The Compounder Bro: Past, Present and Future

Amongst the value community, one of the lasting legacies of the 2010s bull market will be the rise of a new beast of value(ish) investor- the Compounder Bro. It all began as the peak capitulation of the GFC began to fade and lying in plain sight were a few unexpected businesses.

The shellshocked Compounder Bro emerged from the rubble to discover Microsoft appearing in the classic Ben Graham screen*. It was looking pretty beaten up and growth wasn't assured at this point, but still reeling they summoned their nerve and made one of the buys of the decade. Fellow early Bros are also reported to have picked up Apple in the $40s (split adjusted).

Throughout the 2010s rates dropped away rapidly and monetary policy became looser and looser. Google charged ahead, Facebook emerged after a swoon post IPO and Mastercard began to appear on the 13F of any Buffett-quoting hedge fund manager with a shred of dignity.

The problem (for me anyway) was that fundamental value had roared through the 2000s and was actually quite expensive by 2010. Whereas growth was relatively cheap and a large beneficiary of cheap rates. This lessened the importance of near term earnings, or even any chance of future earnings in some cases. For those with a "durable brand" and "consumer franchise", price was rapidly being removed from any pitches to be replaced with charts showing decades of above market ROEs.

Then Third Point bought Facebook and value investors were turning themselves inside out to justify a piece of the FANGs, even Netflix got a run from some of the legends of value, by comparing its value per subscriber to that of cable television in the 80s. The option stubs like Weymo and Oculus were all the rage, other ways to win and hidden value. Moonshots were a buzz word for those in the know.

A simple discussion of LVMH or Markel and their brand power and capital allocation brilliance was enough to send the Bros into raptures. Constellation Software could be bought on ever-shrinking yields, despite the fact that every acquisition they did made the needle incrementally harder to move. Many even introduced prudent diversification to their portfolios by buying Visa to go with their Mastercard (if you weren't holding MA by this point you really had to buy it at any price or risk being turned away at your next Bro conference).

Value legends were being carved into those who realised that moats were all that mattered and the rest. David Einhorn saw brutal performance sticking his neck out to short the FANGS. Millennial growth investors who had never seen a full cycle were laughing at Greenlight as it held its grizzled group of low PE longs. Carl Icahn went publicly bearish and was eulogised in Brotown for sticking with his miserable, capital intensive companies and daring to question the sustainability of profit margins.

Quality would go on to be one of the best performing factors of the decade and portfolios like these have had stellar performance and I congratulate them for it. But can the next decade possibly see the same? The Bros seem to have used the last decade as irrevocable proof that old school value investing is dead.

Even the intellectual home of Ben Graham, Columbia Business School, finds a new way to mention how value investing has "evolved" on its podcast each week. Graham and Doddsville has been wiped off the map and it's been renamed Compound Town. Even in something as nerdy as finance, the jocks have emerged to kick sand on the geeks at the beach.

I think they are calling the game at half-time. Microsoft was a deep value bargain in 2010. Is it a value anything today at 8x Price/Sales? I know, I know- the cloud and all that. But trees don't grow to the sky and (as I've referred to in the past thanks to Research Affiliates) Top Dogs** don't often survive on the list till the next decade.

Quality isn't hard to identify, but paying the right price is extraordinarily difficult. This bull market has been kind to the good residents of Compound Town, but I'm not sure there are as many Buffett-like business analysts out there, as there are Bros getting around leaving a whiff of smugness in their wake.

If you are a long term holder of a Compounder Bro portfolio, you may not want to sell for tax reasons or the likes and what a great problem to have. But like any style that does well, many junior Bros have been lured in late to the party. Will their resolve be shaken one day if managers actually have to use a price in their Ferrari buy thesis? Even a cursory perusal of Fintwit will show just how crowded the Bro trade has become. The ship is certainly loaded on one side.

One of my core investing tenets is the reliability of mean reversion. If Bro investors want to look down on deep value guys like hyenas fighting over a rotting carcass, so be it, but I think it's a little rash to write off a strategy that has consistently outperformed over all the data we have.

Cliff Assness's comments on a recent podcast seemed prescient to me, when he pointed out that a broken strategy wouldn't look anything like the behaviour we have seen in deep value. A broken strategy would ping off random results that would have no bearing to its underlying valuation. It wouldn't consistently lean one way while the underlying prices became cheaper and cheaper.

The only other time fundamental value was this hated (the late 90s), it went on to absolutely crush it over the next decade. We are not far away from a similar spread now.

So thanks for your gentle condescension and Heico humble bragging Compounder Bros. I'm trying to "get it" but I'm a natural tight-arse and I don't think a decade into a run is the time to jump on the wagon. I'll be sticking it out with my telcos and cigar-butts for now.

In the mean time though, if you see my laptop flying out the window, you'll know I've heard a Bro going on about the incremental rate of return on his retained earnings one time too many.

Guy

*The screen originates from a body of research Graham carried out late in his career with an aeronautical engineer named James Rea. Find the criteria here-http://www.investmenttools.com/benjamin_graham_s_10_rules.htm

** Research Affiliates have done excellent research showing that the largest companies in any index by market cap rarely survive to still make the list after the next decade. Competition, mean reversion and their sheer size often catch up with them.