Dan's Perspective: When Goliath Wins

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The story of David vs. Goliath has been told countless times of the smaller David takes on the much larger Goliath and wins against all odds. As a Toronto Raptors fan watching Kawhi Leonard lead us to a championship against Steph Curry and the Golden State Warriors, it really felt like a David vs. Goliath moment. However, when it comes to investing, we have found that putting our capital behind Goliath can be a sound investing strategy for the long term. When we do come across a market leading business with a strong competitive advantage, management that act like owners and a growth runway, we are excited to have found our next Goliath.

The power of network effects

One of the underappreciated benefits of already having a large successful business is the potential for network effects to develop and become re-enforced. Facebook has been in the news for the wrong reasons recently but as investors we also see one of the best examples of network effects executed globally in modern history. Despite being much larger than their closest peers, Facebook has grown to connect more people to each other than their next five biggest U.S. competitors combined. Over the last four years Facebook has added 550 million users to their ecosystem while the closest four peers have 590 million users combined. This has been the foundation of Facebook’s resounding financial success as advertisers allocate their budgets towards channels with high consumer engagement and real-time analytics capabilities that can measure the return on investment.

social networks by user size
Source: Company Filings, Cambridge Estimates

social networks by users added
Source: Company Filings, Cambridge Estimates

Strong operating leverage

An attribute we look for in industry leaders around the world is the ability to continue improving profitability on their core business while also expanding into attractive side businesses. As long-time followers of the global payments’ duopoly, we have said many times their creation and subsequent privatization was an accident of history to the benefit of shareholders (How else can we describe thousands of banks around the world agreeing to a common set of standards?). They have created strong competitive moats but what is even more impressive has been their ability to take some of the highest margins we can find of any business and raise them to new heights. This has been driven by a naturally scalable business model where every new dollar of revenue comes with little extra cost. Paired with innovative new products quickly adopted by customers, both Visa and Mastercard have increased profit margins over 1% per year for almost a decade.

payment networks profitability
Source: Company Filings

Attractive capital allocation opportunities

When we are looking at the capital allocation track record during our due diligence process, it’s not just about focusing on a major acquisition or disposition. Our businesses are allocating capital every single day through thousands of smaller decisions made from by employees across the organization. Finding companies with a runway to allocate capital organically and inorganically can lead to strong returns for patient shareholders.

Take Ashtead in the equipment rental industry, with two industry leaders followed by thousands of smaller competitors. By making hundreds of small strategic decisions astutely, Ashtead has been able to add more equipment per store. Adding more assets that generate revenue without increasing the number of employees in a location, the returns on new equipment are highly attractive. By having a platform to invest capital at returns higher than competitors, it becomes harder for the smaller players to ever catch up. 

Ashtead unit economics
Source: Company Filings

Closing thoughts

We remind ourselves every day that past performance is not always a guarantee of future success. After all, one-day Facebook will run out of people in the world to connect. Finding businesses that exhibit these characteristics at a price that provides us with downside protection is not an easy task and bigger is not always better. However, when we are conducting due diligence all around the world, our sights are squarely set on finding these special types of businesses and following them for years to come.

As always, thank you to our clients for entrusting us with your savings and giving us the opportunity to help compound your wealth and secure your future. We wake up every morning focused on making that a reality.

Let’s go Goliath!

Dan Rohinton, Portfolio Manager



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Published January 20, 2020.

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