Middleburg over Midtown? How Akre Capital Outperforms

Tom Saberhagen is a Partner at Akre Capital Management, a $7 billion-plus asset manager based in Middleburg, VA. Prior to joining Akre, Saberhagen  was a senior analyst for Aegis Financial Corporation and worked in management consulting.

SumZero interviewed Saberhagen to hear his thoughts on value investing, active management and his experience to date at Akre.

Kevin Harris: What do you think is most misunderstood about the discipline of value investing today?

Tom Saberhagen: Lots of people want to compare “value” against “growth” but we would make a different distinction, between “investing” and “speculating.” Investing is about valuing businesses. You can value a business if it is public or private. So investing doesn’t depend on the stock market at all. On the other hand, speculating is about trying to predict the price movement of something, anything, that trades. Speculating is often completely unrelated to business valuation. Rather than debate the old labels of “value” versus “growth” we’d love to see more people ask hard questions about whether a strategy is actually based on investing or speculating. 

Harris: How does Akre’s ‘three-legged stool’ approach differentiate you from other funds?  

Saberhagen: We try to be very transparent about our approach. We think it’s important for our clients to understand and agree with what we do. And everything we do is built around trying to identify long-term compounding opportunities. The three-legged stool is our way of describing how we look for these compounding opportunities.

Because we try to be very straightforward about the approach, it’s really not that difficult for someone to come along and try to copy it. What differentiates us really is the discipline, expertise, and judgment of our team. We’ve had a lot of practice doing what we do.

Harris: How do you decide when to sell out of ‘compounding machines’ as defined by the three legged stool?  Which of the legs tends to give out first?   What catalyzes your getting out of a buy and hold position?

Saberhagen: We try to buy great businesses and own them until they’re no longer great. If we evaluate an investment correctly, we will often end up holding shares for many, many years. But we have to recognize that no exceptional opportunity lasts forever. Any number of things can go wrong, and it’s a very important part of our work to monitor risks closely. 

The unique thing about our sell discipline is that it’s almost entirely based on fundamentals. We don’t have target prices for selling. To put this another way: we don’t go into an investment with one foot out the door. We will often stand by patiently as holdings appreciate to valuations well in excess of where we’d be buying new shares. 

If you’re a logically minded person, you will think this sounds a little irrational. But in practice, I can tell you that the approach of hanging on to great businesses even when they trade to high valuations works nicely when you truly believe you are investing in exceptional businesses and managers. If the business and its managers are truly exceptional, they are going to regularly surprise you to the upside. The business will grow into the valuation, unless its valuation has gone completely off the charts. On the other hand– if you know that you are buying bad businesses run by bad managers, i.e. you are purposely investing in a cigar-butt type situation because you think it is so cheap, then by all means get out at your target price! In these cases, something is sure to go wrong and quickly. But that type of investing is not what we do at all. For us: buy the great ones and let them compound. Watch out for signs they are no longer great.

Harris: In your What Do We Mean By Reinvestment? white paper, you drilled into your focus on reinvestment.  Is the focus on ROIC the most important part of your investment screen / process?  How else do you determine a business’s ability to compound?

Saberhagen: It’s absolutely important to examine returns on invested capital. It is a different mindset than thinking only about earnings. The returns on capital a management team can achieve are absolutely reflected in the share price. But we don’t follow a mechanical process. There are numerous ways of measuring returns and invested capital. We want to think seriously about the economic truth in each investment. Sometimes the accounting numbers are close to the truth and sometimes they’re not. Also, it matters more where a business is going rather than where it has been. The sustainable ROIC matters more than the ROIC of any particular period. Finally, it’d be very unwise not to consider the other legs of our investment stool – the people and the business model – when assessing a situation.

Harris: What is your reaction to the rise of quantitative strategies versus the relative decline of more traditional discretionary ‘value’ strategies?  Any particular thoughts on the rise of ‘smart beta’ products/ETFs?

Saberhagen: It’s obvious that machines are getting faster and smarter. I think quantitative strategies are best suited for short term speculation. The judgments involved in making outstanding long term investments are more subtle. Our advantage is that we are investors, not speculators, and we keep a very long time horizon.

ETFs are largely based on indexes of one kind or another. Indexes have the allure of being average, by definition. To me, it would be nonsensical to arrive at a point where everyone only buys indexes. So really the people who buy indexes are just hoping someone else is still out there ‘minding the shop’ and applying relevant information to establish sensible securities prices. Serious investors need to be comfortable with the idea that they will see periodic results that are different than average.

I’m not sure I understand smart beta. A lot of financial products are just unnecessary complications or marketing contrivances. Investors can do very well holding a portfolio of a select number of businesses they admire and respect, rather than getting caught up in the various ways securities have been wrapped up and marketed. 

Harris: How has your strategy changed with the growth in Akre’s AUM to $7 billion-plus during your tenure?  Have any unexpected challenges grown out of managing a relatively concentrated portfolio at such a large scale?

Saberhagen: It has not greatly changed. You’ll see that many of our top holdings have been very meaningful contributors to the portfolio for a period of five years or more. We intend to continue holding a concentrated portfolio of mid- to large-cap companies. At the present size, it’d be hard for small-caps to move the needle since we intend to maintain a concentrated portfolio. But small-caps never really did feature prominently in the fund.

Harris: What was your biggest investment mistake?  What did you learn from it?

Saberhagen: It’s especially important in this business to try to learn from your mistakes. I bought shares of Qualcomm in the early-90’s and Apple in the mid- to late-90’s. At some level, I recognized great potential in these businesses. But I also sold the shares relatively quickly. I took gains rather than having the patience to allow things to unfold. Every investor should strive to have some “100-baggers” in their career, and with hindsight these two opportunities were right in my grasp. I wish I had simply held on. As for the Akre Focus Fund, a couple of things we could have done better: First, in 2010 we were up more than 19%, well ahead of the market, but we averaged more than 30% cash. I wish we had pressed our bets hard coming out of the Financial Crisis. This gets back to the timeless advice to be greedy when others are fearful and fearful when others are greedy. It is very hard to do this well. Second, during 2012-2015 we overpaid when we bought shares in Colfax Corp., and also the position became larger than it should have been. Since then we have tried to be more disciplined about matching business quality with proper valuation and position size.

Harris: What has changed the most in the industry since you started?

Saberhagen: I’d like to think that the principles of investing are more or less timeless through the ages even as the scenery changes. My first stock purchases were in the early 1990’s. I began studying investing seriously in the late 1990’s and became a professional investor in 2002. In the last twenty years or so, we somehow made it through the Y2K crisis, the Dot-Com Bubble, the September 11^th attacks, a couple of recessions including a massive Financial Crisis and Great Recession, and wars, and innumerable political gaffes. But the market is up about 3-4x on a dividend-reinvested basis. It’s important to remember that the long term gains are all about businesspeople going to work every day to compete and create value for customers and shareholders. It’s not about the news.