Buffett said: “Our favorite stock holding period is forever”.
It is worth digging into this further and exploring what characteristics you’d look for in a business you plan to hold long term.
Let’s consider a scenario where you plan to buy a business with your retirement fund that you are unable to sell for 10 years (not forever, but certainly a long time). The reason for wanting to hold this investment for such a long period is the opportunity to buy a so-called “compounder” – a business that is able to employ capital at high rates of return – and to enjoy the compounding effect of growth on the value of your investment. But how do you know which stock to choose?
There are over 2,000 publicly-listed companies in Australia alone. Within this group some companies will cease to exist within that 10-year time-frame, many will muddle along, and some will perform well. Only a very select number of companies will be able to compound capital at attractive rates of return for a multi-decade period. As we learn in management consulting, excess returns in an industry attract capital from other firms, and those returns get competed away, and so does the opportunity to achieve outsized investment returns. So then what should investors look for to avoid an investment that’s likely to do poorly?
If we were to think about what would be needed to tilt the chances of this investment being a success in our favour we could narrow it down to a company that:
(i) has a durable competitive advantage/business moat. This could refer to a low-cost/scale advantage, network effects or strong reputation. Essentially you want to find an industry where the asset/market positioning the firm has built up is very hard to replicate. -> 1ST Group:✔
(ii) sells a product or service that is a high value component to an overall process, but also a low cost. This is the so-called “Jesus nut” on a helicopter – the bolt at the top of a helicopter propeller shaft that holds all the flying parts together. It’s called that because if it fails, the helicopter would detach from the rotor, and only thing the crew could do is pray to Jesus. This is obviously a mission critical component, but also an infinitesimal cost of the overall helicopter, which makes the component less likely to be substituted out for a competing product on the basis of price alone. These businesses also tend to have better pricing power over time. -> 1ST Group:✔
(iii) has the ability for its economics to improve over time. A business whose costs move in perfect tandem with its revenue line will obviously benefit much less than a firm that’s growing its revenues with a fixed cost base. Said in a technical way, businesses that earn high incremental margins and have the opportunity to improve the economics of the business (fixed cost leverage) are favourable to own. -> 1ST Group:✔
(iv) has low levels of debt and cornerstone shareholder support. Even the best business can be destroyed if it is saddled with too much debt. Virtually all businesses exhibit varying levels of cyclicality (although to greatly varying degrees), so it’s advisable to look for companies with at most only modest levels of leverage. -> 1ST Group:✔
With this in mind, perhaps it is not so hard to see why the number 1 shareholder in this stock has a 10-year plus time horizon.
The question becomes, what level of revenue could 1ST Group achieve in 10 years' time? If 1ST took just 30% of the total market in Australia (which is conservatively below its current market share), that would account for annual revenue of over $75m of subscription revenue alone For a growing SaaS company with revenue of $75m, a $500m to $1,000m valuation seems reasonable, even conservative. That would be a share price in the range of $1.40 to $2.80.
Let's return to this post in 2030. I do hope you hold across that time period because for an end goal $750m market capitalisation, that is a 35x return compared to the share price today. The ship continues to sail. It will no doubt go through some rough ocean water along the way, but, the industry tail-winds behind it are very strong indeed. Let's see how far this boat is carried as the antiquated healthcare industry continues on its path of digital disruption.
Enjoy the ride.
(20min delay)