would say core capital allocation is absolutely something that can ruin a great business. It's really unfortunate because we own a lot of great business models and out of either boredom

or they need to smooth out earnings for Wall Street to increase their multiples, or you just simply hire a business development person and they have nothing to do. And if you give them a hammer, they're going to go around looking for nails. But invariably, these great businesses ruin their companies by buying into lower quality business models. If you already inherently own a great business like Moody's Debt Ratings, and you go and buy a lot of other things for your Moody's Analytics business, you're ruining the business quality, the overall way

weighted average business quality of your company. And so it drives us nuts. And it's really quite unfortunate. FICO does not do this. So they deserve a blue ribbon for that. To date, they've not gone out and decided they wanted to diversify into other areas. But arguably, like with S&P Global, they have a debt ratings business, which we love. They have the S&P Index business, which is a phenomenal business.

even maybe Plath's. But with IHS market, they bought some things where they were able to roll into other areas. But does market intelligence, is that in the same league as debt ratings businesses or the index business? Absolutely not. And if S&P goes out and starts to make a lot of acquisitions to bolster its market intelligence business because growth is slowing there, we think that ruins the overall business quality of the company. So it's frustrating for us. You can't throw out the baby with the bathwater because it's

They still are one of the best business models in the world. But yes, I'd love to go around and shake a lot of these CEOs and these boards and say, what are you doing? You've been lucky enough in life to have one of these great business models. Why are you lowering the business quality of the company? That's an unforced error.

Robert Leonard : I see with a number of your holdings, share repurchases is a key part of their capital allocation. Is that your preferred method after they make any investments into their business that they need to make a lot of that should be allocated towards share repurchases?

Ideally, we want to own businesses that have very little in the way of reinvestment, preferably zero. Obviously, that's not reality. So most of the companies that we have do require some reinvestment, but it's very small relative to their enterprise values. Given that the companies trade in a range of reasonableness, and we believe in their long-term ability to compound, buying back stock remains the most efficient use of capital. Raising the dividend is fine, but with current tax rates on dividends, that's really

really an efficient way to return capital to investors. So we love it when a great compounding machine buys back a lot of their stock. That is our preference. I think it also keeps these companies out of trouble. So my preference is a company that holds virtually no cash because it keeps them from making mistakes.

Wonderful. Well, Dev, that's all I really had for you today. I really appreciate the opportunity to chat with you and have you on the show. Again, here, I want to give you a chance to give a handoff to how people can learn more about Valley Forge Capital Management and learn more about you if they'd like.

We really appreciate being on the program. They can find us really anywhere on the web. I love to mentor and teach. And so there's a podcast on FICO. There's another podcast I've done with your colleague. So if they just Google us, they'll find a lot of material on who we are. As Buffett and Munger have already said many times,

It's so darn simple when you describe it. There's a lot of nuances to how you execute the plan. But my goal is to keep investors out of trouble. I grew up in a lower middle class family. It upsets me when I hear about a family that is trading Bitcoin or doing something silly, day trading options. And even if you think about endowments and pension funds, wouldn't it be nice to build another building or dormitory for your students or students

to have more money available for your pensioners. And I just see allocators continue to make the same mistakes over and over again. So I want to be a voice of reason and common sense. Buffett and Munger are the best in the world. I sort of want to follow in their footsteps. But if I could help in that messaging in any way with both individuals and allocators, that would be really a great way for me to have impact on the investment industry.

Wonderful, Dev. Well, I know many people are going to enjoy this conversation and I think they'll get a ton of value out of it. So thank you again. Thank you.

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