We recently had the pleasure of interviewing Jake Rosser, managing partner of Coho Capital Management. Jake founded Coho in 2007 after working in equity research positions at the value-oriented Auxier Focus Fund and sell-side firm Pacific Crest Securities. He was also a strategy consultant at Alliance Consulting Group. He holds an MBA from Tuck and lives in Portland, Oregon.
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Q&A with Jake Rosser
The Manual of Ideas: Please tell us about your background and the genesis of your firm. What motivated you to set up your own firm, and how do you envision Coho Capital evolving over time?
Jake Rosser: Curiously enough, I did not discover value investing until after business school. At the time, I was working in strategy consulting and happened to come across The Essays of Warren Buffett. In consulting you spend a lot of time trying to fix broken business models and learn much about what kinds of operating decisions can imperil a company. Buffett’s common-sense approach to assessing the value of a business as well as the simplicity with which he ran the companies within Berkshire struck a chord with me. It represented the antithesis to the way most companies conducted themselves. From there, I read the Intelligent Investor and at that point I was hooked.
My route into investment management started with a stint at a boutique investment bank focused on technology, called Pacific Crest Securities, where I was part of the semiconductor research team. While many investors are quick to denigrate the caliber of sell-side research, I found my experience on the sell side invaluable. It gave me a solid foundation for deconstructing company financials and conducting scuttlebutt research. Most importantly, because there is a voluminous amount of writing involved in publishing research it forces one to focus on the fulcrum points of a company’s business model and its investment merits. And surprisingly, given the herd behavior on Wall Street that the sell side helps foster, it helped bring a clarity of focus to my research efforts. This was due to the fact that to be a good analyst on the sell side, one had to truly become an expert in their field of coverage. While now a generalist, that kind of singularity of purpose has served me well in fleshing out the knowledge base for the companies in my portfolio.
After Pacific Crest, I had the good fortune of working for someone whom I consider to be one of the best investors in the world, Jeff Auxier, with the five-star rated Auxier Focus Fund. As the Focus Fund’s only analyst I had the opportunity to examine hundreds of investment opportunities across dozens of industries. Jeff has a profound respect for what risks lie beyond the financials, and he taught me to be a business analyst before a stock analyst. My tenure at Auxier also helped me learn the intense discipline and patience required to wait for the fat pitch to come your way. In the Internet age, one is barraged with so much information, that one’s focus can be obscured. It takes discipline not to get sucked into the chatter. Working with Jeff helped me develop a feel for the extraordinary alignment of events required to create an attractive investment opportunity. They are by nature, rare, so developing a feel for what creates an extraordinary opportunity and enough skepticism to watch hundreds of pitches whiz by the plate is a learned art.
After three years at Auxier, I thought the timing was right to hang my own shingle. The inspiration behind Coho Capital was Mohnish Pabrai. There may have been another investor who brought Warren Buffett’s partnership model into the modern age but I am not aware of one. Unlike the vast majority of investment vehicles, it was clear that Pabrai’s vehicle was designed to make money with his investors rather than off his investors. The ethics of that equation had an instinctive appeal for me.
Like Buffett’s original partnership, Coho Capital is an all-cap fund unconstrained by style boxes and is agnostic with respect to geography. The number and quality of fish one catches is determined by how well stocked their fishing pond is. Our all-cap mandate and lack of geographic confinement allow us to fish from a well stocked pond.
In terms of the evolution of Coho Capital, I hope to expand my partners’ retirement options. If I can deliver on that goal, everything else will take care of itself.
The Manual of Ideas: When it comes to stock selection, what are the key criteria you look for in potential investments?
Jake Rosser: Successful investment outcomes derive from buying the right business at the right price. We have found that more often than not, buying the right business has a much larger outcome on investment returns than buying at an absolute bargain basement price.
To that end, we focus first on appraising the value of the business. This starts by reviewing the industry in which the company operates. There are many industries we will give a pass simply because the economics are unattractive. This is typically true of industries that are capital intensive, exhibit low barriers to entry, possess unionized work forces or are characterized by a lack of pricing power.
Shipping, grocers or mining for example are not industries that would meet our requirements. We try to not be too dogmatic in our approach, however, and recognize that even in unattractive industries, a superb management team with superior capital allocation abilities can trump poor industry economics. Wilbur Ross in steel or coal mining would be one example. Another example would be the management teams of Markel (MKL) and Aspen Insurance (AHL), which we own in the fund, in the commoditized insurance industry. On balance though, we subscribe to the Buffett adage that “when a management team with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
In assessing industries, we also want to make sure we understand the industry enough to make informed judgments on competitive dynamics. Industries with ephemeral market leaders, such as technology, often get thrown in the too hard pile. To have enough conviction to hold a stock when the market is moving against you, you have to be able to understand it, which is why we endeavor to remain within our circle of competence.
Assessing industry dynamics before drilling down on the business helps us think like an owner. Like all value investors we view a stock purchase as fractional ownership in a business. We want to judge the staying power of that business before committing capital to it. As part of that effort we spend a lot of time searching for companies that have some type of competitive moat affording the company pricing power. Next, we attempt to understand how durable that moat is. We examine how businesses have fared across economic cycles and assess trends in margin structure for any clues that either refute or strengthen our conviction. Such an approach results in a list of the world’s best businesses.
These businesses are rarely cheap, however, so we are often left in the position of not being able to act on our research. It is an iterative process, which allows us to build a mental database of the world’s best businesses. That leaves us well-equipped to act when they go on sale.
In terms of valuation work, we look for the same things that other value investors look for, including high free cash flow yields and returns on invested capital. Ideally, we are looking for businesses that not only produce significant free cash flow but also possess the opportunity to reinvest that cash flow back into the business. Like Marty Whitman, we like our stocks to be not only cheap but safe. So we spend a lot of time tearing apart balance sheets as well. Apart from providing another cut on valuation work, balance sheet analysis can often yield clues on additional sources of value not recognized by the market.
We think it is important to recognize that valuation work is as much art as science. Everyone has access to the same information but it is how you weigh that information that makes a difference. The markets are dynamic and new inputs constantly shift the merits of an investment. We focus on trying to establish an intrinsic value for a potential holding but recognize that a range of value may be more appropriate than a precise value.
We bring a jaundiced eye to our research process and actively focus on what can go wrong with our investments. Such an approach leads to an insistence on an adequate margin of safety.
The Manual of Ideas: You wrote in your investment philosophy statement, “The best investments are anti consensus.” How do you spot situations in which the consensus opinion is most likely to be wrong?
Jake Rosser: Despite the low regard in which efficient markets theory is held among value investing practitioners, we find that the collective wisdom of crowds is indeed more often than not correct in its judgments. This gives us a healthy sense of humility when approaching situations marked by widely accepted market wisdom and mentally establishes a higher burden of proof in building a contrarian investment thesis.
Situations in which the consensus opinion is most likely to be incorrect are typically marked by excessive pessimism and uncertainty. This is often the case in industries ignored, misunderstood, in transition or out of favor with investors. The best investment opportunities typically result when headlines are negative and fear and panic abound. In such situations, entire industries can sell off with little regard to the competitive dynamics among industry players. The for-profit education industry is one recent example, with the ethical violations of certain schools tarnishing the entire segment. The resulting industry wide selloff was indiscriminate in meting out punishment and it allowed us to pick up DeVry (DV), which we consider best in class, at a lower valuation than available during the credit panic of 2008-09. We typically sharpen our pencils in “baby with the bathwater” sell-offs as they often allow one to pick off industry leaders at marked down prices.
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