[REPLAY] - Mike Trigg – Defying the Fade at WCM (Capital Allocators, EP.162)

26:29And when the company first came public, the narrative was not that different than what you saw with Taiwan Semiconductor 20 years ago, which is why would you want to own an outsourced culture and bacteria company? You know, like wouldn't you want to own brands and wouldn't you want to own distribution? And these are the kinds of companies that are going to play to the emerging middle class consumer. There's nothing really sort of all that unique. But if you dug into it, you realized in the same way they were moving up the value chain. And that is, companies like Danone wanted to basically make certain feature claims about their products, either being sugar -free or being able to be stored at certain temperatures.

27:09I mean, a lot of it ended up being about health and wellness. All that stuff was like getting enabled at the supplier level. And so they were becoming an increasingly important partner to those customers. And that over time just manifests itself in not just great growth opportunities, but also opportunities for more margin. And so when we looked at the company initially, its margins were around 20%, I think, when it first came public. And we sort of obviously didn't look at it as an ingredient supplier like most people did. We looked at it as more of an outsource business. And so if you looked at the other outsourcers that we'd studied, and to us, it was clear that this could be a 30%, 35 % operating margin business.

27:52And that turned out to be the case and actually much more. So that's a form of pattern recognition that we do. And I think it's kind of enabled in part by the fact that we're not just a bunch of specialists. We're global generalists. We cover the world. we can kind of see some of these patterns, I think, that we wouldn't be able to if we were all stuck in certain lands, just covering certain countries or certain industries. With the outsourcers, there's this typography. You've kind of figured out there are these four key criteria that help you figure out what's happening with the moat. What are the other ways that you've tried to measure these widening moats across either different typologies or industries?

28:32Yeah. Well, one thing that we realized eventually with the case study approach was there is some selection bias that comes with that. If I know intuitively that most outsourcers turn out to be great businesses, okay, I can give you a list of 10 that we should go study, but I kind of forget about the ones, or I never knew about the ones that tried and failed, right? And so certainly you can study the life cycle of the moat and figure out what potential sources of deterioration there are, but it's hard to know what the failed examples were. And so we've also done this, I think, in a more quantitative way by taking an industry and all the participants in the industry and then study what's happened to them over the course of a few decades.

29:15So as an example, luxury goods is, if you're a global investor, odds are you've spent a lot of time looking at luxury good stocks over the years. And we studied about 50 luxury companies over the course of 30 years and tried to find what were the markings of the ones that really compounded returns at really high rates for a lawn period. I'm not the ones that, you know, sure, there's many of them that had their day in the sun, but what are the ones that were really lasting and enduring? We're the real coffee can investments in that group. And when we did that, it was really clear that there was two criteria.

29:49One, the higher the price points, the better. So the more aspirational the brand, the more enduring it tends to be. And then the other one is controlling your own distribution. So direct sales, not heavily relying on wholesale channels. And that in and of itself explains to you probably why the companies we've been involved in in the past are things like Louis Vuitton, Hermes, Ferrari, they all sort of fit that criteria. And then at the same time, we've been reluctant to invest in stocks like Caring Group or Jones Gucci. Not that they haven't done extremely well in recent years because they have, but it doesn't really fit that framework that I'm talking about.

30:29And oftentimes we think that if anything, the frameworks or the typologies, one of the things they really do is help you make distinctions between what's just momentum and what's actually really structural differences in companies that's going to lead to long lasting above average growth. It doesn't mean they're always right, but more often than not, they're going to be very helpful in that regard. So that, along with the filtering piece that I mentioned a second ago, right, like kind of tune out all the noise, I think is probably two of the more important things that they do. The other really important part about mode trajectory, and, you know, to be honest, we talk about this internally all the time.

31:08It's a mindset, right? Like it's sort of steers a lot of the questions that we ask companies. It's as good as it is for finding great ideas. I think actually it's probably more valuable in just steering you away from bad ideas. And I think so much of successful investing is you're going to make mistakes. And so you want to minimize the frequency and then the damage when they take place. I think that's an unappreciated part about it. And particularly growth investing, I think. Maybe that's historically partly why growth investing got a bad name. Another way to kind of think about moat trajectory is there's the moat, and then there's the growth formula.

31:44And those two things combined give you a positive moat trajectory. And depending on the type of business that you're looking at, for some, you have to be more sensitive to the moat. And then for others, you have to be more sensitive to the growth piece, right? So if you're looking at a consumer staple company, take Pernod Ricard. Their moat is pretty well understood. It's not going to change. It's brands, its distribution, its scale. But what's going to dictate whether that's a good investment or not is their ability to execute on growth. But if you contrast that with something like Shopify, which is another name that we own, the growth piece of the Shopify thesis is pretty well known.

32:30Everyone can look in pretty quickly and realize, okay, Shopify is going really fast and they've got a huge TAM and they've got probably 7 % of their total adjustable market in terms of merchants and they've got a massively growing ecosystem. What's going to derail that investment is really things around. It's going to be disruption. It's going to be their moat. It's going to be competition, right? And so we have different sensitivities that we'll sort of focus on. Those are all designed to, once we own the name, obviously just make sure that we don't end up owning, in the case of the Pernos, a bunch of dead money, high quality stocks.

33:02And in the case of things like Shopify, businesses that we're going to wake up one day and there's going to be a significant change to the competitive landscape. And we're going to find that there's been a really significant impairment in the valuation of the business. We're going to take a quick break in the action to tell you about SRS Aquium. Want to make sure your M &A processes aren't stuck in the past? Partner with a company that's been defining the future of dealmaking for nearly two decades instead. When it comes to M &A innovation, SRS Aquium has reshaped the way that deals get done, streamlining processes for maximum efficiency and minimum headaches.

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34:30And some of the names you mentioned are traded at traditional looking valuations pretty expensively and have for some time. I've gone through a full life of learnings when it comes to valuation. My first lesson really in investing coming out of 2000 was the importance of valuation. And then I gravitated towards discounted cash flow models because there's something so seductive about that, especially when you're young and very impressionable. I remember the first time I did a discounted cashflow model and I put in what I thought were some reasonable estimates for growth and for margins and capital expenditures.

35:08And then I looked at what the price was and I thought, oh my goodness, I'm actually pretty close to the current stock price. Like I actually might be decent at this. And so there's this like false precision that I think can become pretty seductive. But over the years, for one, I've learned that it's just ridiculous to think that you can precisely determine what a company's worth. I mean, things are changing constantly. And particularly if you're investing in companies that are in growing industries with moats that are growing and then with cultures that are super adaptable and finding other ways to grow, your valuation work is going to look so wrong in a very short period of time that it's not really worth all the effort and problems that come from relying on discounted cash flow models.

35:56not to mention the fact that focusing a lot on DCFs there's false precision it gets you very focused on the short term when in the reality most of the value in a discounted cash flow model resides in that terminal period right which you spend zero time actually thinking about and if you're a long -term investor that makes no sense and we've kind of actually come up with this term called defy the fade is one of the big mistakes that you see people make when you do modeling is you look at a company and you're very focused on the short term and the company's growing five or six percent today you think okay i like the business things are going well six seems pretty good that's close to company's guidance maybe they'll do that again the next year but after that it's probably going to be five and then it's going to have to go down to four and then before you know it it's down to gdp and the same is true for your return on invested capital assumptions in a discounted cash flow model.

36:52And so what really Mo trajectory and culture are designed to do are identify those companies that can defy the fade, defy that inevitable fade. So we're not saying that fade will never take place, but by focusing on the companies with its attributes, they're going to maintain that competitive advantage period far longer than anybody thinks. And it's that delta between what the market's expectations for the fade are and when they actually take place is where all that alpha generation opportunity exists. And I think we've just come to a place where focusing on the qualitative assessments of a business around moats and culture and how that translates into the durability of a company's growth rate, I think that is far more predictive of a successful investment than trying to find things, waiting for price breaks on businesses of reasonable quality, that there's some sort of short -term impact that's like disrupted the stock price and you jump in at a 20 % discount, close that gap, earn a little bit of the cost of capital on top of that, and then you're out of the business in a few years.

37:56I think a much more successful way to invest is the way we do it now. So you touched a little bit on culture and this notion of culture being aligned with that competitive advantage that creates that growing mode trajectory. And Paul's talked about that. You've mentioned it a bunch of times. What does it actually mean to do the analysis on a company's culture that's aligned with their competitive advantage? It's been a huge evolution here. So when I came to WCM, actually, Paul and Kurt were already talking about culture. They had experienced a huge transformation in their own lives, which Paul talked about, I think, in your conversation and became convinced that culture really, if it mattered for our company, it should matter for the companies we invest in.

38:35But the truth of the matter is that at the time, I think there was a pretty narrow view of what a great culture really meant. In fact, I think Paul would tell you that basically what we were trying to do was just go find a bunch of companies that sort of smelled and tasted like WCM. Hey, if they talk about the same things that I'm talking about, and I'd really want to go work at that company too. If I was in that industry, then that must be a company with a great culture. And over time, we just realized that that's a really flawed way to kind of look at things. That number one, there's no perfect culture.

39:08And particularly, what culture works in one industry might not be right for another, right? So the joke that we've used for years is Google's infamous for unstructured time that they give developers to go work on pet projects and create things. And that's a huge part of their culture. And Canadian Pacific, which is a railroad that we've owned for a long time, that is a very operationally driven company that's all about sweating its assets and operational excellence and efficiency. you know, if suddenly they decided to give everybody in the company unstructured time, I mean, there's going to be a serious problem in terms of the company's competitive advantage.

39:46And so at the same time, if you applied some of the things that Canadian Pacific does from a cultural perspective to the developers at Google, I mean, there's going to be a pretty big revolt. So there is not one perfect culture that you have to start from it there. And you have to make sure that your own personal biases of what is and isn't a good culture actually get in the way. That's another key piece. And the ultimate question is, let's try to understand what the company's strategy is to grow their moat. Like every company has a strategy to differentiate itself from its competition, to grow its business, to take market share, to whatever their strategy for shareholder value is.

40:28Let's try to understand what that is. A lot of that comes through in the mode trajectory analysis. And then once we think we understand that, then we want to talk to the company about what the behaviors are that they think are necessary to achieve that strategy. So what are the parts of your research that you'll go into the company and kind of ask about to tease that information out? What we've done over time is developed a bunch of questions that we think are really helpful in terms of teasing those things out. So there was a period of time, not that long ago, I mean, five, six years ago, when unfortunately, we'd sit down with companies and just say, hey, will you do me a favor and just describe your culture for a little while?

41:07And most companies can't do that, interestingly enough, particularly if you're reserving the last 20 minutes of an hour and a half meeting to ask them that question. And what that really hit home with me a number of years ago, we were actually going up to visit Tencent. Tencent has a fantastic culture. We've done extensive amounts of research into it, but we had never really had just a dedicated culture meeting with them. And so we were talking to one of the senior executives there, and I started off and I asked that stupid question. and they just described your corporate culture. And he immediately just gave a horrific answer, to be honest with you, and started talking about having to pay programmers more money because of competition from Alibaba.

41:48And so I sort of pivoted the conversation and ended up asking them about a decision they'd made to close down their search business, which they had spent a bunch of money on. And he said, oh, that was a, I go, well, talk to me about that decision and why you did it. And this is when they were trying to build a competing product with Baidu. And he said, that was a really easy decision. our product managers came to us and told us we should shut the business down. And I said, well, that's pretty impressive that they felt comfortable enough to do that. I mean, after all, they were probably responsible for a lot of the product.

42:16And he said, well, actually, it was pretty easy for him because we compensate people based on user satisfaction, not based on revenue growth. And that really is sort of the core of what Tencent's culture is all about. It's an obsessive focus on the user. That was a pretty light bulb moment for me that we weren't asking great questions. It was kind of like the straw that broke the camel's back. I kind of already knew it intuitively. And so we set on a journey to figure out how to have good conversations with companies about their culture. And we just talked to lots of folks and built some relationships with people that had spent a lot of time talking about this in the academic community, tested a lot of questions, asking CEOs, and ultimately have come up with a series of questions around one, around alignment, because that's a huge piece of it.

42:57And then two, around adaptability. That's the other big hallmark of a great culture is one that's adaptable. And so there's certain trappings or things that we look for in adaptable cultures. And we have questions that we ask around that. So as an example, we're trying to get it alignment, which is like I said, it's sort of like behaviors. We'd ask, first question would be, let's hypothetically say the son or daughter of a good friend of yours is going to work at the company. They start next week. You're going to have coffee with them this afternoon. What are the three pieces of advice you're going to give them to be successful?

43:35That's a much easier question for a CEO to answer than saying, hey, just describe your culture. Tell me what it's all about. So you have to prime them and put them in a place to answer the kinds of questions that give you the information that you want. And then like things like on adaptability, ultimately for adaptability, you're looking for a learning orientation. And, well, what does that require? Lots of candor, learning from mistakes, external awareness. And so we'll ask companies, it's a pretty simple question, but you could ask a company about mistakes. Like what's a mistake that you made that you look back on now and you're like, wow, I'm so glad we made that mistake because we're so much smarter because of it.

44:15And when you ask that, you'd be surprised. Sometimes you get really good answers, but oftentimes you don't. When we ask that question and somebody starts talking about some $10 million acquisition they made three years ago where they misjudged the people and they had to write it off. I'm like, seriously, you're a $50 billion company. Give me a real mistake. That would be kind of a yellow flag that maybe there's not as much adaptability here as I thought. So it's that. We do that with management. We do that with former employees. And then really the next big foray for us and things we're spending a lot of time on now is more data -oriented culture work.

44:51And I think that's going to become a source of meaningful differentiation. And some of that's being enabled by a lot of the work that's going on in the ESG landscape. There's just going to be more data to look at and to glean cultural insights from. And so I think that'll be the next big push for us in the next five years. As you've gone through this incredible trajectory in the firm, even in the last three years that we've known each other, how do you turn that lens onto WCM? So how do you think about what's happening with WCM's moat and what's happening with WCM's culture? We're all of the view that nurturing and protecting and keeping the culture as healthy as possible is probably the single most important thing we can do.

45:36And I think the cultures, obviously things are going to change. They change with size, but we spend a lot of time trying to articulate where we've come from, the difficult periods, the behaviors that we think were essential to get us where we are. I worry honestly when you have people that have come in and all they've done is experience a tremendous amount of success and prosperity and they don't have a big reference class of experience to look at that they might miss certain attributes that I think have been sort of core to making this place successful and I worry that they stop trying to make the firm better because they think it's already so great we talk about the core values of the firm which are fun and gratitude and I think Paul went into those in your conversation.

46:21But on the research team, we have our own core values as well. And they're think different and get better. And in some ways, the firm embodies those as well. But the research team went through its own process of establishing core values. And it was a very similar process to what the leadership team did when we came up with fun and gratitude. A lot of it's like just looking back and saying, okay, how did we end up here? And what really makes us different than everybody else? It's not talking about smart people or hard work, that sort of permission to play in the investment community. But like, what are the behaviors that I think have really made us successful?

46:56And as we went through it, think different and get better just bubbled up to the surface. And if you step back, it actually makes perfect sense. Because when you think about the industry, and one of my other partners, Sanjay Ayers, does a really good job articulating this, and we've now dubbed it the WCM platform. But if you think about the industry where you've come from in your career, it's really difficult to detect and know whether somebody's talented or not. And some of that's because there's really long feedback loops in the industry. You know, it can take 10 years or longer to know if somebody's actually a really great investor.

47:34There's a lot of noise. There's a lot of luck involved. And so because of that, these rules emerge in the industry, like these unwritten rules, Everybody sort of acts the same way. They dress the same way. I mean, if you go to an investment conference put on by one of the big banks, it's a little sad almost how much uniformity there is in those rooms. And people tend to look at the same schools for hiring. Everybody watches and reads the same things. And so from that, you get, I think, these really counterproductive behaviors that largely explain why active management struggles. And it's a lot of groupthink.

48:14People are worried about standing out from the crowd. They're worried about careers. So they play it safe. They hug the benchmark. They focus on a lot of short -term information. They become information gatherers, largely, not trying to stick their neck out on really unique insights. And then they have a fixed mindset. They perpetuate that myth that there's like just some people that have the it factor in this industry and some that don't. And they want you to think that they're smarter than everybody else, even though everybody in the industry is already pretty darn smart. And so think different and get better is kind of the antidote to that.

48:54If there's a lot of groupthink that's part of the problem, like, okay, well, let's totally flip that on its head and make the whole culture about being different. Let's run really concentrated portfolios. Let's, again, focus on things where there's compounding knowledge like mode trajectory and culture where we can actually get better at assessing those things over time. Let's not focus on developing insights that are going to be worthless in six months once they come to fruition. And then let's pound this idea of being irreverent and scrappy and just a little different than everybody else. And then let's really make the firm about this journey of getting better.

49:32And what does that take? Well, it takes a lot of candor. It takes a lot of trust. You got to be willing to talk about your mistakes. And you got to lean into them. You got to make them not just an opportunity for you to learn, but from the whole firm to learn. Hey, we're not perfect. We've made mistakes. But what I think we've always done is really learn from them. And I think that that's been core to the success of the firm. And so when new people come in and I think about, well, how the culture is going to change, I mean, I'm actually pretty confident if people can just continue to think different and get better, then I think the firm is going to be in really good hands.

50:03Mike, I'm curious, as you've grown and you think about the business, so much of that incredible growth has really come in one product. Have you thought about just trying to get better and better at doing that one thing and mostly international growth compared to taking the skill set and broadening out in different investment strategies? Yeah. I mean, I think that's going to become a huge part of our story in the next 10 years. It's interesting because I think growth is kind of a dirty word in investing. And I look at it slightly differently and say growth is such a huge part of our story and what makes this a fun place to work, why people are so engaged.

50:45And so we need to continue to find other avenues of growth. So we've done that out of the global equities team by moving into global emerging markets, international small cap, global launch short. We have a China fund now. And there's a lot of interesting things that we're doing. And I think asset classes that we're exploiting some major inefficiencies, and we're going to develop some great businesses out of those products. But then also what's really exciting is trying to make this a platform for other people. I mean, I think I look at it and say, we are the luckiest guys in the world to be sitting where we are.

51:22And what better thing to do than give other people an opportunity to do what we've done. And so we started doing this actually a number of years ago, we brought a team in that's now does small cap value that's based in Cincinnati. We've got a team in St. Louis that does small cap growth. And then we've got an ESG team in Denver. And I hope we continue to do those. I mean, our intention is to continue to find people that are passionate about what they do. They've got a good idea. Maybe they've been stuck in a bank or an insurance company, or they've been at a firm or something went sideways and they just haven't had that really true moment and the time needed to really make it work.

51:58And we have the resources and the platform that they can come in, plug into, and then really just have the freedom to go chase whatever it is they're most passionate about. I think that that's definitely something that at the firm level that we'll continue to pursue because I think there's just a lot of opportunity that we can give to people. If you make it this far each week, you're probably ready for the closing questions. But wait, there's more. If you sign up for a premium membership, you can access our premium feed, which includes an additional set of closing questions each week and removes all the ads from the show, including this little pitch to subscribe.

52:36Hop onto the website to sign up. Thanks. And let's get on with it. Great. Well, Mike, can't let you go without asking a couple of closing questions. So what is your favorite hobby or activity outside of work and family? I love cooking. I think that's one of my favorite things to do. It's one of the few things I can do that actually distracts me from what else is going on in the world. So there's something pretty meditative about chopping an onion. And in California, we're obviously blessed with an unbelievable amount of great produce. And so like right now we're transitioning from the summer of corn and heirloom tomatoes into blood oranges and stone fruit.

53:16And it's kind of fun to watch that happen and take advantage of that in the kitchen. What's your most important daily habit? You know, I try to start every day doing some type of spiritual related reading. And well, the thing I find that's so helpful with that is starting your day that way, is it just kind of grounds you a little bit in what really matters, gets me a little bit more focused on what's to come in the day, how to handle it. And it makes me worry a little bit less, actually. So everyone has their own version of what spiritual is to them, but I think that's just a fantastic way before you pick up your phone and start plowing through emails or check your Twitter account.

53:54Doing something like that, I think, has been, for me, really, really helpful. What's your biggest pet peeve? Probably the biggest one is people that just lack self -awareness. I find that to be a hugely important thing here in the firm. People that aren't self -aware, they tend to be really, really difficult to deal with. They get defensive without recognizing it. And it sort of chokes off the ability to, I think, get better, right? If you're not self -aware about what you're good at and what you're bad at, then it can become pretty difficult to attack those bad things. So I think probably lack of self -awareness is the biggest one for me.

54:28What teaching from your parents has most stayed with you? I think my dad was always really good about when I made mistakes, like looking at them as learning opportunities. So that's part of the reason I feel so strongly about some of the stuff that I mentioned earlier. And then I think my mom, I came from what seemed like a dysfunctional family at times. And I remember as a kid complaining to my mom about that. And she'd be like, yeah, you just don't realize every family's got their issues. As I got older, I started to realize, hey, that's actually really true. And the more you can have open, trusting relationships with friends and deal with those types of things and not bury it, I think that that leads to really good relationships.

55:05So that's probably what my mom taught me most. All right. Last one. Now, as you know, we're going to tack on a few more for our premium members. But here's the last one for everyone who's listening. What life lesson have you learned that you wish you knew a lot earlier in life? The biggest one is where to look for wisdom. I think, at least in today's world, I think we're led to believe that wisdom is going to come from people with big balance sheets and celebrities and athletes. And the more I've interacted with people like that, the more I realize that it can oftentimes be disappointing, more so than not.

55:42And that really wisdom comes from talking to people that have had struggles, that have made mistakes. and oftentimes it could come from a teacher, it could come from a cab driver. And so creating those moments of just random interaction and talking to people and hearing about people's stories and journeys and looking for it in unusual places, I've really leaned into that idea in recent years and I wish I would have known that at a much earlier age. Mike, it's great. Thanks so much. Thank you. Really appreciate it. Thanks for listening to this episode. I hope you found a nugget or two to take away and apply in your investing and your life.

56:20If you'd like what you heard, please tell a friend and maybe even write a review on iTunes. You'll help others discover the show and I thank you for it. Have a good one and see you next time.