- Glenn D. Surowiec
How GDS Invests
The GDS Investments philosophy is to invest in foundationally strong companies which are well-positioned for long-term growth and then hold them for a long time.
That strategy directs our focus onto companies with talented leadership, long-term strategies which include current investment for future growth, and vision which extends well beyond the next news cycle. Ours is a strategy in opposition to market and media environments which are oriented toward short-term actors chasing the next big thing or responding to the latest moves by the Federal Reserve.
In many ways, we’ve become a nation of stock renters rather than stock owners, with far too much focus on either last quarter or next quarter, leading to subsequent overreactions due to “short-termitis.” Excessive focus on short-term factors can lead to a company’s market value being taken down for no reason other than near-term earnings pressure, even with the core business intact and sunnier days ahead.
Fundamentally, stock owning is where money is made. To paraphrase Howard S. Marks, the co-founder of Oaktree Capital, companies which are “excellent for a few years” are not nearly as powerful as those which are “pretty good for a long time.”
That is why we subscribe to a straightforward value investing philosophy of buying assets at a discount relative to fair value and waiting for value to rebound and grow over time.
Why do we follow value investing principles?
The value investing philosophy is built on the premise that the market can massively mis-price stocks in the short-term but will tend to closely follow the actual value of a business over the long-term. We believe the value of an investment tends to accurately reflect the ability of that business to generate cash over a long period of time. When we see a stock undervalued relative to the business’ inherent capacity to generate profit, we can reasonably expect outperformance over time.
That’s what we look for: strong companies where the market has become short-term oriented and has consequently overreacted to something inconsequential to the long-term health and viability of the business.
Value investing is not a monolithic philosophy, however. There’s no single right way to do it, and value investors approach it with myriad strategies and ideas for how to make investment decisions.
How do we make our investment decisions?
The answer isn’t necessarily the same at all points in time, but it always starts with a rigorous foundation of discipline and patience.
Stock picking is actually easier than stock owning, and patience underlies success in stock owning. There is always a delay between seizing an opportunity and realizing the rewards. We may need to wait years to reap the reward for great ideas. That waiting can be difficult, and some investors may be tempted to chase a perceived quicker reward. Indeed, short-term underperformance is so anathema to many investors that they will, unintentionally or not, forego long-term gains to avoid short-term losses.
Our philosophy, though, is built on a long-term view of a world where discipline and growth matter. We believe that people hire GDS Investments for a robust process that incorporates an element of discipline that they can't replicate on their own, with a methodology that wins over the long term and, by extension, allows our clients to achieve what they want to over the long term.
To that end, the assets we own must meet a valuation test as well. If patience is the foundation of success, valuation is its fulcrum. We can buy the best asset on the market, but at the end of the day, if we overpay, it's going be hard to make money. Valuation is at the center of everything we do.
Altogether, that means the core of our strategy is looking for companies with a lot of inherent value … and then waiting.
First, we wait to buy. At any given time, there will be dozens of companies that we have qualified to our satisfaction on the basis of earnings calls, communication with management teams, and our quantitative and qualitative analysis of their performance and strategy.
But the one thing that may not have satisfied us is the price. So, we wait. Out of those dozens of qualified companies, almost inevitably we need wait only a month or six and suddenly one of these companies will be 30, 40, 50 percent cheaper because the market is reacting to something short-term, superficial, or exogenous to the company itself.
Then, we wait to sell. Patience also means we want to keep those assets even when the market seems to turn against them, as long as the underlying fundamentals supporting the original valuation remain unchanged. As value investor Warren Buffett famously wrote in Berkshire Hathaway’s 1989 Annual Letter, “When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.”
How do we evaluate our investments?
We bring an open mind to valuation, avoiding capture by single, simplistic metrics like low price to book, low P/E, or low EV to sales. A reductionist approach fails to realize that there might be a level of investment there that might understate the true long-term earnings power of the business. Many strong companies screen poorly under simplistic measures but have the ingredients to improve profitability over time.
In general, GDS Investments looks for companies with long operating histories and solid balance sheets, but which are within the bottom quartile of their historic valuation. We always work to reposition the portfolio toward companies which have the following characteristics:
Are the company’s products and services so exceptional that consumers remain intimately engaged for extended periods of time?
Does the company have a defensible and growing competitive advantage (moat)?
Does the company have a history of pricing power?
Is the company’s balance sheet so strong as to enable investment optionality?
Does the company have low maintenance capital requirements (including labor costs)?
Are the company’s leaders missionaries instead of mercenaries?
Can the company be purchased at a healthy discount to intrinsic value?
All told, we typically favor “best-in-class” businesses that have size and scale advantages, meaning they're generally number one or two in their sector, with a history of taking market share. They have an increasing capacity to use existing cash flow to finance future growth, with clean balance sheets and an ability to generate a high return on capital, ideally through margin and turnover, not leverage.
More importantly, they must be managed well. A good management team is like a good money manager. With a healthy tailwind, investors can ride that team’s successes for a long time and make a lot of money. Importantly, we look for management teams that are shareholder friendly, especially around capital allocation. If they're taking our money, we want them to be reinvesting in ways that create value as opposed to ways that destroy value.
That means they must be implementing a business model that can generate revenue. Business models can be challenge to judge, but it’s the corollary to having a good management team. If we want them to be reinvesting free cash flow in smart ways, they need to operate under a business model that facilitates their efforts. The business model is what separates a dying DVD-oriented Netflix from a thriving streaming-oriented Netflix, for example.
What we don’t do
We do not own an excessive number of positions.
Diversification in holdings is a hedge against risk, but over-diversifying can introduce risk as well. The market isn’t efficient enough to support 50 great ideas simultaneously. No single investor has enough insight into enough different businesses and markets to have that many great ideas simultaneously. In fact, investors who try to come up with new great ideas every day are asking too much of the market. At that point, they will inevitably put money into at least some bad bets. In the attempt to use diversification to protect against losses, they guarantee losses. Balance is the keyword here, and we favor no more than 15-20 assets at any given time.
We do not overestimate what we know.
It helps to own companies in areas where we possess deep-rooted knowledge. We cannot maximize the value of someone else’s insights where our own insight is low. We are very sensitive to what the other side is thinking about a given position, and we don't necessarily want to just rush into a buy thinking that somehow our differentiated view is automatically right. We want to be both humble and intellectually honest about how much insight we actually have.
We do not follow an indexed approach.
We do not index our decisions to a formulaic system or set of positions. Indexing has its place in a high-functioning market, but it tends to introduce unaccounted costs and an inability to adequately personalize the portfolio to the individual situation and needs of the portfolio holder. They are also often over-concentrated in specific areas. Finally, indexed buying and selling also tend to be more responsive to short-term adjustments, which runs counter to the value investing philosophy.
Ultimately, like all value investors, buying assets at a discount to fair value is the centerpiece of my strategy.
We remain steadfastly committed to that core principle. That commitment keeps us focused upon companies which are structured and managed to succeed in the long term. Of course, there will be periods when stock values appear depressed. In these times, we’re best to remember Charlie Munger’s advice:
If you’re going to invest in stocks for the long term, or real estate, of course there are going to be periods where there’s a lot of agony, and other periods where there’s a boom. I think you just have to learn to live through them. As Kipling said, treat those two imposters just the same. You have to deal with daylight and night – does that bother you very much? No. Sometimes it’s night and sometimes it’s daylight. Sometimes there’s a boom. Sometimes there’s a bust. I believe in doing as well as you can and keep going as long as they let you.
