This week Matt sits down with Ross Glotzbach, CEO and Head of Global Research for Southeastern Asset Management, for another insightful perspective on investing in the capital allocator series. Ross starts by defining what value investing is to them and the way in which his company, Southeastern, uses it. Ross then shares further insight about the impact long term value investing has had in the past and how it has changed over the years. Matt and Ross then discuss the process that Ross goes through in choosing whom to invest in and the conversation comes to a close with a discussion around the application of psychology in explaining investing behaviors.
Episode Transcript
Ross Glotzbach 0:00
And then if you just look back over the whole entire history of all kinds of investing
back to data back to the 1800s, value investing has been the way to go over that stretch
of time as well, buying things for significantly less than they're worth when they're
great going, growing companies. It just makes sense.
Matt Waller 0:20
Excellence, professionalism, innovation, and collegiality. These are the values of
the Sam M. Walton College of Business explores in education, business and the lives
of people we meet every day, I'm Matt Waller, Dean of the Walton College and welcome
to the Be Epic podcast. For the next few episodes, I will share my conversations with
capital allocators in the seed, venture and private equity space. They will discuss
how their capital allocation works, and provide tips to entrepreneurs on how to stand
out. I have with me today. Ross Glotzbach, who has a CFA he is the CEO and Head of
Global Research for Southeastern Asset Management. Thank you so much for joining me
today.
Ross Glotzbach 1:09
It's great to be here with you. Thanks for having me.
Matt Waller 1:12
Ross, before we get started, would you tell us just a little bit about Southeastern?
Ross Glotzbach 1:17
Sure. So we are headquartered in Memphis, Tennessee. We were founded in 1975 by our
current chairman, Mason Hawkins. And we are long term value investors. So we can talk
more about what value investing means later and how we define that because plenty
of people define it different ways. But you know, we've had a good constitution from
day one, we want to do what we would be excited to do with our own money. We want
to put ourselves in the shoes of our clients. And we want to just focus on the right,
right long term decisions all around.
Matt Waller 1:59
Well, that's great. And you mentioned you know value investing can be defined a lot
of different ways. So what how do you define value investing?
Ross Glotzbach 2:12
You'll hear a few words from us over and over again. Business, people, price, it's
in that order for that reason. So business means this has to be a great business that
we can understand. It might not necessarily grow in a straight line, or be readily
apparent as a great business at all moments to the stock market. But we define great
business, you know, good incremental returns on capital pricing, power, structural
growth, tailwinds and a good industry structure. On the people side of things, we
want to partner with great like minded owners who are incented to do the right thing
for value per share, and free cash flow per share over the long run. And, you know,
because we've been doing this for over 40 years, we've got a good network, we want
to check on these people, want to go meet them, we want to just run them through a
job interview process like if you and I, were gonna hire somebody for something. Everybody
wants a great business with great people. This is pretty obvious, right? So we've
got to be able to find a company like this, when it's, you know, hated or misunderstood
or maybe even just ignored. And that gets to the price side of things. We try to pay
two thirds or less of our long term, discounted cash flow appraisal for each of these
companies. And because we are such long term and concentrated investors for each of
our portfolios in a given year, we only need a few good ideas. So we can be choosy.
And that's a long and thorough process to get to those few qualifiers. But that is
that is how we would define value investing, you know, paying a discount for something
that's great and misunderstood.
Matt Waller 4:04
Excellent. Yeah. Usually, when we think of value investing, that's what comes to mind
the price piece.
Ross Glotzbach 4:10
Yes.
Matt Waller 4:10
But as you said, Well, you first want to make sure you have a good business. And then
you want to make sure they've got good people. And then you want to make sure yes,
this really has value from a price perspective. But I'm glad you explained that because
typically, we think of price first.
Ross Glotzbach 4:31
Well, it's easy to get sucked in as a value hound by the deeply discounted price.
And the two kind of patron saints in the value investing world are Ben Graham and
Warren Buffett. So Ben Graham started off in the Depression, buying companies that
were trading for basically less than the cash they had on the balance sheet. We're
all about that too. But there aren't too many of those left these days in an efficient
market. Although if the stock market keeps going in this direction, maybe there'll
be some of those. Warren Buffett, on the other hand has, you know, evolved over his
long and storied career to focus much more on business and price. And he's almost
more to the place where he'll pay a fair value. For a company when he feels like he's
got both of both of those two things, business and people, we want the best of both
worlds. So that's where we're coming from.
Matt Waller 5:25
When you talk about business. And, of course, you mentioned earlier just briefly,
that you're concentrated, because concentrate again, that's like the word value, it
can mean, usually, when you think of value, again, you think of price, you have a
richer kind of view of that. And then when you think of concentrated, you know, you
could think of five, you could think of 100, it depends on who you're talking to in
the situation. When I say five, I mean, like five investments or 100 investment, what-
how do you all think of concentrated?
Ross Glotzbach 6:07
The number that is the average number for most of our portfolios is about 20 stocks
and academic studies and our real life experience would say, once you own a kind of
roughly defined teams, number of stocks, the incremental benefit from that additional
stock helping you diversify, goes down, you know, pretty materially. So, we've found
often, you know, sometimes we'll have companies that might be exposed to a single
risk factor in a single industry or country, and therefore, we might be a little bit
on the higher end of that teams, that's closer to 20. We have always thought that,
you know, we are best at being stock pickers. And, you know, therefore, we need a
concentrated number of companies that we deeply understand, where we feel our edge
is biggest. And also, you know, we want to be able to truly be differentiated, than
the stock index, and it was, you know, ETF and index investing was not really much
of a thing in 1975, when we started today, it is very much a very big thing. And we're
not here to talk pro or con about index investing should probably be a part of a lot
of portfolios. But you need to make sure if you're willing to be an active investor,
that you are a truly active investor, and therefore, not what we would call a closet
indexer. There's a mathematical measure of this called active share, where if your
active share isn't up into the 90% plus zone, which ours has always been, you risk
basically being an indexer or a closet, indexer. And we will never be that we want
to take concentrated bets, where we feel, you know, we are going to be rewarded over
the long run.
Matt Waller 8:10
You mentioned that, of course you want to pick good businesses. And you talked a little
bit about, you know, free cash flow per share over the long run, do you mean cash
flow per share over the long run, going forward? Or historically?
Ross Glotzbach 8:32
Well, you know, I think a good investor once said 100% of the information we have
about a company is the past, but 100% of its value will come from the future. So we're
focused on the future. And we are often unfortunately having to inform that by the
past, the stock market will zero in on the immediate past and the immediate future.
What we want to do is look at the you know, as long of a sweep of history as we can,
you know, talk to customers, competitors, suppliers to see what this industry is going
to look like several years from now to get at what that free cash flow will be several
years from now because our average holding period is is three to five years although
we've certainly held longer we're not opposed to holding shorter to if we can have
a you know, quicker return or or find out when we're wrong and move on from it sooner.
So, so you're right is that is that few years from now free cash flow per share, because
the closer you are to today, the more the market has an edge versus long term focus
people like we like us.
Matt Waller 9:39
That makes that makes a lot of sense. So when you're when you're looking at other
business aspects, like maybe you know the structural growth or just good, a good industry
structure, what specifically are some things you're looking for there? If I may,
Ross Glotzbach 10:07
You know, there's there's some qualitative and some some quantitative, you know, the
first qualitative is just can we understand it? You know, or is this just too hard
for us and we don't have to play. You know, most publicly traded companies, especially
as they, especially as they get up to a certain size, they'll they'll have pretty
good understandability to them, you know, we're not in the private venture capital
business, we're focused on pretty established publicly traded equities here. Once
once we've gotten that understandability. And it's not just understandable, five years
ago, or today, it's on into the future, because that's where the value comes from,
of course, then we're going to be looking for Okay, are there are there growth tailwinds?
You know, starting on the demand side? Do people want more of this year over year
in an understandable way, you know, can this grow at or above population growth or
whatever the right kind of, you know, baseline metric would be. And then once we start
getting into some of the industry structure, and, you know, how, how much the potential
company we own or are looking at will get of that structural growth? You know, usually,
it's, it's pretty, pretty standard Porter model analysis, where, you know, how many
real competitors are here, who has the power customers, suppliers all up and down
the chain. Two good ways to measure that mathematically will be return on incremental
capital, and pricing power. You know, if a company truly has pricing power, which,
you know, we would often talk about pricing power in the pre inflation days, and it
would, it would be harder to measure and not coming through. And now, now, the, it's
flipped about 180 degrees, where we need to look through maybe today's extreme inflation,
and look towards what a what a more normal environment might be like. But that that
pricing power and that return on incremental capital are often two two sides of the
same coin, you know, if you're, if you're able to grow your your net free cash flow
more than than your costs, then your incremental capital returns will probably be
going up.
Matt Waller 12:24
Also getting to the people. Just digging into that a little more. I know you said
you were you're looking for partners that were incented properly.
Ross Glotzbach 12:38
yes.
Matt Waller 12:39
What would- What do you mean by that? Exactly?
Ross Glotzbach 12:42
That means we are going to dig deeply into their proxy statement filed by the SEC.
And, and there, you'll see, okay, are they actual owners? You know, how many shares
do they own? And then you can look at the form four filings with the SEC, if they've
been buying or selling recently. And then you want to see how are they paid? You know,
if they're paid on, not really asked at risk metrics, or it's too short term focused,
you know, and they just want to get that annual or quarterly bonus, and then be gone.
We don't want any part of that. But, you know, we'll be looking for a few things.
And this is the kind of engagement we like to do with companies and their boards,
trying to make sure that they are focused on the right things, we would say if we
had to pick three, to see on that proxy, we would want to see long term free cash
flow per share growth as a metric that's important, long term return on incremental
capital growth, which I've already mentioned. And then just total shareholder return,
you know, course it's out of management's control, if a stock goes up or down, you
know, day to day, week to week, but over the long run, the markets probably more likely
to get it right than not. And if managers are both real owners themselves, and then
incrementally compensated on how those three metrics go, usually, that's a winning
combination.
Matt Waller 14:13
Would you mind explaining a little more about your investment process, per se?
Ross Glotzbach 14:18
Sure. So, you know, we probably are of a size such that, you know, I would say several
1000 companies around the world are big enough for us to invest in. And then we reduce
that list further, focusing in on those ones where we can understand them. They're
in countries with a good rule of law. And so we probably say about 1000 to each in
the Americas, in Europe and in Asia. That's what we call our master list, and that's
what we're going down every day. Now because we're long only investors and most valuations
are distributed, at least somewhat normally, we're going to be trying to focus on
that underpriced end of the curve. And we've got a, you know, a team of researchers
here, going down that list. And, you know, if each researcher looks at, you know,
100 plus companies in any given year, in some level of detail, which is really only
two a week, then you've got a good amount of coverage right there. Now, there are
different levels of detail warranted amongst that 100 or so per analyst. And, you
know, I'd say, for each portfolio that that we manage, only, you know, dozens, you
know, or so per year, depending on what the stock market is doing, will be looked
at in detail. And that's when things start getting into our devil's advocate process,
where each doc is assigned somebody to take an opposing view, not necessarily a knee
jerk opposite view, because that's not helpful, either, but just an independent view,
and go there on the initial management meeting. And then we, you know, talk about
this amongst ourselves, what are the key kind of pain points here? What are, you know,
points, we need to further research, who knows this guy somewhere that we can talk
to on the board, or, you know, who's done business before with a competitor or a supplier.
And, you know, that's a process that can take months, or if it's one that we've owned
before, and not much has changed, and the stock market just freaked out about it for
the wrong reason, it can take days, you know, it's we don't want to have like, pointless
bureaucratic levels of red tape to, you know, waiting periods or something like that.
We just want to get it, get it approximately right, and then go from there. And again,
that's a process our whole team is weighing in on and ultimately, the portfolio managers
will make that decision.
Matt Waller 17:01
Well, you know, I know you have a background in economics. And there's this concept
in economics of loss aversion where, psychologically, the pain of losing is twice
as powerful as the pleasure of gaining. And there's all kinds of other aspects to
it, than that about risk aversion and stuff. But I'm curious, have- do you take any
behavioral economics kind of concepts into account in your your process?
Ross Glotzbach 17:38
Yes, is the short answer. As you did some research on me, you probably saw that I
was an econ major, but I took a lot of psychology classes too. And I kind of wish
I would have been a psychology major, and maybe a finance minor, or double major or
something, but then that would, that would imply that I, you know, a different kind
of college perspective, maybe it's easy to say that, right. So, loss aversion. And,
you know, you can list all of Kahneman and Tversky has other very important biases
that we always have to wrestle with, you know, because we are fundamental bottom up
investors, we're not purely quant investors where a computer is making all of these
decisions, we think that's better over the long term. But in the short term, it's
always going to lead to debate and hard decision making, you know, loss aversion,
I have this thing I like to talk about, where if we're doing a great job, we're right
about three out of five choices. And that means we're going to be wrong, maybe two
out of five. Now, to your point, if those two out of five, are felt at least twice
as much as the winners, which studies would show that's probably the truth, then you've
got these kind of four bad feeling units versus these three, good feeling units. So
concentrated, long term investing is almost guaranteed to always feel bad. And that's
what makes it rewarding in the long term. And that's why not everybody's doing it.
And that's why we keep going. And we're, you know, excited about our future here.
Because it's not the kind of thing that that self selects easily. You know, it's not
like, Hey, look at these guys in Silicon Valley been making money forever, or other
kinds of things. It's just this this is a unique skill set that requires years to
build up to how we did it.
Matt Waller 19:48
Ross, there's a lot of people who would think that value investor investing hasn't
been as effective in the recent era of investing. What would you say to that?
Ross Glotzbach 20:02
Well, I would say they are definitely correct, looking backward, the last several
years, or even longer. But that's what has set us up for a very exciting, you know,
next 5, 10, 15 years. You know, when I first started learning about investing myself
in the late 1990s, and early 2000s, that was a very interesting point where the 1990s
had been a very strong bull market, growth and .com stocks were were all the rage.
And if you didn't own those, you have no idea what you were doing. And that set up
a very good subsequent five to 10 year period for value investing. And then if you
just look back over the whole entire history of all kinds of investing back to data
back to the 1800s, value, investing has been the way to go over that stretch of time,
as well buying things for significantly less than they're worth when they're great
going growing companies. It just makes sense. And, you know, makes sense, mathematically
and intuitively. So, you know, we think that the the 10 years plus leading up to this
period, that was the unique time when interest rates kept going down, or being stable
and money was pretty free. And that was a nice wave that was surfable, by many different
things in the public and private markets. That has changed dramatically this year.
And now money has a very real cost, and it could be going higher, over the long run.
Times like that have been very good for our style of investing, where we appraise
individual businesses and look for companies that are able to go on offense themselves
to grow free cash flow per share, no matter what the environment is, versus just a
rising tide lifting all but boats. And that's, that's not going to be the time when
our deep research shines through. So pain to get to this point. But that's how you
get excited as a contrarian, long term investor, which is what we are.
Matt Waller 22:16
Well, Ross, congratulations on your great success in your career. And thank you for
taking so much time to visit with me. I really appreciate it.
Ross Glotzbach 22:27
No, thank you for having me. Go Hogs.
Matt Waller 22:31
On behalf of the Sam M. Walton College of Business, I want to thank everyone for spending
time with us for another engaging conversation. You can subscribe by going to your
favorite podcast service and searching. be epic. B E E P I C.
