A Conversation with François Rochon, founder of Giverny Capital
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Last week, François Rochon gave me an hour of his time to pick his brain and talk about investing. We touched on several topics such as valuation, what a high quality company is and how management ownership and compensation plays a role in François’ decision making.
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Leandro: Welcome once again to the Bester Stocks podcast! This is actually the first time that it's been recorded on video, so our guest today is going to be a pioneer in this kind of format. Today I have the pleasure of talking to François Rochon, founder of Giverny Capital. This is a very special episode for me because as many of the listeners already know, I am an admirer of François' investment style and ability to swim against the current.
I imagine most of the listeners will also know you François, but let me talk briefly about your achievements. Giverny Capital was actually founded in 1998 and registered in the year 2000 and the fund has a track record of outperforming the benchmark. You can go for more details to to Giverny's webpage.
So, yeah, welcome François, and thank you very much for taking the time. I imagine you have a pretty busy schedule, more so during earning season and especially at the beginning of a new year.
François Rochon: Well, these days it's writing the annual letter that takes possible most of the time, and it usually takes about two months.
So I don't do it full-time, but I put a lot of effort to make it interesting. But you know, we're long-term investors, so earnings season, yeah, we look at the results, of course, but it's not that important, the short term, results of our companies.
Leandro: Good, good. I think many people are anxiously waiting for the 2022 annual letter.
So I think many people listening to this are trying to build maybe a professional career in the investment industry and maybe would like to know your career path before founding Giverny. So, so let's start there. What did you do before founding Giverny?
François Rochon: Well, I was very interested in stocks and the stock market from a very young age, but the stereotyped image I had was that it was a big casino dominated by financial sharks. So it was not something, although I was interested, it was not something I thought was a serious career path. So I was interested in the mathematics and physics and, you know, understanding how other worlds work.
So engineering made a lot of sense to me. So I started to study engineering at the PolyTechnical School at Montreal, got my degree, and then did a master's degree and then started to work as an engineer. The first years I was a research assistant. So, and you know, when I started to have some savings to invest then started to invest in the stock market, then I wanted to learn everything about investing.
So I took some courses, I read some books, accounting books. So probably for a year, I read everything I could on the stock market and accounting. And one day, someone talked to me about Peter Lynch. So I bought his book "One up on Wall Street," and it was really like seeing the light. So, it was not a casino the stock market.
When you bought shares, you became a shareholder in a company. So my view of the stock market totally changed. And Peter Lynch, you know, presented the idea of value investing, buying a company for less than what it's worth. And in that book he also talks about Warren Buffett. So the next step was to read about Buffett.
So I sent him a letter to Omaha because that was before the internet, and he sent me a big package of old annual reports and I read everything. I think it went from 1977 to 1992. So, I read everything and you know, I read the Intelligent Investor, Benjamin Graham, I read Philip Fisher's book, and you know, I found that so interesting.
And the approach of Mr. Buffett finding great companies and buying them below their intrinsic value and holding them many, many years. And companies with competitive advantage uses the word "moat", or franchise value in the first years. It really struck a chord with me. I thought it made a lot of sense and I wanted to use that approach.
So I started to manage my own capital. And, after, you know, three or four years of having good results, I decided that this new career was for me. So, I left engineering in 96 and went to work for a portfolio management firm, but I quickly learned that institutional investment firms sometimes have shorter time horizons that I did.
And so after two years of working at few firms, I decided that, for me, the best thing was to start my own investment firm and really apply the long term investment approach based on Warren Buffett's investment philosophy. So that's when I started Giverny Capital and the approach was very simple.
I would buy for the clients, I would buy the same security, so I would clone my portfolio to their portfolio. And really that's how it started.
Leandro: So I think a bit linked to this question, something that always makes me curious is how an investor style develops until reaching a point where maybe it only needs some minor tweaks.
I think that by reading your annual letters, one can infer that Giverny was born with a somewhat established investment style. I know that you just told that you started with Peter Lynch, then Warren Buffett, but did your investment style evolve through the years until the investor you are today?
François Rochon: I would say the basic investment philosophy evolved very quickly.
I would say I probably started trying to find unknown companies that were very cheap and did okay with that approach. So it was probably a little more like Ben Graham approach, and I wouldn't even say years, it was probably months because, pretty quickly by reading Warren Buffett letters, by reading also Philip Fisher's book, I realized pretty quickly that the best thing was to find right companies and perhaps pay higher PE ratios than typical value investor would be ready to pay for.
So probably already in 93 I had that approach and, when I started the portfolio and to measure the return and everything, I think the investment philosophy was already the same as it is today. I like to think it has improved with experience and all the mistakes I've made over the years.
I think I've learned a little bit and I've improved on the process of finding those investments. But the basic investment philosophy I think has not really changed since 93.
Leandro: Okay. So you mentioned there that you invest in quality companies that sometimes trade at maybe higher multiples that any value investor would maybe bother looking at.
I know this might be a difficult question, there are many moving parts, but how would you define a quality company in one or two short sentences? You can take three or four sentences if you want.
François Rochon: Well, I think one very good indication is a company that has high return on equity for many years without leverage.
So I think your leverage can sometimes distort the calculation of return on equity. So, it's really looking at companies that can earn, I would say, good return on capital. And that can be sustained for many, many years. So it's not a year or two or at the top of the cycle, it's sustainable in years.
And there's a reason behind superior returns. You can find some kind of competitive advantage within the nature of the company or its culture. Either it can be a brand or a first entry to a technology service that makes them very special and unique. But basically they have a competitive advantage.
That's probably the main characteristic of a quality company. Of course, there's a reason behind a competitive advantage. Usually it's great people, great managers that either have built a company in the past and built those intrinsic competitive advantage, or they are still managed by great people and they are improving year after year the depth of the moat of the company.
So I would say it's really a competitive advantage, yet it's probably reflected in the high return on capital, but the source of those great returns, it's really a kind of competitive advantage.
Leandro: Yeah, and I guess many people when looking at analyzing quality companies, they tend to think that it's actually like the numbers back it all up, but there's obviously a lot of of things that are subjective because it also depends on the durability of this competitive advantage.
So what would you say are the things that you focus on the most and the things you focus on the least? I guess that, well you already said that the people are very important, so maybe that's going to be at the top.
But around management, I would like to know how do you look at management's ownership and compensation?
Because I know that a lot of investors put a lot of weight here, but others don't care as much, as long as the manager has, for example, a track record of excellent execution.
François Rochon: It's not easy because there's not one simple answer. It's really, I mean, in some ways, every human being is different.
So you have to judge them kind of one by one situation. Yes, of course, the ideal situation would be...an example of that would be probably Fastenal (FAST) 30 years ago. I mean, Fastenal 30 years ago was managed by Robert Kierlin and he was the CEO and founder, he owned, I don't remember 25% of the shares, he was paid a hundred thousand dollars a year. And, you know, he had no stock options. So that was the ideal situation. He was a great entrepreneur and great, great culture. They were very low cost. He owned a big chunk of the company didn't have stock options and his salary was very modest, so that's the ideal situation.
The non-ideal situation is when a manager is paid a lot of money, doesn't have a big stake, and he's not necessarily rewarded exactly in line with how the shareholders are rewarded. It can be rewarded without really the shareholders getting superior returns. So beside those two extremes, there are a lot of situations.
But ideally you want a CEO that owns a good percentage of the business. But I've seen some cases when the managers didn't have a lot of shares on the company but did an incredible job over many years. So I think it's really to see what's the plan, how we manage the business, does he have a long term horizon?
And then probably the one great quality that is needed for CEO is capital allocation. So if you'd gone all the company for 10 years, a big part of your return will be linked on how yearly profits were reinvested. Did they make acquisitions, did they buyback stock? Did they give dividends? Did they develop new products?
So capital location is very important and it has to make sense in terms of building a culture and, you know, increasing the moat the business has compared to their competitors.
That was not two or three phrases, was it?
Leandro: No, no, but that's fine. I wanna briefly touch on the topic of, again, competitive advantages. Like we know that there are many types of competitive advantages. Like some companies would have a competitive advantage that is protected, but maybe a high capital intensity while others, and this has been especially true in the last years, have maybe a moat that is protected by technology or maybe network effects.
So do you have kind of a categorization of competitive advantages? I know it's probably, like the question before, it's on a case to case scenario, but do you favor some competitive advantages over others? Because I know that there are investors that will look more at, for example, capital intensive businesses and will avoid completely investing in tech stocks because they think that it's not a real moat.
So what are your thoughts on that?
François Rochon: I would start by what I would avoid. If you sell a commodity oil or some kind of metal, zinc or steel or copper, I think it's very hard to develop a competitive advantage. There's some exception, of course. I mean, Nucor (NUE) was a great company for many, many, many years. So even in a very tough industry like the steel industry, they managed to do very well.
So it's really a case by case. And you talk about technology. There are some companies like Microsoft (MSFT) or Amazon (AMZN) or Google (GOOG) that do have an incredible moat in our opinion. Of course, if you look at history, there are very few technology companies that have been able to be leaders and sustain their competitive advantage over decades.
It's tough because it changes so rapidly. If you miss a turn somewhere, yeah, you can be cast out of the market very rapidly. So, and you know, there's many companies that I purchased 25 years ago, 24 years ago, and they don't exist anymore, so I've learned from that. So it's tougher probably in the technology industries because it changes so, so much.
Doesn't mean that you can't find a great company in those sectors with some competitive advantage. And, you know, Microsoft (MSFT) is probably one of the great enterprise of all time. So it's certainly possible. And it's been great for many years, many decades. So it's really a case by case.
But you know, when you study the history of American corporations, the life expectancy is not that high. A lot of companies will disappear after a few decades, and some that used to be, you know, great, great companies, I mean, Kodak or Xerox, the company still exists, but you know, it's not as dominant as was many years ago, IBM or Sears, for instance. So it's very hard to keep on being dominant and having this moat. The moat for any company is always shrinking or expanding, always.
So you have to always be open to follow what's happening to company and try to find those that the moat is increasing and perhaps avoid those that the moat is decreasing. I mean, in the retail industry it has been very hard to find permanent winners. I mean, there are some, one example I think is TJX (TJX). They've been in this niche of selling clothes at very low prices. But, that's one exception because the general experience of many retails has bee very tough.
Leandro: I think you bring up a great point in that the moat is dynamic. So even when it feels like super safe, it's actually going one way or or another. And an investor must assess where it's going.
So after finding a high quality company, then you must decide how you build your position in case the valuation is appropriate, of course, and how much you allocate to it. So do you have a process to decide how much a position will weigh or how you will build your position and do you have any hard rules, so to say?
So for example, I will never let a position be more than 15% of the entire portfolio or something like that.
François Rochon: Probably in my younger years I was more confident in my decisions. So probably I could start with 4 or 5 or 6% in that company very rapidly. Today I've seen my share of, you know, disappointments.
So I'm much more prudent. I usually start with 1 or 2% with a new investment, and as I get more confident in my decision, I will increase it. And the goal is to have something like 20 to 25 names with an average weight of about 4%. So if everything goes well an investment, it will become something like 4% weight.
And we have the attitude of letting our winners run. So as a company does well, it will become a bigger part of the portfolio. And once it reaches 10%, we'll trim it. We don't want any position to be more than 10%. In the first years probably there were some securities that went up to 15 or 20%. I think that probably the highest was 20%.
But like I said, with experience, comes more realism and it's very hard to find a company that, you know, there's absolutely...there are some that the risk is very low, but, to me, and it depends from one person to the other, to me having a 4 or 5% weight on average for one investment and having a maximal 10%, I'm comfortable that I'm managing the risk properly.
But you know, I have friends that are very smart and very bright that have, you know, nine stocks in their portfolio. So the average holding is 11, 12%. So, and they're doing well. It's just different ways of seeing things.
And I have my own personal way of looking at it, and I think 20 to 25 names is kind of a good balance between having sufficient diversification. So you reduce the risk of, you know, one or two mistakes. And also at the same time it's focused enough, it's concentrated enough so that you have odds of beating the index.
Because once you go to 50 or 60 names, I think it's very hard to beat the index, the odds become very low.
Leandro: And I think also if you have 20 to 25 positions, you can actually follow the portfolio maybe as closely as you would like, because if you see, I don't know, many portfolios of 100 to 150 companies, like for me, obviously I don't have the resources of a large fund, but for an individual investor that would be very, very hard to keep up with.
Maybe you have...well even a portfolio with 150 positions can be concentrated because you can have a lot of weight in some positions and then some very small positions so you don't have to follow them as closely.
So I think something that's very common... I'm going to talk about a theme that it's more of what we're seeing today that is that a lot of investors are trying to jump from one factor or one sector to another. Trying to catch the upswings and trying to avoid the downswings. I think this is very common obviously when stocks are going down because everyone wants to be in the safe part of the of the market.
I know Giverny doesn't follow this strategy, but when I look at your positions, I do see that you have, like, the portfolio is very diversified across industries.
So how do you think about the circle of competence? Are you always trying to expand it or are you comfortable with industries you know by now and you're trying to fish in those industries?
François Rochon: It's really case by case, again. We don't really focus on industries. We focus on companies and trying to find companies that we believe have something special. And yeah, I think we own four bank stocks in the portfolio.
It sometimes was lower than that but probably four is the highest we had. I'm not a fan of the banking industry. I think it's very competitive and it's very hard to have some kind of edge compared to the others. I do believe though, that they are great bankers. So I always say when we invest in a bank, what we really are doing is investing in a banker, so the CEO is very important.
I think the culture that he is installing in the bank is very important. And we want a culture that is very based on conservatism. So, most banks that fail, it's because they made bad loans, so they weren't disciplined enough, to make loans, you know, that made economic sense.
So we want bankers and the culture they've installed the banks that are very prudent and conservative. And I think the four banks we own are those kind of banks. But it's not because we love the banking sector.
It's the same thing with the insurance industry. We've got Markel (MKL), Berkshire Hathaway (BRK) of course, and Progressive (PGR). I'm not a fan of the insurance industry. I think it's a very competitive industry. It's very hard to sustain for many years high return on capital. But I think those three are very disciplined. They focus on some niche, I think Progressive is probably the best car insurance in the US and they've been gaining share for, you know, 50 years, I don't know, more so since they started selling insurance on the internet in 99.
So, and you know, I owned Progressive, I think from 99 to 2005, and then followed it for 14 years and bought it back again in 2019. So, there were some periods that I think where tougher for Progressive, but with the proliferation of telematics, they're more able to price the insurance for their clients. I think the last few years have been good, and the next few years should also be good.
But it's not a decision to invest in the insurance industry. It's really because we found companies that we believe have some kind of competitive advantage in the industry.
So you know, we own NVR (NVR), which is a company that builds houses. Again, this is a very cyclical industry. It's a little better now, but for many years it was a very capital intensive industry. But NVR found kind of a niche where it didn't own a lot of assets. They were very light asset balance sheet and they had options on land and there were very focused on being very effective in building houses. And, you know, I've been following it for, I don't know, 20 years and I think it's very well managed. It's of course a little cyclical, but probably less than the other companies in the industry. So it's not I'm a fan of the housing industry in general, but I think this company has some kind of niche and competitive moat.
So it's really the same thing we do for all the sectors.
Leandro: Yeah, I think there was a paper by Mauboussin where he talked about the return on invested capital, and obviously you could see that there were industries that were good on average. Like there were a lot of companies doing well, but there were always, even in bad industries, there were always good companies.
So I think that summarizes what you said here, that obviously you can... it might not be the best industry, but you can find a player that is outperforming their peers or is better than others. So you are not going to say no to a company just because the industry is maybe doesn't have the best economics.
François Rochon: When I started to invest, probably at that time the best industry in the US was the drug industry. I mean, you looked at Pfizer (PFE) and Merck (MRK) and J&J... They were all great, all great businesses, but at some point it become tougher. And if you look at the last, you know, 10, 15 years, the growth has not be as strong as it was probably in the eighties and early nineties.
So sometimes an industry can be very good for a while, but after a few changes in the environment, it's not as good. So, and you know, if you take the railway industry, for so many decades, it was a very tough industry, very capital intensive, lots of costs, and it was very hard to earn high return on equity. But you know, some changes happened at the end of the nineties and early 2000s and when we bought shares of Burlington Northern Santa Fe, it was probably 2007, I think it was a fantastic business. And, Berkshire bought it in 2009 or 10, and they've done very well with it. And we owned, after a while, I think in 2012, we bought Union Pacific and owned it for seven or eight years. And it's been a good investment also.
But for so many years, the railway industry was not a very good industry to invest it. I don't think they have lots of moat but they, at some point they were able to build a moat. And, today it's either Union Pacific, there are great businesses.
Leandro: You talked about the drug industry. I don't know if I'm correct here, but I think one of the mistakes you cite in one of your annual letters is actually a drug company that is Valeant, I think.
So I want to talk a bit about, because mistakes are sort of taboo in investing. Like you see a lot of people laughing about the mistakes of others as if they themselves didn't make mistakes, which is obviously not true because everyone makes mistakes while investing. So obviously there's nothing wrong with this. And I think it says a lot about a person being able to be transparent about the mistakes and you even give them medals in your annual letters.
So through these decades managing Giverny, what would you say was by far your largest mistake and what did you learn from it?
François Rochon: Well, it was not Valeant, but Valeant was a big mistake and, although I'm a little ashamed, I can talk about it a little bit.
We were lucky with Valeant because I think overall we probably doubled our money over four or five years. But that was luck because that was a big mistake. And the reason we invested in 2011 is that, like I said, I knew that the drug industry was not as profitable as it used to be. And one reason was that a lot of billions of dollars were spent on a R&D that didn't yield good results. So, Mike Pearson came up with this plan of reducing costs, reducing R&D, so acquiring companies that didn't have necessarily a patent, but had a drug that had revenues and just reducing costs and improving the profitability of those companies. And part of it was also to increase the price of the drug.
So he did that for a few years and had good results. It didn't really fit all that well into our investment philosophy because the accounting was a little aggressive and also they had a little bit of debt on the balance sheet, but they were some great acquisitions. Probably the best one was Bausch & Lomb, it's still a great business.
And, I remember we had some other money manager friend that owned Valeant, and one of them used the phrase that Mike Pearson was a value investor in the drug industry. That's really how we saw Mike Pearson and his plan.
And like I said, for a while he did very well, but the last acquisition that he did didn't turn out very well. It put a lot of debt on the balance sheet, so things turned sour and very quickly we realized that, we sold all our shares, and I knew that the risk in Valeant was a little higher than the other investments in the portfolio so what I decided to compensate for that higher risk was to cap that investment, not at 10%, but at 5% in terms of market value in the portfolio.
So when they started very well in the first years we trimmed it every time it went beyond 5%. So we were lucky in the end because we, I think we trimmed it twice.
And also we sold it as soon as we thought that this situation was a little serious. So in the end we did, I think overall from the start to the end, probably a double of money, but it was a big, big mistake. And the mistake was really in the judgment of the quality of CEO of Mike Pearson.
I think he was just too aggressive that, and it turned out that things went very bad. So that was a mistake, but it's not the worst mistake.
The real big mistake is when you find a company that really fits your criteria and you don't buy it for some simplistic reason, like it's a little too pricey and you know, the stock increases a thousand percent over 10 years, or 2,000% over 15 years, and you don't see the costs in the statements.
But you know, when you miss a 2,000% investment because of some stupid reason, that's a much bigger error than the stock that you buy, that you lose 50%. So if you look at the medals, you know, I think I've been giving medals to the mistakes for the last 20 years, so we're probably talking about 60 medals over the years, probably of the 60, there's 55 that are omissions. So errors of omissions, not commissions, the big mistakes.
And you know, there are so many, I don't know where to start. But you know, one that comes to my mind is Copart (CPRT) I think it's a fantastic company. I knew the company, I read the book the founder wrote, it's a fantastic business.
I mean, Starbucks (SBUX) I looked at in 1994. Can you imagine? Probably I would've made 50 times my money. And, I mean Microsoft (MSFT), we used to own it and we sold it just before thing really improved, I don't know, 2016 or 17. And, you know, it goes on and on. I mean, LVMH (LVMH) that owns Louis Vuitton. I look at that, like 11 years ago during the European crisis around 2011 and it was trading at 15 times earnings and I thought: "ah, it's a little too expensive", and it's probably one of the best business in the world and it's up 500% since then.
So these are the big mistakes. Companies that do fit your criteria and for some reason that are usually linked to not paying perhaps the appropriate price you miss it and these are huge costs.
Leandro: I was actually going to ask you what you just said with Valeant, because I think many people equate a mistake with losing money or maybe not making money, but I think there's actually quite a fair bit of mistakes that many investors can make and they're actually making money on the investment, but they thought maybe this company is going to appreciate for reason "x", and then they look back in five years and the company actually appreciated, but it was due to reason "y". So they don't take it as a mistake, but it's actually not one of outcome, but maybe one of process.
And I was actually going to ask you this next, but you just described it perfectly with Valeant, which was a situation where you made money, but you actually made a mistake and you were...well you didn't have like the ego to not cut the investment just because you were making money and you were able to cut it.
François Rochon: You know, if you take the example of Visa (V), that's been in the portfolio for 12 years. I bought it in 2010. I always say I was lucky with Visa because I was stupid, but I was lucky in my stupidity. I looked at Visa, probably the stock was, I don't exactly remember the numbers, but let's say $30 in 2010 and was, I don't know, 20 times earnings.
And there was some political pressure to reduce the interchange fees and the stock went down to $20. So it went down 25, 30, 35%. And I was lucky I had my opportunity and I bought it and we did well. And today the stock is at $200 or $250, so we made probably 10 times our money.
Sadly we trimmed it a few times, so we didn't have the full thousand percent result that we should have. But we still did very well. But the mistake was...I was lucky that the stock went to $20 because if it didn't, if it had not corrected to $20 and it stayed at $30 in 2010, probably I would never have bought it.
And it would've been a big mistake because even if you bought it at $30 before it went down 30%, you still would've made six or seven times your money instead of 10 times. But, making six or seven times your investment over 12 year period, still a very good return and you know, it's a great company Visa (V) so the intrinsic risk was very, very low. It seemed pricey at that time, but it was not that pricey.
So I did a mistake of not buying at $30, but I was lucky enough to buy a $20 so you don't see that mistake in the statements, but mistake if the stock had not corrected back there.
Leandro: . So I think linked to this, one of the very important things for an investor is probably the psychology or the mentality. So the emotional coefficient, not the intellectual coefficient.
And I think one of my favorite annual letters is one where you talk about something called the tribal gene and how not having it or succumbing to it has potential benefits for long-term investors.
So first, can you explain for people that don't know what the tribal gene is, and then I'm going to ask you like very direct question. Do you think that a long-term investor can only be born and cannot be made?
François Rochon: Well, that's a very interesting question. So I'll start by the first one. Yes, the tribal gene theory that I came up with, and it is a theory as I have not proved it. And since I have a scientific background, I understand the difference between, theory, hypothesis and, facts and, you know, conclusion that makes scientific sense. So it doesn't make scientific sense. So I want to say that upfront.
But it's kind of an observation and my observation is most human beings that have a normal DNA sequence have this gene which I've called the tribal gene. So when the tribe runs, you know, they have the instinct of running with the tribe. And because it's probably, there's probably a good reason for the tribe to be running. I mean, probably 25,000 years ago, you were in an old village and a big tiger would come up and everyone would start to run while the thing to do was to run. So this gene was passed over many thousands of years of evolution.
And, it's just how the human being is programmed, but for some reasons it's probably a defect. 5% of the population doesn't seem to have that gene. They can go one way when the tribe is going the opposite way and they can think for themselves, they can think in new ways. These are usually the creators, the artists, the writers, and I think also the ones that build companies, the entrepreneurs.
So they're able to think differently. They're able to find value in something that the others don't see, and they are able to think for themselves. So when everyone wants to buy tech stocks or Bitcoin, they're able to think by themselves and say, well, I don't think it makes sense. And it's very hard, like you say to fight a gene because, you know, people will rationalize it, but at the end it just respond to natural impulses.
And you're right, I do believe that to be able to have better than average return on the stock market, I think you need to have missing tribal gene. If you have it, I think it's very hard to beat the index. If you don't have it, I think it's possible. So I would say you're right. I would say that it cannot be really, it can be thought in some way, but you know, if you are part of the normal 95% of the population, I think it's almost impossible over many years, of course, to do better than the average because you're not able to go one way when all the others are going the other way.
And I mean, the crowd following attitude of most investors is sometimes surprising. Not to follow the crowd is an exception, it's not the rule, just how human natures are. So to answer the question, yes, I do think that to beat the index over many years, I think you have to be in that 5% that don't have the tribal gene.
Leandro: I don't know if you've seen Charlie Munger's interview yesterday, but he actually said that only 5% of the people that were there in the interview would beat the index.
So that's like a perfect match between the 5% that doesn't have the tribal gene.
And I don't know if you also mentioned that if, for example, I don't know if I read this in your letter, but if, for example, a person likes fast cars or adrenaline, then it's difficult for that person to be a long-term investor because they will always be looking for the rush or the adrenaline and obviously long-term investing is... I don't feel it's boring because I think long-term investing is not boring if you love analyzing businesses, but if what you'll like is looking at stock prices and making money fast, then obviously long term investing is very boring. I don't know if it was in one of your annual letters.
François Rochon: No, it wasn't. But, I'll trust you that it does make sense. Well, I don't, I'm not a fast car person.
Leandro: And now continuing a bit on this topic of investor psychology, I want to touch a bit on the topic of the past because I mean you see many investors trying to search for the next Amazon (AMZN) or the next Apple (AAPL) or the next Constellation Software (CNSWF) or whatever.
Maybe because they've studied the history of capitalism that these companies are closer to the end because they have lived for longer. So they are just trying to find maybe that same company but 15 years ago. But I want to talk about the concept of the Lindy effect that states that when a company has lived for many years, then the probability of that company surviving for an equal number of years is larger than, for example...I'm gonna put a simple example.
So the Lindy Effect basically states that on average, an 80 year old company has more probability of surviving an additional 80 years than maybe a 10 year old company has of surviving the next 10. So what are your thoughts on the Lindy Effect, and do you focus on the past when analyzing a company?
Because I feel like many people just underwrite the past, like, "this has happened. It doesn't matter. Investing should be about the future."
But I actually feel, I personally weigh a lot the past when I am analyzing a company, not only because I feel it's important to understand how a company has built itself, because it can always show you important things of how maybe a company has survived a past recession, what the management did.
François Rochon: Yes. Of course, you are right on one thing. When you buy shares, you are really buying the future. It's the future results that's gonna reward you. Past results only reward past shareholders. So when you buy a company, what you're really buying is future cash flows that can be discounted to today's price.
That said, I think Warren Buffett had a perfect phrase to sum it up, he said it many years ago, but I remember it was an annual meeting
"If a company has a great future but a lousy past, we'll miss it."
So I would say that's really what also we're trying to do. We're trying to first find company that has a great pass and a great present. I mean, they have good return on capital, they've rewarded shareholders in the past, they have a competitive advantage, a great balance sheet, and we believe that everything is in place for continuation in the future of those great results.
But if the company has a lousy past or is a very young company that doesn't really have much past, I think it's very hard to have an idea what the future look like. You'll probably take risk and sometimes it will work out. Sometimes it won't work out.
The danger is to find a company that does have a great future, but it's already priced in the level of the stock market today. So if you buy a great company that trade that, I don't know, hundred times earnings and, you know, earnings increase by sixfold in the next decade, but the PE ratio falls to 20 times, you know, didn't really have a good return because so much of the future, that was great in the end, was already discounted in the price. So you have to be very careful when you're buying the future.
Leandro: Well I'm gonna take this example because I think it's perfect for the next question, maybe not at the extreme of a hundred times earnings, but there's a common belief that high quality companies are always fully valued, but then you can see that they keep outperforming the market despite these fears.
I mean, I think that they always trade at optically expensive PE ratios, especially if you're anchored to a PE ratio. I don't know, if you say I'm not going to buy anything above 10 times earnings, then obviously these companies are going to appear to be very overvalued.
But then these companies kind of continue to prove that they were not fully valued by the market. So what do you think the market is missing in valuing high quality companies? Is it something of the quality of the business itself? Maybe the durability?
François Rochon: Well, if you study the last 50 years, there have been periods when great growth companies were very popular around trading at very high PE ratio. I wasn't around really, I was alive, but I wasn't investing, in 1972, you had the Nifty 50 that traded at very high PE, 40, 50, 60 times earnings. And you know, in 73, 74, they, they went down a lot.
So, in the end they were great growth companies. Not all of them, but most of them did very well in terms of intrinsic growth and their value, but they were so pricey that they didn't do that well for an investment. And I do remember probably at the end of the nineties, probably 97, 98, I think General Electric traded at 30 times earnings, Coke (KO) at some point was 40, 50 times earnings.
And General Electric turned out... didn't do very well, but Coke did continue to grow at good ratios. Not 15% per year, but 6, 7, 8% a year. But the PE ratio today is probably 24 or 25 times. So, there was a big reduction in the PE ratio in the last 25 years for Coke.
And a lot of companies, if you look at Cisco Systems (CSCO) for instance, because I know the company well, we purchased it in 97, I think for two years, and it did well, but if you look at the peak of 2000, I think the stock traded that $80 per share and, the earnings per share were 65 70 cents per share. So the PE ratio was more than a hundred. And if you look at the stock today, I think it's $52. And last year they earned, don't remember exactly, but let's say $3 and a half. So earnings did grow something like 8 or 9% a year in the last 22 years. But the stock is lower today than it was at the peak of 2000. So that's a very long time, 22 years for not making money. So I think even the greatest company, the intrinsic value is not infinite. You need the margin of safety.
Ben Graham, when you wrote the intelligent investor, the conclusion, the last chapter is that if you had to sum up an intelligent investing in one phrase was margin of safety. Still think 70 years later, that's still the right three words. Margin of safety. Yes, we want to own great quality companies, but you need a margin of safety.
And the PE ratio that you paid for them, is it 15 times 20, 25 up to 30? I don't know the exact number, but I think you always need a margin of safety. And in the example of Cisco or Coke in 98, I think the margin of safety was very low and the results were probably disappointing for many investors and, of course, it exists today in many growth stocks, I do believe that. Some will do okay because valuation is more reasonable and some will do poorly because valuation is way too high.
Leandro: So staying in this topic of valuation, I think it's a very complex topic because you need to discount the future, but the future is very complex to model, so to say, because there are a lot of uncertainties or maybe events that are impossible to foresee.
François Rochon: Yeah, that's it. Yeah. Future is unknown, really. I have a general assessment that have a few, and you can believe that you understand the company and that you know, the future looks great and you can be right, but you have to accept that the future is unknown.
What you'll want to do is find companies that you believe the odds are higher than average that you can have a good assessment of what the future will look like.
Leandro: Do you build, so to say, complex valuation models or do you take more of the simple route where you project maybe an EPS or the earnings power of the company, I don't know how many years out and then you slap a multiple on that or, or how do you go about valuation because a lot of people view it differently.
François Rochon: Yeah, that's what exactly what we do. We try to, usually we go five years in the future and try to have a model for the next five years. We come up with an estimation of what the earnings per share will be five years and apply a PE ratio that we believe is justified.
And it's hard of course, because it will depend on how the prospects look in five years. But we try to come up with a reasonable objective, realistic number. And, you multiply the PE ratio, you decided that made sense, to the earnings per share you estimate, and you get five year target.
Ideally, we wanna buy today at half what we think it's gonna be worth in five years. So if we're right, we would earn 15% annually in that investment. That's what we're trying to do. We realize that there's a lot of uncertainties and, but like I said, we try to favor the one that we're more confident that will be right on the earnings assessment and also the PE ratio that we believe makes sense.
Leandro: And, of course, there will be investments that will be wrong, but there's also uncertainties to the upside, so to say. So maybe you model, something that gives you 15%, but the company executes much better. So it makes up for the companies that have performed worse.
François Rochon: Yeah, and I will say that the next step of what you just said is the key, which is to hold on to the ones that do well and probably as fast as you can, you sell those that, you know, things didn't go as planned. But the big winners, the one that not only did your scenario happen, but as you said things were even better because, you know, we're always conservative and sometimes we were too conservative.
And things did go well, much better than anticipated. And when that happened, usually the stock will do very well and look a little pricey at some point. And the trap is to sell this company that's done well when the PE ratio looks a little high. And I think, you have to be reluctant to sell the investment that are doing very, very well.
So you, you want to keep your winners and try to sell the losers as quickly as possible. When you're conservative, sometimes you'll have surprise on the upside, but that's the one you want to keep.
Leandro: I think trimming and well, selling in general, is also a bit of a personal topic because, for example, I find it very difficult to exit a position and then rebuild it. I don't know why. I think I know it's something personal at, it's like completely objective. But I am very reluctant to sell something because it's expensive, because I know that I'm gonna have trouble getting back in maybe when it's not so expensive. That's something personal.
I think staying here in the topic of selling, I think it's much more difficult than buying, obviously, because especially if you have held something for, say, 10 years and you have a nice gain on that position, I think you're sort of biased, so to say, to sell because you've held it, the stock has done well.
And Valeant here is again a great example because you've made money, but you need to sell it. And I think it's kind of psychological there.
So I think you already touched on this, but would you sell if the valuation gets too extreme or even then you'll just hold to the position?
François Rochon: That's a tough topic because, you wan't to hold onto your winners. You, like I said, have to perhaps accept a higher PE ration than you'd like to, but there is a point where it doesn't make sense.
And no, I talked about Cisco and no, I don't want to talk for Warren Buffett, but probably Warren Buffet, should have sold his shares of Coke when they were trading at 50 times earnings.
So, yes, we want our great companies, but there is a level that is just too high, it does happen. And I think when it happens, the rational thing is to sell and just invest in something else. And even though there's probably some tax consequences or anything like that, there is a level that, you know, at some point doesn't make sense.
François Rochon: I don't know where to start, but I've seen lots of example that of companies that got way pricey and it stayed that expensive for many years sometimes. But usually the stock market always reflects the intrinsic value and valuation will get back toward more normalized level at some point.
So have to accept that and, yes, of course, I think some companies, the stock is just too pricey, have to sell it, even if it's a little painful.
Leandro: So it's been a great conversation François, thank you very much for taking the time. I want to jump into the last two questions. The first one is, I think you touched a bit on this topic at the start. How does one manage to build a successful long-term oriented fund in a world that's dominated by short-term incentives? So, I mean, fund managers are constantly looking for how to increase AUM by trying to outperform every year, or like jumping from one style to another, just to be in the top charts.
So now, it's obviously, I would say it's easier because you have a track record, but in the early years, was it really tough to get up from the ground because you were zagging while the industry was zigging. What you said you were on the 5% that was not following the crowd.
François Rochon: Well, when I started, you're right, it was very small when I started and, I think I was alone for the first four years, JP joined in 2002. So it was very hard even to pay a salary at the beginning, so it took many years, but I was ready to wait. What was important to me first was doing what I love.
The way I thought was intelligent. I may could have been wrong, but it had to make sense to me to invest in a certain way. And I knew that it was not popular necessarily in the short term. And, you know, I started Giverny probably at the end of the tech bubble in 2000, so, the first probably months, of the company it was hard to gather clients because people were making lots of money on Nortel networks and GDS Uniphase or other companies that were doing very well at that time and it was hard to convince them that we could invest in stable company growing 12% a year. That didn't seem very sexy at that time. But, you know, I thought the approach made sense and in the end, more than 20 years later, very slowly, the assets under management have increased.
And I was ready to wait. There was no hurry. The important thing is at that time, and still today, is to invest in a way that I believe is rational and is sound. And, you know, I manage money for family and members and friends and colleagues and entrepreneur friends that have entitled me with their savings. And it's very important that I be a good steward of capital.
Yes, I want to have good returns, but managing risk is also very important. So when you follow the crowd, I think you increase the risk of permanent losses. So, that was the key thing. I wanted to invest the way I believe made sense and I was ready to wait for the results and the rewards to come later and was able to wait for many, many years.
And that was okay. Of course, I don't have regrets, but it was not that painful. I was ready to suffer for a while, for better rewards in the future.
Leandro: Being faithful to the mentality of a long-term investor.
François Rochon: And, you know, I was very lucky because Warren Buffett was such an inspiration. From the start of Giverny I went to the Omaha annual meeting every year and every year it was a time to go back to the roots of what I'm always doing. And Buffett and Munger were big inspiration. And sometimes I would, you know, just human nature. Sometimes I would be a little discouraged or disappointed, but you know, I got some validation that I was on the right path because I was, following those great investors.
And I think that's the greatest quality of both Warren and Charlie. They're very patient and they're very rational, and if they're on the right path, the right track they'll just stick to their guns and be patient and wait for things to.. the fruit will be...they'll be rewards at some point in the future.
And that's probably the big lesson I've got from Berkshire Hathaway. Yes. And I still go over there today.
Leandro: I read an article the other day that Buffett has, well, Berkshire has just started investing in some Japanese conglomerates. And they actually waited like 20 years until they were at a point where they felt comfortable buying.
And you have to think about the 20 years, but then also that Buffett is making these investments when he's already 90 years old. So he's 90 years old and he's still thinking 20, 30 years out, and being patient for 20 years. So I think that's just like a culmination of patience in any investor.
François Rochon: Yeah. I think, Warren and Charlie, they're really people about principles and, by definition the principle cannot be outdated because it wouldn't be a principle and they have sound principles. And I think that for me at least, I've learned a lot from them, I owe them a lot. Also, it was an inspiration for many years and they are still an inspiration today.
Yesterday, the meeting at the Daily Journal and the interview with Charlie was really addressing, I really love, I mean, he's 99 years old and I mean those peanut brittle, you know, actually eat more of that earlier, makes it's wonderful. The results are incredible.
Leandro: Yeah. And, he's so sharp at that age.
François Rochon: I mean, these are really great mentors and you can learn a lot just by reading what they've said over many years. You can you know, you can at least read all the Berkshire Hathaway annual annual letters and goes back to 1977 and it's probably the best thing you can do with your time if you want be a good investor.
Leandro: So the last question is actually somewhat related. What's your favorite investment book that maybe, it doesn't have to be, I know you talked about some, One up on wall street, the Intelligent Investor. It doesn't have to be underrated, but if you know one book that may be the people who are viewing or listening to this maybe don't know, and it has been a source of inspiration for you, what, what would that be?
François Rochon: I still think that the best book ever written on an investment in stock market is the Intelligent Investor. I think everything is in there and there's three or four different versions from 1949 to, I think the last version is 1972. But they're all interesting.
Perhaps a book not as well known, would be the second book of Philip Fisher. It was called "Path to Wealth Through Common Stocks." And I think that's, that's a very good book. I think it was written in the 1960s, so it applies on another era. But, lots of great lessons. I really love that book. I've read it many times for many years. It was hard to find, but it's been republished recently, so you can find it.
Leandro: Okay, perfect. Then I'll definitely buy it because I have not read it. I have read I think the one that everyone has read from Phil Fisher, that is Common Stocks and Uncommon Profits.
François Rochon: Which is a very good book. But this, it's worth reading it.
Leandro: So, that was the end of the questions that I had prepared.
So thank you very much François. It was a great conversation and I'm actually honored that you took the time to be here and come chat with me and I think that a lot of people will benefit from this conversation.
François Rochon: Oh, my pleasure. Thank you.
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Congratulations! Amazing interview.
This was a great and informative interview! Thanks