Before Pat Dorsey started his own investment firm, Dorsey Asset Management, he spent over a decade at Morningstar building the equity research group from ten to over 100 analysts and crystallizing the idea of what an economic moat is and how to identify one. But he hasn’t stopped developing his approach to investing, and he doesn’t think you should either.
“One of the dangers people in the value investing community often fall into is slavishly following Uncle Warren and Grandfather Ben, and sort of worshipping at their feet. But investing’s not like that, Buffett himself has said that investing is a learning process, and if you look at what he does today it’s very different from what he did fifteen or twenty years ago,” said Pat Dorsey in an interview with ValueWalk.
“People often mistake having an intellectual discipline for being stubborn. When you cross that line from having a philosophy you believe in to ignoring the way the world changes, you’re not doing yourself any favors as an investor.”
Looking for three-standard-deviation managers
As an example, Pat Dorsey says that while he’d still rather invest in a company with good moat than a good manager, as he’s spent more time researching non-mega-caps internationally, he’s found that there really are ‘three standard deviation managers’ who can seemingly create something out of nothing.
[drizzle]While these truly great managers aren’t easy to find, he says that some people build really impressive track records and continue to be discounted by investors who want to attribute everything to luck. He points to the Rales brothers at Danaher and Colfax, Bill Stiritz at Ralcorp and Post Holdings, and Patrick Drahi at Altice as examples of exceptional managers that investors should be aware of because they ‘can almost do the impossible’.
“At Morningstar I probably pounded on ‘moat matters more than management’ harder than I should have in hindsight,” explains Pat Dorsey.
Finding a three-standard deviation manager isn’t easy to do, but there is a profile that investors can look for. Pat Dorsey says that most of the time they are owner-operators who started with limited capital and resources, and have a strong track record of great asset allocation decisions – not just a single big success. Then you need to have some view of how they make decisions so that you can be confident the process is replicable.
They also need to be people who are in it because they love what they do. Pat Dorsey likes to ask CEOs what drives them in their business, what gets them up on Monday morning.
“If they don’t immediately give an answer that indicates a true passion for what they do, then it’s not the guy. The really incredible individuals love what they do and can’t imagine doing anything else. And that passion, that joy, is evident when you speak with them,” says Dorsey.
Even though individual investors can’t usually ask CEOs a question directly, Pat Dorsey still recommends looking for evidence of that passion in interviews, speeches (you might be surprised what’s floating around on YouTube), even internal newsletters if you can get your hands on them.
The three things Pat Dorsey looks for in a stock
“A firm needs to have a sustainable competitive advantage to even get on our radar screen because that’s our circle of competence,” says Dorsey, explaining his current investment strategy.
But a moat isn’t enough on its own. McCormick and Oracle both have strong moats, but Pat Dorsey isn’t interested because they don’t have much organic growth, and he believes that the best way to benefit from a moat is when you can re-invest into it. The combination of a moat, strong management, and compounding potential is what he really wants to find.
He gives two examples of companies that he’s currently invested in that fit his criteria. Silverlake Axis is a Singapore-based provider of core banking systems for banks in Southeast Asia. There are similar businesses in the US and Europe that have a good business moat, but there’s not a lot of growth. In Southeast Asia you have much larger opportunities because more people are entering the banking system every year, getting their first bank account and gradually using new services, and because about half of Southeast Asian banks don’t yet have a modern core banking system in place. Silverlake Access has been in business for twenty years without losing a customer, and Pat Dorsey = believes the company has a long runway ahead of it.
Another example is Aurelius AG, a German company that buys assets from large European corporates and turns them around. It’s similar to private equity except that it uses its own capital instead of LP money so Aurelius can afford to be more patient. Pat Dorsey sees a lot of scope for Aurelius to buy non-core assets from larger owners that need to deleverage and streamline their operations, and then sell those assets for good value down the road.
How Dorsey keeps himself intellectually honest
Whatever your take on value investing is, Dorsey has one piece of advice that everyone can use to keep themselves honest.
“Every time you make an investment, in fact every time you make a decision, write it down. It’s very easy with the hindsight bias to rationalize that decision when things don’t go in the right direction,” says Dorsey. “Then you can pull that out three months later, one year later, and say – does reality today match what I thought it would be?”
Sometimes you might be wrong and still remain invested for different reasons, which is okay, but it’s important to acknowledge when your assessment didn’t pan out and re-evaluate the situation. Pat Dorsey says that the appearance of thesis creep is a big sign that someone is getting into trouble.