You're listening to TIP.
On today's episode, I'm joined by Andrew Brinton to discuss the inefficiencies he's seeing in today's market.
Andrew's the CEO and co-founder of Turtle Creek Asset Management.
Since its inception in 1998, Turtle Creek has achieved an average annual return of 188, versus just 87 for the SP 500.
$10,000 invested in their fund at inception would have grown to over $1 million today.
And had that money been invested in the market, it would have been worth around $95,000.
During this conversation we'll cover Cliff Askins' recent paper on the efficiency of markets whether today's market resembles the 1999 tech bubble and Andrew also gives an overview of his investment thesis on floor and decor in Kinzel Capital.
So with that, I hope you enjoy today's discussion with Andrew Britton.
Since 2014, and through more than 180 million downloads, We've studied the financial markets and read the books that influence self-made billionaires the most.
We keep you informed and prepared for the unexpected.
Now for your host, Clay Fink.
Hey, everybody.
Welcome back to the Investors Podcast.
I'm your host, Clay Fink.
And today I'm pleased to be joined again by Andrew Brenton from Turtle Creek Asset Management.
Andrew, welcome back to the show.
Great to be back, Clay.
So you've been a guest a few times on the show now, and I'm thrilled to have you back.
We're going to be chatting about today's market, as well as a couple of your holdings a bit later.
Let's talk by talking a bit about the efficiency of markets.
So, as you know, value investors will shun the efficient market hypothesis and pride themselves on trying to spot the market's biggest inefficiencies.
How about we start by discussing why having efficient markets are important and something that we should even care about?
Sure.
I mean, if you believe the purpose of the capital markets and I'm now talking private markets, the debt markets, the public stock market if you believe the purpose is to allocate capital to the deserving groups at the right price or cost, then I think it's absolutely critical.
It's a foundation of most the definition of capitalism and it's the foundation of the success of the Western world since the Middle Ages or even predating that.
So I think that foundational idea of how do you get information, that messy, messy process of figuring out what a company is worth and therefore what you should pay for shares when that company needs to issue equity, is absolutely a critical component of the modern world and, I think, very important.
So Cliff Asness wrote this great paper titled The Less Efficient Market Hypothesis, and he actually believes that markets are becoming less efficient over time.
And he points to three different factors here.
So first he mentioned the driver that everyone's familiar with, which is index funds and passive flows.
The second is very low interest rates that we've had for a very long period of time.
And third is just technology and social media leading to more of this herding effect where people are crowding into the same stocks and everyone has the same outlook.
There's a lot of groupthink happening.
Do you agree with Asens' train of thought that markets are in fact becoming less efficient over time?
I think that's right.
And it's funny when I was at school which is probably around the time that Cliff Asens was at school, that was the height of the efficient market hypotheses and I didn't start as an investor.
I started in investment banking and mergers and acquisitions and I quickly realized that came out of school thinking markets are perfect, markets are efficient and quickly realized that isn't true at all.
We don't really, if you will, read a bunch of other stuff, if that makes any sense.
Our approach is to be intensely owners of companies that happen to be public is how we think about it.
But someone sent me a Cliff's paper.
Actually, I think I saw it and read just the abstract and thought, yeah, that makes sense.
But I didn't read the paper.
And about six months ago, I actually sat down and read the paper.
And it was actually a foundation for one of our quarterly commentaries this year.
And I do agree that markets have become less efficient.
We've seen it over our 27-year now history at Turtle Creek.
They're not less frenetic.
They're not less liquid.
So if you define efficiency as lots of reaction to the latest tweet, the latest quarterly results, that hasn't changed.
That's actually become more extreme, but that doesn't necessarily equate to efficiency.
If you think efficiency means getting reasonably close to fair value for the shares of a company.
And that's, I think, what most people would define as efficiency, as opposed to volumetric reaction to every new piece of news.
I love the quote from Robert Shiller, the economist, and it goes along the lines of the thought that, because the markets are reacting to every new piece of information, that they are then getting it right.
There's no logic in that connection.
And it's the greatest economic error in thought in the 20th century.
I mean, I'm paraphrasing, but that's the essential thought.
And if you think markets were inefficient, always to some degree I do agree with Cliff's observation that in his career markets have become less efficient.
And we've seen the same thing.
It's such an interesting thought experiment.
A couple of thoughts come to my mind when it comes to the markets and efficiencies, and how those end up resolving themselves over time.
I think part of the inefficiencies is just simply due to human nature.
Humans are the ones doing most of the buying and selling, or programming all these algorithms that do the buying and selling.
And I think about how people just tend to be loss averse, for example.
So when a stock is dropping, our gut instinct usually tells us to avoid that stock, to avoid losing money.
And many stocks drop simply due to things like uncertainty.
Humans tend to hate uncertainty.
And another human bias that I think lays into markets quite often is just this natural tendency to extrapolate.
So the market tends to assume that a company is growing is going to keep growing, or a company that's experiencing decelerating growth is going to keep experiencing decelerating growth.
And then once the tide sort of turns, you can see a stock double fairly quickly.
And I think there are plenty of examples that we could point to that sort of illustrate just how moody the market can be.
You know, it's interesting right.
Recently, meaning the last 10 years, with the whole rise of behavioral finance and all of that great work like thinking fast, thinking slow.
When I read about all of the biases, I look at them and say, that's not us.
And I read the next one and say, that's not us.
So, for example, loss aversion.
My view is, if you have done the work ahead of time and you have a good fundamental view on what you think a company is going to do for the next 10 and 20 years, and if you also believe that there is no informational content in the share price, I think that's an important point.
I can understand people on the outside looking in on a company that the market's telling them things aren't going well because the share price is down.
But if you understand that very, very few people, an increasing number of fewer people, are actually doing that fundamental work, a declining share price doesn't fuss you or fuss us, but equally a rising share price doesn't get us excited.
And so it's not really a fair description when the classic line of why do people get excited at supermarket when tuna goes on sale but not when stocks go on sale?
And the simple answer is, people have an understanding of what the price of tuna is.
You have to go fish it, you have to process it, you have to get it into cans, you have to get it into the stores.
And so if a food store puts something on sale like that, you know you're getting a deal.
The problem is in the stock market very few people have done the work to say wow, at that lower price, that's a really good deal.
And so, as I say, it's not really a fair comparison.
And if you think there are fewer fundamental investors in the market, and for sure there are.
And then if you take the fundamental investors or the active investors and you put them into the bucket of closet indexers or quasi-closet indexers, and then, when you mentioned the three reasons that markets have become less efficient, from Cliff Asness's standpoint, the one that doesn't really resonate with me is necessarily low interest rates.
It does create you know, exuberance and easy money.
So I get that.
But I think there's a fourth, and that is the shift in active management from that longer term fundamental investor from groups like a Fidelity or a T Rowe Price to the pot shops, to the quants that are given the mandate.
You know, you can't look beyond three months.
We want you to figure out where their share price is going to be in the very short term so that their temporal advantage situation is.
They have to think very short term.
And so it's not just a move toward index funds.
It's this, I think, a structural shift in the stock market to more of the trading, or more of the activity where people who are making their own decisions are doing it based on trying to figure out what's going to happen in the very short term.
And maybe, of all of those, maybe the most profound in terms of the impact on the market where we're sitting today.
One of the other interesting points I'd like to touch on is just this understanding of value investors needing to be patient and sit through some periods of pain.
Let's call it.
So one of the core principles of value investing is buying something for less than it's worth.
And a lot of money can be made by simply waiting for the market to recognize that value.
In some cases the stock can go up 50 in six months after the market realizes it initially had it wrong, and In other cases a stock might trade relatively flat for two, three years and the market just simply doesn't care about it or for whatever reason.
Maybe the story's too complicated.
Maybe the market's more interested in AI or quantum computing stocks, or perhaps it's just in a sector that the market just doesn't like at that period of time, and maybe their peers aren't doing as well.
But eventually, the market does tend to recognize that value.
Based on your experience, how long do you think these really big inefficiencies tend to last, on average?
Robert Leonard I think it's probably getting longer.
So I can only speak from our experience.
So 25 to 15 years ago, we were overwhelmingly Canadian equity.
So I can only speak to the Canadian market at that time.
And now we're the majority are US companies.
Generally, we use a five-year timeframe.
So our approach in terms of portfolio construction, in terms of how cheap something is, we give the market credit that over the next five plus years the share price will get dragged, kicking and screaming toward our view of intrinsic value.
If we're right in our view,
And we've seen that borne out time and again.
And to your point, sometimes it happens in a year or two.
Sometimes it takes more than five years.
It's really hard to make this statement because I think we're in a unique stock market environment right now.
But for sure, it takes longer today than a decade ago.
And I think that again was one of Cliff Asness' point that you know, if you can take the approach of being truly understanding value and owning value, given the market structural changes, the opportunity set is greater, but you have to be willing to sometimes wait longer.
And I think that was the most important summary, in a way, conclusion that he made at the end of his paper absolutely believe that we see greater mispricing today than we've seen in the past.
And I'll set the dot-com bubble aside, because that was a you can analogize to today, but there was crazy mispricing then.
But otherwise, if you think of regular markets, the mispricing on average is greater today than it was 10 or 20 years ago.
I think you hit on a really good point earlier of not falling prey to resulting.
I think the stock market's just such a great place to gain humility, because if you attribute success as an investor to a stock price going up and failure as an investor to a stock price is going down, you can do some really silly things in the near term.
And Asness he has this wonderful point in his paper that the enemy of the efficient market hypothesis is a bubble.
According to Asness, we're in a bubble when we have a large number of stocks that are trading at prices that can't be justified under any reasonable model.
And I think a couple of important points on that sentence is it needs to be a large number of stocks.
So it's not just maybe one little sector, maybe a few small caps that are trading at high prices.
And then also their prices can't be justified under any reasonable model.
So if there is a reasonable case for higher valuations, then it's more difficult to justify it calling it a bubble.
As you mentioned, today's market is particularly interesting, as there are several industries that are really struggling or, as you've stated, are really in a recession.
While the broader market continues to march upward and is primarily being lifted by the market's big winners in tech and AI.
How about you talk a little bit about if today's market does resemble the 99 tech bubble and maybe in what ways?
You know, what's the line?
A history doesn't repeat itself, but it rhymes.
And I think again in Cliff Asness's paper and in other commentators who've been around for a while.
I agree with this comment that you expect a bubble once in your lifetime, because once people realize, it's the next generation that creates a bubble.
And I guess it's been long enough now that it is the next generation.
We were around for the dot-com bubble.
And I remember at the time people asking my view on a Canadian company called Northern Telecom, 360 Networks, Global Crossing and Cisco and Intel.
In fact, Microsoft is the one that comes through all of that.
But it took a long time for them to come through in terms of recognizing what they're worth.
And we refuse to give a view because we weren't doing work on those companies.
And so it's similar for us today with the Magnificent Seven and AI, in that our approach is to try to find the special company in an industry, and we're going to talk about two today, I think, that are really doing unique things in their industry, as opposed to trend investing or thematic investing, where we look at a theme like AI or synthetic biology and then try to find a company that is in that space.
But just in terms of the attitude of people And what it feels like and frankly, the multiple of the broad market, it feels very similar to the dot-com bubble.
Again.
You can always find arguments to say this time is different.
But those are the four most dangerous words in investing.
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All right, back to the show.
It's funny.
The other day I was chatting with a listener of the show and his son was a college student and he had the best returns of anyone I've heard of in the past year owning Palantir.
Many of these AI stocks I haven't heard of that are up three, four X in the past year.
And I think that's sort of some of the telltale signs of some of the things that happen during market euphoria.
So let's get here to talk about two of your portfolio holdings.
We have Florin Decor and Kinzel Capital.
And you believe that the market is getting the pricing of these stocks wrong.
And we'll get into why that is.
How about we start with floor and decor?
Talk about some of the things that you like about this business.
You know, it's interesting.
The two you mentioned, Clay, they have similarities.
We came across floor and decor a number of years ago.
And it's interesting, I think here in my office one day years ago I was having a thought experiment.
And the thought experiment was if we'd been active in the US when Costco was early days, would we have understood the opportunity set that they had?
Because our approach is not to just.
We're thinking of 10, 20 plus years and trying to be balanced in our forecasts.
And I walked down the hall and spoke to some of the people on the investment team who were hanging out in the hall.
And I posed that point.
I said do you think we would have recognized it?
And they smiled and looked at me and said we think we have one for you.
And it was floor and decor.
And so, if you think, a good value investor, I think is not someone who's looking for a net, net right.
That was 60, 70 years ago.
And a good value investor is trying to find what's the present value of all future cash flows.
Could be high growth, could be low growth.
It's just what's it worth based on the future.
And with Floor & Decor, if you understand their business model, they set out 20 years ago to essentially recast the hard surface flooring market.
As they describe it, they go direct to the mountains.
So they have 250 vendors in 25 different countries around the world.
And the founder, who is not running the company but is on the board, set out to democratize hard surface flooring.
And I don't know what that means, but-
I think I understand the thought.
Their structural cost advantage against the Home Depots and the Lowe's and the other specialty chains is shocking.
They cut out the middlemen to the extent they can.
They have their own big box stores, as you know.
It's cash and carry.
They've upended the market.
It's a true disruptor in their industry.
And so when we found it and met with management and talked to them and understood it, one of the things I stress to the people working on that financial model is I will be as upset right looking into the future.
If you are conservative in your forecast.
We conclude you know it's not cheap enough to make it into our portfolio because we are very valuation focused.
And then five, 10 years later I look at what they've done and look at our original forecast and we were woefully low.
So that will make me in a way more upset than if I look in five to 10 years and realize we were too high, if that makes any sense.
Trying to get it right company by company.
And so it's a little surprising to me that a pure organic growth company that many investors understand that has that business model was cheap enough three years ago to make it into our portfolio, given our valuation criteria.
So it needs to be a great company with great management, long tenured management typically, which this company meets all of that high business quality.
But then it has to be cheap enough to kick something out of our portfolio.
Would speculate that three years ago with the short-term focus on, is the US going into a recession?
It got cheap enough to make it into our portfolio.
And I'd also speculate that there'll be a point when things are fine out there because they're not fine right now, but when they are fine out there in North America because this is such an attractive organic grower taking share every year in their industry that it may well get to the point where the share price is such that it doesn't stay in our portfolio.
During our previous interviews, we discussed in depth the idea of buy and optimize instead of buy and hold.
And looking back at floor and decor stock chart, buy and hold investors aren't faring too well.
Over the past five years or so, in 2020, the stock price was 60.
You see it double, get cut in half, double again, get cut in half again.
And you look at the business and revenues have nearly doubled.
The number of stores have also doubled.
The earning side of the equation is struggling in light of the industry being in a cyclical downturn.
So how about you touch a little bit on this buy and optimize that we've touched on so many times in the past and how you manage that with a stock like Fuller & Decor?
Sure.
I mean, I would start on this conversation to say I worry that we overemphasize this as part of our process because it's different, right?
The best investor of all time, Warren Buffett, preaches buy and hold.
He doesn't practice buy and hold, by the way, but he preaches it.
And I understand why he does that.
And it's funny, right, that my partners and I come out of private equity.
We set up and ran the private equity arm of one of the big Canadian banks back in the 90s.
And I looked at the public market and thought, there's this extra lever.
You find good companies and you take a buy and hold mentality the way you do in private equity.
But then the price moves around and it's just a lever to be additive to your return.
So the fundamental idea take a floor in decor is you've done the work, you have a full long-term forecast.
And at a point in time, the share price is cheap enough to make it into our portfolio.
And then, which means, since we have a target of a fixed number of holdings, it does push something out.
And if nothing then were to happen, we wouldn't do anything.
We are at core a buy and hold mentality like any good value investor.
But here's the thing about the public market.
As you mentioned, we added it at around 60 a few years ago, more than once.
And I looked at the stock chart last night in preparation for talking to you today.
It just reminds me how much it's moved around.
And in the meantime, our view of what the company's worth hasn't really fluctuated that much.
It's gone up over time because you move forward in time.
So value is increasing as you move forward in time, almost by definition, if you're a value investor and they're making money and they're on plan with what you forecast.
So if we feel like we sized the position when we first bought it at 60 bucks and at a point the stock's 120000, to sit and say, oh look, how smart we are.
The stock has doubled.
If you don't say to yourself, we shouldn't own as many shares.
We should actually make sure it's a smaller percentage waiting in the portfolio with that higher share price.
And this is our thought experiment when we started, Turtle Creek was hey then, if you don't want to sell stock at a hundred bucks, you didn't own enough at 60.
And of the things that we try to communicate, the most Difficult thing to communicate with our philosophy is we are a buy and hold.
Unless floor and decorous valuation goes through the roof.
We're going to own this company for a long time.
But the amount that we own is going to be a function of our view of value, which changes a little bit over time right,
But primarily, it will be the margin of safety, right?
What's the share price versus our view of intrinsic value in it?
It's something that we apply across the portfolio.
But as I say, I want to make it clear, it's icing on the cake.
It is the bulk of our returns come from adding a company like Floor & Decor at a good entry point and sizing it to the correct weighting to the best of our ability, and then reacting to owning more at a lower price, but owning less at a higher price.
I also just can't help but think about Floor & Decor is a great business.
But in the 2010s, it has had this massive tailwind at its back.
Being a hardwood flooring company, they are very much tied to the housing market.
So if real estate prices are going up, if interest rates are going down, this is a major tailwind for floor and decor.
As a lot of homeowners go and refinance, do a home equity line, get some capital to go and redo parts of their home.
And I think that a lot of the investment case today is that the housing market is, or the hardware flooring industry is, near a cyclical low and there's a lot of pent-up demand that's going to eventually be unlocked as the market rebounds.
I just checked prior to this interview, the operating income for Floor & Decor has gone from just shy of $400 million in 2022 to $256 million in 2024.
I have this natural bias against trying to avoid many cyclicals just because I just never know where we're at in the cycle.
So Talk about how you think about where we are at in the cycle for floor and decor to ensure that we're not entering a value trap.
I think of value trap as basically getting things wrong on our forecast.
Floor and decor is a company that's never going to issue equity.
They're not at the point of returning capital to their shareholders because they have such a runway for growth and can take all of their capital, even at this lower rate of earnings, and redeploy it into geographic growth.
And the last time we spoke to the CEO, I did ask him, when are you coming to Canada?
Because I recently did a renovation and I know how expensive it is for stone and slate and tile and understand the value prop that they provide.
I don't believe in value traps.
If you've done a full model and you've done your best And you own companies that don't need a high share price.
And then when they have surplus capital, they return it to their shareholders.
And I think the reason why, as we found floor and decor and did work on it, that the reason we own it is all of the things you just said.
If you have the ability to think long-term, to look past this frankly profoundly weak environment we're in in North America.
I think that what we talked about earlier the AI wave and the hyperscalers and the megaprojects and the data centers are clearly, I think, covering up quite a weak economy.
Away from that,
It was interesting when we spoke to management, I guess a few months ago, maybe six months ago.
Now they've taken their new store build for 2025 down twice.
And we asked them, well, in what situation will you regret that decision?
I think they went from 30 to 25 and then 25 to 20.
And they said well, if we come out of this recession with a V recovery rather than like a U recovery,
And so in their world, they've been in a recession for a number of years.
And, as you say Clay, there is pent up demand.
Since the great financial crisis and the housing bubble then, Household formations have been profound.
New home builds have not been.
And so there is pent-up demand.
There is no question about that.
But we've got the timeframe to not really worry about.
Is it going to happen in six months or a year, or in three years?
Because if you own the company in an industry that's just structurally advantaged as floor and decor is and they're taking share of from their competitors,
They're still growing, as you say.
They've doubled their store count over the last few years.
And the point they made to us is, well, we've taken our store openings from 25 to 20.
But by the way, we're still, we've acquired the land, we're building those stores.
We're just not staffing them and putting inventory in them until next year.
So it is still a high growth company that is taking share from competition.
And We don't spend a lot of time thinking about, well, when does the turn happen?
We're looking out five years, 10 years plus.
That's our focus.
And I think because of that, there are a number of companies that have made it into our portfolio in the last three years because of the fact that the economy in North America is soft and they're more impacted by that.
And so the share prices have gotten to the point where we're able to say if you have a long view, These are now cheap enough to make it into our portfolio, to push other things up.
And floor and decor is a good example of that three years ago.
Yeah, I mentioned interest rates there and the low interest rate environment that fueled the real estate market.
And now, of course, we're in a slightly higher interest rate era.
How does recent interest rate cuts and just your outlook on the US housing market?
How does that play into the thesis on floor and decor?
In a way, it doesn't, right?
Because this is a company with net zero debt.
And even in this soft environment, they're making lots of money.
So that thesis might play into where's the share price going to be a year from now, but it doesn't play into what's our view of the intrinsic value of the shares.
So the macro environment is not a big factor in how we think.
But let me be clear.
If you gave us two companies that are equally attractive well-run, one of them's floor and decor, one of them is a non-cyclical business.
With the same cheapness, we would have more of the non-cyclical business.
So we're not afraid of cyclicals like floor and decor, but we do titrate down how much we would like to own versus something that is non-cyclical.
We own a US company called SS&C and they are very non-cyclical.
So at the same cheapness, we'd have a lot more in SS&C than we would in floor and decor.
But they're not at the same cheapness today.
So it's in our thinking, but it's more we think about well, what's the impact on their industry and what's happening to their competitors?
I mean, one of their large competitors has filed for bankruptcy or did last year.
Sometimes the weak economy for a company like floor and decor can actually be a positive if you're thinking out long enough.
Because it's taking their competitors who don't have the same business model.
It's taking them out of the market.
And it just gives them greater share in five plus years when the economy is much stronger.
It's a classic case of many mom and pops simply being undercut on price.
And these new stores are being built across the country and stealing share from many of these smaller players that just are structurally disadvantaged.
Robert Leonard You mentioned being very valuation focused.
How about you talk a little bit about the valuation of floor and decor and, in general, what sort of discount to intrinsic value you're looking for in your portfolio additions?
Sure.
I mean.
So when we say intrinsic value, you can think of it as what's the present value of all future.
Free cash flows back to shareholders at about a 10 rate.
We've never played with that discount rate.
When we started, rates were higher than they are today.
And of course, rates for a long time went close to zero, as you mentioned.
And now they're back to what I think of as a more normal environment, if you have a very long view.
So we've never changed our discount rate on our companies because of changing interest rates.
And so when we talk about intrinsic value, that isn't where we think the shares should trade.
And when people have share price targets, we don't have targets.
We just say There's a huge range over which floor and decor could trade and it would be very defendable, right?
People can always come up with a reason why it's trading where it is today.
And as you mentioned, the share price has been north of 120.
Now it's back today a little below 60.
They're both fine.
Those are reasonable prices.
Our view of intrinsic value is well above 120, but that doesn't mean we think it should trade there.
I mean, in a very rough way, you could think of it as the takeover price of a company.
Not that we think anybody's going to step up and offer a huge premium for a floor and decor.
It's just not that kind of target.
So what we do is we say the bigger the gap between the intrinsic value and the share price, adjusted by a bunch of aspects of a company like cyclicality, just as I mentioned.
We just have a target waiting for each holding.
And it's higher today than it was a month or two ago, when the share price was actually quite a bit higher than it is today.
And nothing's changed in the business.
If something did change, if there was a new entrant and some structural change was occurring in the industry, we'd really focus on that.
But none of that's happening with floor and decor.
It's a very strong management team with some new additions and some recent very logical changes for executive management.
So I think everything's good in the company, if you know what I mean.
And so we just let the noise of the market wash over us and we take advantage of that noise to do somewhat better than a long-term buy and hold.
What we know is that the long-term buy and hold for us on floor and decor is going to be really good.
Let's take a quick break and hear from today's sponsors.
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All right, back to the show.
So as you mentioned, you're a very valuation-focused investor.
I believe the typical stock in your portfolio is around a PE of 11 or so.
You love cheap stocks.
But when you look at floor and decor, its headline PE is actually around 30, which leads me to believe that there's going to be some adjustments that need to be made here.
And you could also probably make the case that this might be a higher growth name relative to some of your other holdings.
How do you think about making adjustments to the earnings of a company like floor and decor, if any in this case?
I mean, it's company by company.
And in the case of a pure organic growth company under US GAAP, it's not bad, right?
There are some of our companies.
We own a lot of what we call platform companies, that they make acquisitions, and then the accountants.
Under the accounting rules, you no longer amortize goodwill, but you put them in buckets of customer lists and things intangibles, which
Doesn't make any sense to me.
And then that impacts earnings per share.
So there are some companies that you really have to make, sometimes some pretty material adjustments to the gap earnings or, in our case in Canada, IFRS.
But in the case of floor and decor, the gap earnings are not too bad in terms of a number.
And it's funny, you mentioned 30 times.
I had it in my head that it's more 40 to 45 times.
So you're right.
You've got a high growth company.
And we have a lot of high growth companies.
But then we own some 10 earnings growth companies over the next five years plus.
And we own them because they're trading at a single digit price earnings multiple.
And so it is a mix.
But if you recognize that the earnings for floor and decor they're obviously depressed at this point in time.
So if you thought about a normalized number, it's lower.
And then if you think about the growth they have for probably for decades, it ends up being cheap.
But we never think about the multiple in terms of our decisions.
We do have these large financial forecasts and financial models.
And so when we quote 10 or 11 times for the portfolio, we're just trying to find a way to communicate how attractive the portfolio is, as opposed to saying that's how we value companies, if you know what I mean.
Excellent.
Well, let's get to Kinzel Capital here.
This is another stock in the portfolio that's fairly well-known by our listeners.
So this is a specialty insurer that's been successful in its strategy to grow in the excess and surplus market.
They only have around 15 market share in their industry and that share has doubled over the past five years.
And one of your statements that stood out to me in one of our first interviews was how you're looking for one of a kind unique companies.
And I think Kenzale certainly fits that description.
Actually, previously worked in the insurance field.
So I saw firsthand how slow and archaic some of these companies in the space can be, even when a highly disruptive player like Kenzale steps into the industry.
And this is another very high growth company.
You look back at previous years, many years, they grew top line by over 40%.
Currently, they're growing around 20%.
How has the story and thesis on Kinsale developed since we last spoke last year?
In terms of develop, just everything is as we expected.
And as we get to know companies better, we either rate them higher or we de-rate them.
And it goes both ways, right?
The more time you spend with management.
In the case of Kinsale, I sometimes joke.
We deal with companies, we follow them.
We try to follow them closely.
We speak to them when we can, trying to be respectful of the fact that they're running a company in, almost in a way of waiting for them to say something stupid.
Kinsale has never said anything stupid to us.
And so that idea of it is what we look for a highly intelligent company in a fairly mature market, although especially in excess.
That share is growing from the regulated market.
And as you mentioned, they're taking share in that market.
It's not just that they have a profound cost advantage, which they do.
I mean, you can think of it as much as a technology company as it is an insurance company.
And it's tough to imagine their larger competitors saying hey, we should rip out our systems and do what Kinsale did from scratch.
It's really hard to imagine that happening.
And so they do have a... meaningful cost advantage.
But also, I think as an organization, they're just really good underwriters.
They're thoughtful.
And I'm not an insurance expert by any means.
Our approach is to find a highly intelligent company, and then you learn the industry from them.
We know insurance a little bit.
At times we've owned Fairfax Financial, which many people would know terrific insurance company based here in Toronto.
So we learn from the company.
And when you watch how they dial back their exposure.
When you ask them about large policies like multinational corporations, what they explain is you probably don't want to underwrite that because they're big enough to self-insure.
And so they're really just testing.
Are you willing to give them a policy at a cheaper price than they're willing to write internally?
So their focus is small and medium-sized businesses.
It's just...
We've learned so much from them about their industry and it just continues to impress us.
So, as I mentioned, we have all these aspects of a company that factor into our weightings, away from just the intrinsic value and whether it's management, business quality, which often is the management team has created the business quality.
Kinsale gets really high marks, frankly, across the board.
And so it's better than when we last spoke, I guess is the way I would put it from our standpoint.
And you mentioned looking out at least five years.
I mentioned the market share.
Today here in the US they have around 15 market share.
They have around $2 billion in revenue and $130 billion market.
So certainly room to continue to capture more share.
Do you have a level of market share in mind that either the management team is looking forward to capturing or you guys are looking at?
Or how do you think about how much room there is for them to grow into this market?
I mean, that is the key question, right?
With a high growth company with that kind of structural, self-created structural advantage.
I mean, their expense ratio is much lower than the competition.
And as I said, they're really good underwriters.
So it's a terrific combination.
Will they be 5% market share at some point?
I think it's inevitable.
Will they ever be like Lloyd's of London that our best guess is at 17%?
I think Kinsey would say, that would be a bad thing.
You don't want to be that much of the market.
So again, it's a thoughtful approach from management.
If the market is soft, because we had a hard market And, as you say, they were growing.
Top line premiums written premiums at 40.
It's lower now.
That's self-induced because they're not going to write bad business.
And, as an example, in the commercial property space, at least in certain regions in the US, they drastically reduced their policies.
Written a couple of quarters ago.
Because they said there's new competition, who are going to lose money on these policies and we won't compete on that basis.
So I think part of it is the market share will partly be determined by the competition.
So they're not saying, oh, we want to be 10% or 6% or 5%.
They just want to write good business.
And last year, they announced their first ever share buyback authorization.
And people in the insurance industry, when we talk about kin sale say, oh my God, they're looking at buying back shares at five times book.
And they think the way we do.
Well, by the way, they bought very little stock so far.
But they say well, there's book value and then there's intrinsic value.
And if we can buy our stock at a discount to the intrinsic value, that creates value for our shareholders.
And so they're at the point now where, because their returns on equity are so high when they're not growing at 40, they end up generating surplus capital.
And that just adds another arm to the story, if you will, from being overwhelmingly fixed income in their float to now feeling like they can have an increasing amount of equities at the right time.
Not sure right now is the right time in terms of, for example, the SP 500, but also adding the idea of buying a bit of themselves.
If the share price is attractive and Look if you can find companies like that, you know the share price is going to be higher in five years and in 10 years.
And from our standpoint, I hope the path is jagged.
So far, we've only owned Kinsale for two years.
It's been a very jagged journey in terms of the share price if you pull up a chart.
And that's good for us.
What we love are low intrinsic value volatility.
And just a bonus is high share price volatility.
I remember the first two quarters after we owned the company.
The first quarter they reported for us kind of what we were expecting.
The stock was down 20%.
I don't know why.
We bought more stock.
And then the next quarter, the results were for us in line, and the stock was up 20%.
And so that's a nice thing for us.
We embrace that as opposed to like a steady Eddie share price.
I think you hit on a couple of really important points in relation to Ken Zale and the insurance industry overall.
Insurance can have some very irrational players.
Buffett and Munger have talked about this for years where some insurers will, for whatever reason, get excited and want to write unprofitable business just to grow the top line.
And that's when a company like Berkshire or a company like Ken Zale is going to take a step back and let them pursue some of that unattractive business.
And then there can be periods where there's just opportunities everywhere to write business and that's when they can step in.
And you can just really appreciate a manager that recognizes opportunities when they present themselves and not playing the quarterly EPS Wall Street game of hell.
We need to hit our quarterly numbers so we need to write this business to grow the top line or grow the EPS short term.
The repurchases, I think, is also worth highlighting there.
The first time they're doing share repurchases and, As we know, the management team knows the business and knows the intrinsic value as well as anyone.
So CR repurchases are certainly a very good sign for a company as well-run as this.
Look, I mean, at the end of the day, it's what I mentioned earlier.
We own companies that are never going to issue equity.
We started this conversation talking about efficient markets and the purpose of the.
Why is it important that markets are efficient?
It's capital allocation.
But the other thing to understand about the public market is that good companies are public for a bunch of reasons.
Often the original owners.
It's a route for them to diversify their own portfolio, whether it was a family business.
And so we own companies that are self-funded companies.
They just happen to be public.
And Kinsale's a really good example of that.
They are so profitable.
The debate as we go forward will be Well, how much capital do they have that will get returned to shareholders?
I think of companies like that as slow motion management buyouts.
The number of companies that in our portfolio or over the years, who have said to me you know, either the share price is a lot higher in three years or you and I are going to own the whole company.
So if you have companies like that, it's the classic.
You know the outsiders, that book by William Thorndike, who you know, it's a terrific profile of eight companies that have just knocked the cover off.
And one of the attributes they have is really being focused on capital allocation.
And it was interesting when I first had dinner with Thorndike and this is years ago now he said you know, Canada seems to have a disproportionate number of these outsider companies.
You know, he mentioned Couchetard out of Quebec and others, which may be true.
And maybe it is the less of a aggressive Wall Street mentality here in Canada that allows those companies to be more outsider companies.
I don't know.
But yeah, if you find a company that thinks about that, they're not going to try to be a Berkshire Hathaway, they're going to stay as a pure insurance company.
And they're going to, as they have more surplus capital at the right time, shrink the share count Because, it's funny, we think about share buybacks.
There are a lot of groups or people who can criticize share buybacks versus, let's say, dividends.
We think of it as well.
Why wouldn't you take your surplus capital and buy 100 of the shares from your shareholder who has the lowest opinion of what you're worth?
And that's how we think about buybacks and good companies think the same way.
Before we close it out here, I wanted to give you a chance just to talk about some of your recent performance.
Because, when we look back at the history of your firm, you've had different periods of outperformance and underperformance.
And today you're in a period of underperformance, which really shouldn't be a surprise given the developments with AI.
And I know that you likely haven't flinched at all with regards to sticking with your strategy.
And I'd just like to give you a chance to reflect a bit on the importance of sticking with a strategy when it's going against you, because all great managers are going to go through those periods.
It's just an inevitable part of being a stock market investor.
Yeah, for sure.
I mean it's funny as you were asking the question.
It reminded me of someone and this is a long time ago who commented to me when we went through a bad patch within our first decade.
And he said, it's a good thing you had those great early years to know that what you do works.
And I said I didn't need to have a few good years to know that owning high quality companies, management and boards that are focused on shareholder value over the long term, that I didn't need to have some decent results to know that that's the right approach.
And the same thing applies today.
So yeah, we're lagging on a mark to market basis.
It's one of the reasons that, well, it's the main reason why we actually print a change in intrinsic value. how we feel like we're doing based on the companies like Floor & Decor and Kinsale.
We didn't take our value up on Floor & Decor by 100% when the share price doubled.
We didn't take it down by 50% when the share price fell back down to where it is.
It's been never a perfect, steady progression, but it's company by company trying to communicate.
Hey, this is how the portfolio is doing.
The economy has been a headwind for some of our companies.
There's no question with Floor & Decor.
That's the case.
With kin sale, it's not economically cyclical, but as you were describing, it's industry cyclical.
You can have a hard market and a soft market.
It's not so much the shape of the economy.
It's a new entrance and then there are three hurricanes that are devastating in one season and all of those new entrants leave.
So every company has its own character.
And so from an increase in intrinsic, it's business as usual.
And one of the thoughts or terms statistics in an investment world is something called active share.
And we have an active share of 97.5%.
We look nothing like the indices.
I mean, if it was compared to the S&P 500, it would probably be an active share of 99.9%.
So what we do is we own a collection of high quality companies, at any point in time at the most attractive valuation from the companies we follow.
And you made the comment.
It's inevitable, especially in the environment that we're in, that we're going to lag.
It's happened to us before and guaranteed it's going to happen at some point in the future.
Yeah well, not to make a statement about your future performance, but I think, just looking at in general, when you look at a number of great managers, when the market is just roaring and some of these great investors aren't faring as well,
I think that can be a sign of where we might be at in the cycle.
Certainly not a forecast, but always interesting to look back and compare and contrast how things end up playing out.
But Andrew, as always, I thoroughly enjoy having you on the show and appreciate you sharing your thoughts on the market and discussing a couple of your holdings.
Before I let you go, how can the audience learn more about you and Turtle Creek?
Well, we have a website, but importantly, it's .ca, not because we're Canadian.
And yeah, there's plenty of information there, especially if you click that you're an international investor.
Not that I'm suggesting that you should do that.
And then, if it is a US resident, someone on the team will reach out and you get a code and you have full access.
We've got a pretty good website with all of our communications and lots of information.
We've written, I think, some decent stuff over the years and it's all there on the website.
Thanks again, Andrew.
I really appreciate it.
Thank you so much.
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