RV Capital annual letter for the year ended December 31, 2015.

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Business Owner TGV vs. the DAX

RV Capital

RV Capital - The best year ever

Dear Co-Investor,

The NAV of Business Owner was EUR 439.38 as of 30 December 2015. The increase in NAV was 46.7% since the start of the year and 339.4% since inception on 30 September 2008. The Dax was up 9.6% and 84.2% respectively.

Not without some good fortune

The fund benefitted from two pieces of good fortune last year: the increase in value of the US Dollar and record low interest rates. I did not foresee either and even if I had done they would not have played any role in my capital allocation decisions.

RV Capital - Dollar tailwind

The RV Capital fund benefited from the rise in the Dollar as over the last three years or so I have been allocating more and more of our capital to US based companies such Berkshire Hathaway, Google and Credit Acceptance. Even newer additions in Europe, such as Novo Nordisk, generate the bulk of their earnings in the US.

The decision was not based on a macro analysis of the Eurozone’s woes (real though they are) but because I saw better opportunities in the US and, to a lesser extent, China (whose currency closely tracks the Dollar). This is not just true for the companies I have invested in but also the wider universe of companies I have analysed but ultimately passed on. I can think of tens if not hundreds of US based businesses that have wonderful cultures, great competitive positioning and, importantly, long growth runways. In Europe the list is far shorter. There is no shortage of great companies in Europe, but most of them are more mature. It is rare to find companies such as Grenkeleasing or Novo Nordisk, where one can plausibly argue that earnings and hence intrinsic value can increase at 15% or more per year.

Perhaps the far greater number of dynamic companies in the US does indirectly say something about the economic vitality of the two economic zones and hence currencies, but if it does I would emphasise it was not what drove my capital allocation.

RV Capital - Interest rate tailwind

The fund also benefitted from the collapse in interest rates.

Since a few years, I have increasingly been allocating our funds away from lower multiple companies where the cash flow is front-loaded towards companies with higher multiples where the cash flow is back-loaded (and hopefully greater in present value terms).

A good example of such a company is Novo Nordisk. Novo is the equity market equivalent of a thirty year government bond. Like a long dated government bond, its price has most probably benefitted more strongly from the fall in interest rates than its 10 year counterparts.

I know what you are thinking – “do I really want to be invested in a manager where returns are being driven by such good fortune?” To help you answer this, I am reminded of a quote attributed to the owner of a British soccer club:

“There are two types of desirable football manager,” he opined, “the talented manager and the lucky manger. Frankly, I prefer the latter.”

I hope you agree.

RV Capital - Not all luck

There is one thing I have been doing for many years now and has in my view been absolutely central to the fund’s performance. I mention it not in the spirit of self-congratulation, but because there is far too little attention paid to it and it would be far better for society, not to mention individual fund’s performance, if this was not the case.

I am referring to building an understanding of and conviction around a company manager’s integrity and more broadly speaking a firm’s culture (the two are closely connected as the tone basically comes from the top). Nothing has been more important to managing the fund over the last years than understanding management character.

This is probably counter-intuitive to many of you as investing in general and value investing in particular is considered a quantitative exercise – a race, if you like, to find the companies with the lowest multiples of book value, net-net working capital, or earnings. Judging a manager’s character is, by contrast, a qualitative exercise, which cannot be expressed in figures or proven through regression analyses.

However, consider a handful of the key decision moments in just the 2015 calendar year:

  • In the spring, Google plumbed a two-year low as European media companies delivered around-the-clock coverage of claims by the EU and competitors (though not consumers) that it was an abusive monopolist and should be broken up.
  • In the summer, Baidu lost over a third of its value on fears that it would throw away all its capital on hopeless O2O investments and the Chinese economy was going to fall off a cliff.
  • In the autumn, the VW diesel scandal broke pulling BMW down in its wake.
  • More recently, Credit Acceptance’s share price fell precipitously.

Contemporaneously the New York regulator subpoenaed it regarding its lending practices.

Each of these episodes presented two scenarios and four possible outcomes: in the event that the fears proved overblown, one could either (a) make money by sitting tight or,  better still, loading up, or (b) lose money by selling “in panic”. In the event that the fears proved well founded, one could either (c) make money by cutting losses early or (d) lose money by “stubbornly” persisting with the original buy decision.

It sounds simple enough, but there is a catch. At the time, you have less than perfect knowledge and a window of opportunity of unknown duration but probably short.

Thus, I had no particular insight on Margrethe Vestager’s intentions vis-a-vis Google, the scope of Baidu’s ambitions in O2, the activities of Credit Acceptance’s dealers in New York, nor – wait for it – the software running on BMW’s diesel engines. On the latter point, I was deeply flattered by the number of emails addressed to me – a graduate of Modern and Medieval Languages – regarding the software in BMW’s engines. Alas, it is not something I have ever given much thought to.

So what do you do when you appear to be flying blind in a crisis?

Recall that my research process revolves around three axes – an attractive price, a sustainable competitive advantage, and an honest and talented management. How much use was each of these in the aforementioned mini-crises?

RV Capital - Price not much help

I found low multiple to be of limited value in the above scenarios. For example, what use is it that the market was valuing Baidu’s core search business on a single digit P/E if the fear is that its earnings are going to disappear into a bottomless pit of O2O investments ad infinitum?

Competitive advantage not much help either

Ditto for competitive advantage. What use is a strong conviction that BMW has a wonderful brand if the fear is that cheating on emissions leads to brand impairment, not to mention a huge cash outflow?

Neither my thoughts on valuation nor competitive advantage, though positive, were of much practical use.

RV Capital - Trust in people key

Contrast this with my thoughts on management quality: