Interview with Tweedy Browne Company’s managers from the Graham & Doddsville Fall 2018 Issue.
H/T MarketFolly
Tweedy Browne Company is a value-oriented asset manager that manages domestic, international, and global equity portfolios for individuals, family groups, and institutions from all over the world. The firm was one of the few investment firms mentioned by Warren Buffett in his 1985 speech The Superinvestors of Graham & Doddsville from which this newsletter gets its name. Founded in 1920, Tweedy Browne Company now has 53 employees.
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Roger De Bree has been at Tweedy, Browne since 2000. He is the firm’s Treasurer and a member of the Investment Committee. Mr. De Bree previously worked at ABN AMRO Bank and MeesPierson Inc. He holds an undergraduate degree in business administration from Nijenrode, the Business School in Breukelen, Netherlands, as well as an M.B.A. from IESE, the University of Navarre Business School in Barcelona, Spain.
Andrew Ewert joined Tweedy, Browne in 2016 as an Analyst focused on global companies. He previously worked at Equinox Partners, L.P., Ruane, Cunniff & Goldfarb Inc., MTS Health Partners, L.P., and Bear Stearns. Mr. Ewert holds a B.B.A. from Emory University and an M.B.A. from Columbia Business School.
Frank Hawrylak has been at Tweedy, Browne since 1986 and is a member of the Investment Committee. He previously worked in the investment department at Royal Insurance. Mr. Hawrylak holds a B.S. from the University of Arizona and an M.B.A. from the University of Edinburgh, Scotland.
Jay Hill joined Tweedy, Browne in 2003 and is a member of the Investment Committee. He previously worked at Banc of America Securities LLC, Credit Lyonnais Securities (USA) Inc., and Providence Capital, Inc. Mr. Hill holds a B.B.A. from Texas Tech University.
Amelia Koh joined Tweedy, Browne in 2016 as an Analyst focused on global companies. She previously worked at Deutsche Bank Securities Inc. Ms. Koh holds a B.A. from Macalester College and an M.B.A. from Columbia Business School.
Tom Shrager has been at Tweedy, Browne since 1989. He is a Managing Director, a member of both the Investment and Management Committees, and President and Director of Tweedy, Browne Fund Inc. Mr. Shrager previously worked in M&A at Bear Stearns and as a consultant at Arthur D. Little. He holds a B.A. and a Masters in International Affairs from Columbia University.
John Spears joined Tweedy, Browne in 1974. He is a Managing Director, a member of both the Investment and Management Committees, and Vice President of Tweedy, Browne Fund Inc. Mr. Spears previously worked for the investment firms Berger, Kent Associates, Davic Associates, and Hornblower & Weeks-Hemphill, Noyes & Co. He studied at the Babson Institute of Business Administration, Drexel Institute of Technology, and The Wharton School at the University of Pennsylvania.
Bob Wyckoff has been at Tweedy, Browne since 1991. He is a Managing Director, a member of both the Investment and Management Committees, and Chairman and Vice President of Tweedy, Browne Fund Inc. Mr. Wyckoff previously worked at Bessemer Trust, C.J. Lawrence, J&W Seligman, and Stillrock Management. He holds a B.A. from Washington & Lee University and a J.D. from the University of Florida School of Law.
Graham & Doddsville (G&D): How relevant is Ben Graham’s philosophy today?
Tom Shrager (TS): I would argue that Graham’s philosophy is still fully applicable today. He was one of the first investors to create an investing framework that made sense. Graham came from the credit side of investing and, as a fixed income investor at that time, your downside protection was either the collateral put up against the loan or the bond. He later applied that framework to equity investing and argued that the collateral value of an equity investment is the intrinsic value of the business. The value of the business could be its net asset value, it could be its book value, or it could be an earnings-based valuation.
By thinking in terms of business value and buying at a discount from that value, a diversified portfolio of undervalued securities should earn an adequate return. That framework hasn't changed. As markets have evolved, there are fewer net current asset stocks and book value stocks that you can invest in today. That said, we do find them from time to time in places like Japan and Hong Kong, but our current investments are overwhelmingly trading at discounts to an earnings type valuation.
G&D: What types of valuation metrics do you use?
John Spears (JS): We look for “a satisfactory owner earnings yield.” For example, if you take a company’s operating income after tax and divide that by its enterprise value, and that produces an owner earnings yield of 8-10%, you’re getting a pretty good return.
Jay Hill (JH): Another recent change is that tax rates have been going down around the world. One advantage of this owner earnings yield metric is that it gives a company some credit for falling tax rates. All things equal, we believe that lower tax rates lead to higher net income and higher free cash flow.
G&D: How do you use NOPAT (Net Operating Profit After Tax) to EV (Enterprise Value) in evaluating opportunities? Do you compare it to long-term government bond yields?
JS: To an extent. We also look at it relative to other companies. If you rank 100 companies on EV to NOPAT, how does it shape up in comparison to deal valuations?
TS: However, we don't go much below an 8% owner earnings yield. You have to be reasonable and say, “If multiples in the market are 20x EBIT, we are simply going to pass on that because it doesn't make any economic sense, assuming some normalization in interest rates.” The analysis is both absolute and relative.
G&D: How is the process for earnings-based valuation different?
Bob Wyckoff (BW): Earnings are less predictable. In conducting our analysis on earnings-based businesses, we spend a lot more time today on qualitative factors, factors that might impact that earnings stream over time.
We try to estimate the earnings power of the business, the sustainability of that earnings power, and what the growth of that earnings power might look like over time. It does involve an evaluation of qualitative factors which might not have been as prevalent in our analysis 40 or 50 years ago.
Frank Hawrylak (FH): Previously, you didn’t have to do that. You could find a stock that was trading at 60% of net current assets, and you might glance at the annual report – which used to be 18-20 pages instead of 250 pages – to get an idea of what the business did. All you had to do was get comfortable with the inventory or accounts receivable.
G&D: How has this impacted valuation?
BW: The valuation framework remains the same – we’re still trying to buy companies at significant discounts from a conservative estimate of the underlying intrinsic value of the business. We tend to be pretty conservative appraisers. Today, we often value businesses at 10-13x pre-tax operating income – compared to 6-8x when I first started at Tweedy in 1991 – and try to buy those businesses somewhere between 6-9x. The expansion in our valuation multiples is largely due to this march to the bottom in interest rates. In 1980, when I arrived in New York, the prime rate was north of 20%. You see what has happened since then. Interest rates, with a hiccup here and there, have been in decline for over 35 years, and that has had a significant impact on what people are willing to pay for a business. You see it in corporate transactions and the values people are willing to pay in acquisitions. Debt to EBITDA multiples in leveraged buyouts are very high today. Invariably, if interest rates are low, people are going to borrow a lot of money, and that's going to inflate multiples.
We've incrementally increased our appraisal multiples over time, although reluctantly and with a lag. I think a lot of people would still consider us relatively conservative on that front, and we demand a substantial discount off those appraisals.
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