Supported by Greenhaven Road Capital, finding value off the beaten path.
Pat Dorsey joined Patrick O’Shaughnessy to talk (part1, part 2] about good business. There were two themes. First about operations; what operators should know about running a business. Then about observations; what investors should look for in a business. Ready?
Operations. “The most finite asset is not capital,” explained Dorsey, “it’s time.” How can you suppress FOMO? “(Something) could be an interesting idea but maybe it’s an interesting idea but it’s not one you have any competence at looking at.”
Don’t try to be a round peg squirming into a square hole. Dorsey said, “The first thing is; know who you want to be when you grow up.” It helps to know thyself.
Dorsey’s strategy is to focus on the areas with the most reward. “On the sell side you’re paid to say ‘Yes’, on the buy side you’re paid to say ‘No’.” Derek Sivers puts it another way, wait for the ‘Hell Yes!’
“We have three baskets; in, out, and too tough… we have to have a special insight, or we’ll put it in the ‘too tough’ basket,” explained Charlie Munger. Dorsey added that your ‘IN’ basket should be things that fit you. Like the right cut of bathing suit, adopt things that work for you.
“The path to superior results is to accept only the best ideas,” wrote Seymour Schulich.
Suppressing FOMO and staying focused help Dorsey avoid situations “when people create a product to meet demand.”
Yet, investors have to Be Different. “Don’t just do things other people do.” Instead, have a “willingness to do stuff that looks optically stupid.” If someone says that’s the dumbest thing ever take it as a sign you’re headed in the right direction.
“Firms that are willing to change things that don’t work and that never say ‘because we’ve always done it this way’ is a hallmark of good firms.”
Good processes are run by good people. That means people with open minds and who don’t weaponize information. It’s people with intellectual integrity and humility. It’s people who Argue Well. When asked how to prepare for a stock picking competition, Dorsey said, “Get one member of your pair to take the other side.”
Dorsey succeeds because he has good processes and good people that operate within a circle of competence. He told Patrick, “take care of your customer and ignore Wall Street…at the end of the day, the guy who pays your bills is the guy who matters, and that’s the customers.”
Observations. Dorsey relies on three forms of analysis; financial calculations, destination visitations, and moat inspections.
Financial calculations won’t give the full picture but they can give a peek into a business. Calculations like CAC and customer LTV tell you something, but like any number, require interpretation. They are “very blunt tools.”
Dorsey explained that an LTV:CAC ratio of 1 means something and 5 means something else – but more isn’t always better. Changes in strategy, like when Adobe switched to subscriptions, can change the ratio and changing ratios should change strategy.
Destination visitation is another observation technique Dorsey uses.
“You can’t understand a business unless you sit in the customer’s shoes and the best way to sit in their shoes is to go talk to them.”
“In the case of Chegg, we did an online survey of eight-hundred students across the country.”
“You gotta get off your rear end and work the phone. The insights we get from talking to people deep in the industry are phenomenal.”
Visits are helpful because visits are valuable. In his 2017 presentation at the Value Investor’s Conference, Dorsey said: “quantitative data is often priced efficiently.” While:
“Qualitative insights come from sending out thirty emails and getting one back. It comes from getting out to trade shows and talking to people. That’s how you add value.”
Being there is a powerful information gathering tool. But it’s also a harder one than a database formula. Milton Hershey apprenticed as a caramel maker. Yvon Chouinard was a climbing-gear-user before a climbing-gear-manufacturer. John Elkann worked in half a dozen departments at Fiat before becoming the head of all of them.
When Warren Buffett says that he’s a better investor because he’s a businessman and vice versa this is what he means. There’s a depth in understanding the numbers behind a balance statement line item. Dorsey calls it a “granular understanding.” Visits are not a magic bullet but nothing is.
Dorsey said that he went to India to see if it was “diligence-able.” The verdict, kind of. After a week he learned that consumer taste was not something they would understand, “that’s out of our wheelhouse, but there are plenty of good Indian export businesses that compete on a global scale.” But there’s no rush, “It could be five years or never when we buy something in India.”
Mohnish Pabrai gave advice on how to study and avoid sunk cost tendencies. Like say, flying halfway around the world to find investments.
Moat inspections are the final technique. Remember, not everything is a network effect and not every brand is a moat. “Economic moats are not evenly distributed across the market.” Brands can be a moat but “If a brand doesn’t translate into pricing power it’s not worth what the company spends to maintain it.” Rory Sutherland guessed that people buy brands as a kind of insurance.
At the Value Investor’s Conference, Dorsey noted the question to ask about (signaling) brands.
“Positional and legitimacy brands have a big big difference from low-search-cost brands. If I decide I can get a razor from Dollar Shave Club a lot cheaper than Gillette and it does the same job I get full value from that product without anyone of you having to change your mind.”
Meanwhile, a Rolex and Mickey Mouse watch both tell the same time but it would require social consensus to affect those brand values.
Businesses with high switching costs can have pricing power (read:moats) too but some businesses ahem Bloomberg ahem are more like rent collectors. The better moats, Dorsey explained, are like plumbing. They’re essential services but not primary costs.
However, companies like Boeing and Airbus are fungible. On the consumer side, it’s easier for established brands to get upset. “This was not possible fifteen years ago….moreover, I can use Facebook and Google to target very effectively.”
Dorsey also falls in the less-pain-in-the-ass camp. About Amazon, he said, “Everything comes back to making the customer’s life easier because if the customer’s life is easier they’ll use it more.”
Josh Wolfe told Patrick, “We always point our turret and say a very sophisticated two-word question to figure out where the next thing is; what sucks?”
In his book, Alex Moazed wrote “You can think of transaction costs broadly as pain-in-the-ass costs. All platforms reduce these costs in some way.”
If you can find what Moazed calls a platform company you want something that “will grow itself” says Dorsey. How do you find them? Dorsey said, start with a universe of 5,000 then throw out whatever you aren’t interested in, like commodities, chemicals or life insurance. From there think about who has tailwinds and write up a first pass memo. These, Dorsey explained, are not should we invest but could we invest.
If you want more of Pat Dorsey, his site collects interviews and presentaitons.
Thanks for reading.