MOI Exclusive Interview With YCG Investments’ Brian Yacktman by YCG Investments
We are pleased to bring you our recent interview with Brian Yacktman and Elliott Savage of Austin, Texas-based YCG Investments.
The Manual of Ideas: Please tell us about the genesis of your firm and the principles that have guided you since then.
Brian Yacktman, Chief Investment Officer, Portfolio Manager and Principal: For as long as I can remember, I’ve grown up hearing my father talk about investments, so I think it was natural for me to develop this passion over time. As he mentored me and as I saw the results his strategy produced, I became convinced his methodology had merit and really came to believe in his philosophy. After working with him for several years, and realizing his separate account minimum was so high (it’s over $50 million), I wanted to offer management to those who desired separate accounts but couldn’t meet the minimum. I also wanted to add upon what my father taught me by offering the “option enhancement” strategy. When I suggested lowering the minimum to my father, he basically said, “Great idea, just don’t do it here!” because their business model was focused on managing very few, large accounts. So, with his blessing, in 2007, I left his firm and created Yacktman Capital Group, the name of which we later changed to the initials YCG to avoid confusion between the two firms. Then, in 2012, with my father’s firm growing assets at $1 billion a month, it became apparent to us that they would likely need to close their funds. So, once again, I desired to offer an alternative to those who would be closed off, and, thus, the YCG Enhanced Fund (YCGEX) was born. To this day, we desire to offer the YCG strategy of protecting and growing capital in an objective manner to as many people as are interested to help them achieve their financial goals.
MOI: What are your key stock selection criteria, and what types of businesses have you favored historically?
Brian Yacktman: We utilize a time tested philosophy of purchasing above average businesses at below average prices. We view the world more in terms of probability distributions and so our goal is to construct a portfolio that will be robust in various economic scenarios. We are market cap agnostic and use a “bottom-up” approach. With a 10 year+ time horizon in mind, we seek to purchase stocks which possess one or more of the following “three P’s:” Price, Product, and People.
Brian Yacktman - Price: We turn on its head the common, mechanical practice of estimating distant future cash flows, valuing those cash flows at an arbitrary discount rate, and then purchasing those cash flows at some predetermined discount to intrinsic value. Instead, when analyzing individual stocks, we first ask ourselves, “What is the expected rate of return if we make a purchase at this price level?” We calculate this forward expected return by digging through the 10-K’s to analyze the true excess cash flow, seeking to answer four basic questions: How much normalized cash flow (cash flow adjusted for cyclicality in sales and margins) will the investment produce, after adjusting for often-overlooked items such as option issuance, pensions, and capital expenditures that will reabsorb the cash generated (including acquisitions which we often view as CAPX in disguise)? When will that estimated cash flow arrive? How predictable or risky is that estimated cash flow? What is the price to receive that estimated cash flow? Based on these estimates, we compute a normalized shareholder yield (excess cash that is truly free for the shareholders) and add to that yield our estimate of the business’s terminal growth rate. Then, we assess how vulnerable our computed expected return is to a set of economic scenarios to determine the width of the probability distribution around that expected return, and then compare the yield spread between stocks of varying quality levels. The quality level of the business helps us determine this vulnerability, which leads us to our next two points.
Brian Yacktman - Product: “Product” refers to certain innate characteristics that make up a high quality company. We tend to favor high quality companies because we believe that, counter-intuitively, high quality businesses tend to outperform low quality businesses over the long term with less volatility. Additionally, we believe these types of businesses tend to significantly outperform their lower quality peers during catastrophic periods. Generally, these companies possess one or more of the following attributes: high cash returns on tangible assets, low cyclicality, high returns on incremental invested capital, wide and stable profit margins, high market share, pricing power, conservative use of leverage, and a growing competitive advantage.
Brian Yacktman - People: Since we are long-term investors, we realize the people running the business will make a critical difference. While we do believe employee integrity, company environment, compensation amounts and methods, and management experience are important, we believe the largest impact we can have as analysts is to evaluate a management team’s cash allocation skills by assessing the impact their incremental investment decisions have on growing cash flow.
We find our approach allows us to compare investment opportunities across industries and even across asset classes and thus objectively prioritize and focus in on our best ideas.
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