When investor Jean Marie Eveillard was asked to describe the characteristics of a good analyst at a presentation, his response was “the capacity to suffer”. Thomas Russo picked it up and popularised it.
It’s true. A good money manager must have the ability to suffer though periods of bad performance. Russo, like all other value investors, had the experience to back him up. In 1999, he was invested in good businesses – Nestle, Heineken and Unilever, among others. They were terribly out of favour relative to the forces that were driving the market at the time. His fund was down 2% and the Dow was up 27%. During the early part of the following year, he was down 12-15% and the market up by 30%. He was able to stay the course because he had the ability to suffer. Naturally, the same can be said of his investors.
Russo applies this phrase – the capacity to suffer - to businesses too, when they choose to invest in growth which hits profits temporarily. He explained in an interview with Guru Focus a few years ago. When you invest money to extend a business into new geographies or adjacent brands or into other areas, you typically don’t get an early return on this. That means they have to have the capacity to suffer.
The importance of reinvestment
As an investor, Russo likes strong brands that have capacity to reinvest. According to him, such holdings can really compound over time giving you great bang for your buck. But businesses willing to invest hard behind growth need management that thinks long term.
In an interview with Outlook Business, he elucidates his point where he discusses whether the capacity to reinvest is followed by issues of whether managers will invest enough, since the investments would come at the cost of earnings. He cited the example of activist investors being averse to Canada-based Tim Hortons Coffee expanding in the U.S. market. Russo did not agree and believed that despite upfront losses, investors should applaud a good long-term investment because if companies stop spending they can’t create competitive advantage.
(According to Financial Post, hedge fund Highfields Capital Management LP of Boston and New York-based Scout Capital Management LLC, which held 4% and 5% of the company’s shares, respectively, pressured the Tim Hortons to scale back U.S. expansion, and instead direct capital to share buybacks. This was prior to the Burger King-Tim Hortons merger.)
A more popular, and very successful, example would be Starbucks. When Starbucks entered China in the late nineties, many were skeptical (not Russo) given the fact that Chinese people have traditionally favoured tea. Starbucks lost heavily in the initial years and was willing to bear the pain to attain its vision. Today, Starbucks has firmly established itself in China, which is also its key growth market. By having the capacity to suffer, they built something of lasting value.
In a presentation at the 9th Annual Value Investing Congress held last year in the U.S., he highlighted the example of General Mills, which took short-term gains over potential long-term ones. The company failed to invest when Greek yogurt was launched in the U.S. market. The leading Greek yogurt brand, Chobani, was launched by Turkish immigrant Hamdi Ulukaya (with a Turkish recipe – mind you) in 2007. Within 5 years the company was raking in about $750 million in sales. Last year, General Mills launched its Greek yogurt brand in an attempt to claw back lost market share.
If one were to adopt a mechanistic approach to categorising investing styles, Thomas Russo would be flung headlong into the value investing camp. He looks to buy a business with some margin of safety that comes about because the price paid is at a sufficient discount to value. But when you get to the “real glue of investing” (to use his very own words), Russo breaks away from the crowd.
A few weeks ago in an interview, he explained that unlike most of Wall Street, he looks for businesses that have an extremely low voluntary cash conversion ratio. Many investors seek companies that have cash conversion ratios up over 100% because it reassures them that they can distribute back to shareholders the earnings plus a lot more that comes from free cash flow from access depreciation.
He looks for businesses that have the capacity to reinvest and that gives them the ability to deploy substantial incremental capital of the business to the pursuit of new geographies, brands and adjacent products. That reinvestment is what we count on to drive the value of our shares forward over a long period of time.
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