Investing Guru: "Thinking differently from when I first started out"

We highly recommend this video for upping your investing game. Below are excerpts from the presentation by Tom Gayner, the CIO of Markel Corp.



So the first thing that I look to invest in, is a profitable business with good returns on capital, that doesn't use too much leverage to do it.

I like to see a demonstrated record of profitability. Now the other reason that I like to see that …is that, if you think about what a business is designed to do, and it is to serve others.

So the most successful business you will ever find, is one that the customers are glad they're doing business with you. Because that means their lives are getting better. There is some value that is being created for the customer. And the mark of the business doing that well, is a profit.

The second lens that I look at anything through is the management and the management teams that are running the business.

And when I'm looking at people, I'm looking for two attributes. One is I want character, integrity. And ability.

One without the other is worthless. If you have people who have high integrity, they're good character people, but they're not very talented -- well, they may be nice people.

But in the context of business, they can't get the job done. So as a consequence, that doesn't do you any good, because the business does have to be profitable to continue to persist and grow and last over long periods of time.

If you have people who are talented, who are whip-smart, who are very skilled at what they do, but yet have a character or integrity flaw of some sort … that will not end well.

The third thing that I think about when investing in anything, is what are the reinvestment dynamics of the business? And that's a somewhat complicated way of saying things.

Einstein said it was the most powerful force in the universe -- compound interest.

So what is the reinvestment dynamic of the business? What's the compounding feature?

One of the ways you could think about that, is think about the restaurant business.

In a spectacular five-star, gourmet, lovely restaurant--typically, those tend to be owned by the people who are there every day.

But typically, that is not a model that is set up to be able to replicate it again and again and again and again and again.

Go back in time 50 years, and at the start of McDonald's. And then another McDonald's and another McDonald's and another McDonald's.

That's a perfect example of where that reinvestment dynamic kicks in.

So when I'm looking at something, I'm thinking how big can this be?

How scalable is it? How replicable is it?

So a perfect business is one that earns very good returns on its capital, and can take that capital that it makes and then reinvest that and keep compounding at the same sort of a rate year after year after year. 

That's the North Star.

Now in the real world, this does not really exist very often or very frequently and oftentimes it's very richly priced when you see it.

But how close can you get to it? Because the second-best business in the world, is one that earns a very good return on capital.

It can't reinvest it, but the management knows that. They're intellectually honest that they have to do something else with the money.

And what are their choices? Well, they can make acquisitions, they can pay dividends, they can buy in their own stock.

And then the fourth and final lens is price, valuation. And that's really where a lot of people start in investing because there are books you can read. There are spreadsheets that you can do.

There are well-trod paths you can follow that talk about what's a reasonable price earnings ratio, what's a reasonable price to book ratio, or what's a reasonable dividend—all these quantitative factors.

And those are all good, but as I said, they're not enough.

The kind of errors that really cost you more, although it's a hidden cost and it's an implicit cost, is that you've thought about what something was worth, and you thought about what you wanted to pay for, and this was something that actually did compound, and you never bought it, because it never met your test valuation.

But it just kept on compounding over time.

For whatever reason, pricing or whatever, you didn't buy it at that time, and then you never got around to buying it.

Those are the things that really hurt. That money that you didn't make will end up being a far bigger subtraction from your theoretical end net worth, than the things that you did buy that perhaps did not work as well as you hoped it would.