Freddie Lait: Patience Pays - Lessons From Building a £1bn Business

0:00I think it all boils down to sort of knowing yourself. I truly think there are hundreds of different ways to make money. You know, Cathie Wood and I may have very different opinions on thematics and the market. Could both be highly successful. It really comes down to knowing yourself. What suits you? Your temperament? What suits the way your brain thinks? And really doubling down on building a repeatable process around what really gets you going and what you can really manage within your own psyche. Because it's very emotional as much as it is financial and logical. Welcome to the Master Investor Podcast with me, Wilfred Frost, where we celebrate and learn from the success of the greatest investors, business leaders, and politicians in the world, giving you, our listeners, the edge.

0:46My guest today is the founder of Latitude Investment Management and the portfolio manager of their two funds, Latitude Horizon and Latitude Global. And he is my very good friend as well, Freddie Leight. Welcome to the Master Investor Podcast. us. Thank you very much for having me. Freddie, so you started Latitude, amazingly, a decade ago, 2016, and you've crossed a billion pounds in AUM recently. So enormous congratulations on that. That's following your career at Goldman Sachs, Rothschild and Odie. What's the experience been like of leaving the security, the certainty of those big storied financial firms and going out on your own?

1:29Yeah, look, it's been a hell of a journey. It's been pretty tricky. Raising the business up from 10 million in AUM when we started, as you say, through a billion now, has been a real fight to get people to pay attention to the way we do things. But I think what it's given us on the other side is the investment freedom to run the portfolio how we want to. So you had the security in the bigger firms, but you're always pinned in with some sort of institutional imperative to do it their way. Whereas once you really realise the way you want to do things, you need to create an environment for that freedom.

2:01And I think that's what's shone through. And hopefully that's what our clients and partners have found as we've grown over the last decade. So what is that investment process that you're free to pursue? So on the equity side for us, it simply says that really the way you make money out of investing in stocks is if the stocks grow their own ability to generate profits, cash flow and earnings per share. So looking at a stock and saying it should be worth 20 or 30 times earnings, we think slightly misses the point. We say, can we build a portfolio of stocks where we believe the underlying intrinsic value growth, earnings and profit per share, should deliver 12%, 15 % a year?

2:38We've delivered 15 % a year in the last 10 years. And if we can do that consistently over time, and these companies can deliver that growth, while we're minimizing valuation risk, the price performance should be roughly in line with that. And again, our returns have been around 15 % a year for the last decade. And I should have mentioned the two funds. One is multi-asset, Latitude Horizon, and the other as just pure global equities, latitude global. So what are you saying then, in a sense, is that a stock at a premium valuation, you can be okay with that. It's not something that would put you off buying it, provided that the earnings growth underlying is going to come through.

3:16Because I think if we snapshotted the last 10 to 15 years, a lot of asset managers have missed some of the great success stories because they were put off by the valuation. I think the point is that growth is what you're buying. That is where the value is created. And I think this is truer the longer you look to hold a business. If you're owning a stock for 10 years, say, and you buy it on 15 times earnings because you think it's worth 20, you're just going to make 25 % or 35 % over that period. Whereas if you buy it because you believe it's going to grow its intrinsic value, earnings per share, 15 % a year, then it will double or quadruple its earnings over that period and you will likewise double or quadruple your profitability.

3:58So for us, it's the fact that growth is what we're valuing. And then you say, well, if I've got two different businesses, both of which have similar competitive advantages and similar financial outlooks, call it that 15 % growth rate, why would you pay 45 times for a business that might deliver that, like Costco or Microsoft or something like that, when you could pay 15 times for a business that should deliver that in something like Tesco's or a number of other stocks like McKesson that we owe. And so it's a relative value framework. I read in one of your investment notes, you said most of the value in investing comes from buying well and waiting.

4:36And so it's a patient necessity in all of this. There's lots of different ways to invest, but I truly believe the thing that's missing in fundamental equity investing, i.e. people sitting around a table saying, what's this business worth and what's it going to deliver over the next five or 10 years? The missing ingredient is patience. The market's become ever more short-term, ever more benchmark aware, and really following things quarter to quarter and worrying about short-term stock price moves. And for various reasons, I don't believe that short-term stock price moves now reflect people like me trading.

5:11They're far more mechanistic, much more passive funds. And so if you want real fundamental value to drive your return, you have to take a much longer term view. And the question to us is that we've answered and we believe, how do I build a portfolio in such a way that allows me that patience, affords me that patience to wait 5, 10, 15 years for the returns to come through? So before we get onto some of the kind of current macro and then into some of your individual stocks, just to round off the investment process, how hard is it to then sell a stock because simply it's appreciated enough in value?

5:49If you still believe in that five or 10-year outlook of 15 % earnings growth, can it be very hard to say actually it's run up too much and the valuation does now put us off? So I think this is actually where we're a bit better than some others who, especially in the last five years, might have got caught out holding onto these premium stocks because of this relative valuation framework. So if you buy a business and it does really well and doubles over 18 months, which has been quite common recently, it may sit on 35 times earnings or 30 times earnings, something quite expensive. Well, we would line that up against all the other businesses we love in the world, of which is around 100 at the moment, that we'd love to own and say, is that the best use of capital?

6:30Is there nothing else we can do with our capital but leave it in that business with that growth rate at that price? And normally there is something far better, maybe trading at half the valuation. And we'll just rotate it. And the way we think about it behaviorally is quite important. We don't have to damn that stock. There's nothing wrong with it. It's doing well. It's a brilliant business. Pop it back on the shelf. We might buy it again one year. But right now, we've got better uses for a capital. Have you got an example where you've done that well and perhaps one when you hadn't sold it in time?

7:01So one that we did well on was Novo Nordisk. We owned that for three or four years. And this has some of those weight loss drugs. Exactly. Novo Nordisk is one of two main players in the big weight loss drug craze that's been going on since 2021, I think. And we own the business. It's a fantastic business anyway. It's the global leader in insulin for diabetes and other things. And it went up about 150 % in 18 months, which is a very, very strong move. Pretty good. Yeah, we're pretty happy with that. Now, obviously, because they announced positive news, our estimates for the future went up as well.

7:34but even when you took that into account the valuation that we were looking at was more than double some of our other choices and so we rolled that position entirely into a business i followed for 12 years called mckesson also in healthcare it's a distribution business very different model much more diversified it was on 11 times earnings novo nordisk was on 33 and after that for the next nine months novo went up 80 another 80 and mckesson probably went up 40 but since then novo's down about 70 % and McKesson's gone up another 35%. So I think that's the really good example of what can happen if you take your money off the table when there's a better relative value opportunity.

8:15I think one where we held on a little too long was Diageo. It was trading at a premium valuation coming out of COVID. Obviously one of the big drinks makers in the world. Exactly. So pretty much the largest kind of spirits manufacturer in the world, still only with a 5 % market share. So long runway to go for that business potentially, but it had overgrown coming out of COVID. We'd had the price inflation, which meant they were charging more for their whiskeys and tequilas, but also demand was excessively high. And so there was a premium valuation on a premium earnings number. And that was one that we held on to for too long.

8:49As all of us were doing those Zoom drinks during lockdown, which became incredibly unhealthy. Anyway, moving on to some of the current macro before we're going to pick your top three or four stocks at the moment later, which I'm looking forward to. Are you concerned about US valuations at the moment more broadly, something that we discuss pretty much every week on this podcast? Yeah, it's a bit annoying because I feel like I am in the consensus almost, but I am. I am nervous about valuations. I think there's three major risks facing the market which it needs to overcome. The first is valuations.

9:24They are on nearly every metric in their sort of very near the top of their ranges. But also it's very concentrated. And so the two are linked. The AI and tech theme is very expensive and is a large portion of the market. In many metrics, again, the largest concentration in 100 years or at least post-war. And they were also earning very, very wide margins, the highest in 100 years. So I look at it and think there's a very big risk that some combination of overvaluation, overconcentration and over earning come back to earth in the next two to three years. In terms of the kind of concentration risk, when you see NVIDIA, which is obviously the biggest company in the world, over$4 trillion market cap, and done unbelievably well in recent years, invest$100 billion in one of its customers in OpenAI, which obviously happened recently.

10:17is that a sort of flashing red signal that makes you more than just generally concerned about valuations does it remind you of things that have happened before or is it actually something that could continue for quite some time well i should say all of those things those risks i just mentioned none of them help with timing none of them historically have given you any indication of where the market will be in a year or two's time so i think taking a bet against the market on those on that basis is quite dangerous but in terms of avoiding the risks i think it's very key And I think when you do see things like NVIDIA putting huge amounts of capital into a business that otherwise wouldn't have the ability to buy the chips back from NVIDIA, it raises quite a lot of red flags with me.

10:58And I think the AI story in general, you know, the amount of CapEx, trillions of dollars of CapEx for what currently looks like tens of billions of dollars of revenues and enormous losses. It's difficult at the moment to bet against it. Not that we ever would, but because it's disprovable. You can't say whether AI is going to be a success or failure because no one knows what it's going to look like. It is a great technology. It is very exciting. How monetizable and profitable it's going to be is incredibly unknowable. So we would not invest in unknowable places. So we don't own any real exposure other than through our holding in Alphabet, which owns Google.

11:35And that's a big differentiator for us not owning those things. But it's not because we're betting against AI, if that makes sense. And of course, for the bull case, the flip side argument to Freddie's on the broad AI stuff, then do listen to our other most recent episode with Kathy Wood for the alternate point of view. So just talk us through why Alphabet is in your portfolio then, given is it a hedge against having those other ones or outright you find it attractive? So I've owned Alphabet since 2013. It's always been pretty much in our top 10 for the last 10, 11, 12 years. It's really the ads business.

12:09Search and the advertising business is a very, very strong monopoly, duopoly with Meta. There's been concerns recently that AI will disrupt that in some way. The stock went down 30 % and has since doubled, which is pretty extraordinary for one of the five largest businesses in the world. Tells you how little stock prices really know. And we really like the business in general. And I think from the AI perspective, Google were the first ones to invest in AI. They bought DeepMind back in 2014. They laid out internally AI across Translate, YouTube, their main search function, both supply side and demand side.

12:46And it's been embedded in their business for a long time. They have the ability to fast follow. I think the interesting question is if they had the capability, why did they not do it? And I believe the answer is because they weren't certain of the monetization ability because it's very expensive to serve. But Gemini is now the top downloaded AI app. I think Google are a very good contender in that space. In terms of rounding off the macro, do you think that recession risks in the US are underpriced right now? Yeah, I do to a degree. I think a lot of people are trying to buy into stocks on cyclical recoveries.

13:21So you're seeing more cyclical consumer stocks in particularly trading at kind of premium multiples of trough earnings in the hope that those earnings recover quickly. And I feel like for all the talk in the market about development and employment and growth, the bottom end of the market, the weaker consumers, they've been on their knees for about two years now since COVID. Unemployment in the youth is very high, clearly social unrest, and there's been a lot of pull forward in terms of demand. And I think without the big stimulus that's going through and without the big AI investment, I think we'd already be close to a recession in the US.

14:02Let's dive into your portfolio and talk about some of the individual stock holdings. And we were emailing a bit about which ones to focus on before the conversation. We're going to start with Tesco. For our US listeners, this is the sort of Walmart of the UK. Talk us through what ultimately they do and why it's one of the key positions in your portfolio. Tesco's is probably one of the stocks I get the most pushback on, especially from a UK investor base, although the US guys are much more open-minded about it. Tesco's is the market leader, 25 % market share in UK grocery. Very good in online, very good in some of their other angles around advertising and things like that.

14:41But basically at its core, it's a very large grocer. And the key thing for us in this business is something we look for in every business, is what is the real competitive dynamic look like in your space? and we've probably not got long enough, but the long-term history here is that Aldi and Lidl German discounters came and attacked the market 20 years ago. Tesco tried to gouge on pricing and then really lost its contract with the customers. But they fixed that in 2015 and they've been regaining market share since 2019. The key point is that 25 % market share is held by Asda and Morrison's, two other competitors, both of whom underwent an extraordinarily leveraged LBO in a 2020, 2021, that sort of period, very low interest rates, are now facing huge refinancing risks and negative cash flow.

15:26So their ability to compete and to invest is dramatically diminished. And so what we're seeing is this market share gain coming through Tesco's inflecting higher, we believe, over the next few years. And the business generates a 7 % or 8 % growth even without market share gains. It pays back 7 % or 8 % a year in buybacks and dividends. So that's nearly a 15 % growth without market share. And for every one percentage point, it gets more market share because it's already got all its fixed assets in place. It makes another 15 % growth in the bottom line. So it's highly defensive. It's inflation linked.

16:02It's doubled in the last year or two, still trading on 14 times earnings. For your American listeners, Costco, obviously near a 50 and Walmart near a 40. This business, in our opinion, will grow faster and it's just as offensive god is cost gone 50 times pe like that wow i knew walmart had gone expensive again but i'd miss that on um on costco um talk us through autozone autozone um for the uk listeners who won't have heard of it um is an auto parts retailer so it has stores it sells to diy customers wanting to fix up their car but it also sells to local garages and it does this very very quick delivery time to local garages which crowds out any kind of alternative competitors from like Amazon or someone.

16:45I first invested in them in 2009. So I've owned those shares for 16 years. Again, they've been in the top 10 pretty much consistently for the last 16 years. And for the record, it's generated about a 25 % annual shareholder return, all supported by annual earnings growth. And it's a very simple business. It's 85 % of its sales are required immediately for repair or maintenance for your car. Something breaks, you need it. You need a wiper blade or you need something like a spark plug. It's essential. It's non-discretionary. The car park ages every year by about half a year. Cars get older. The fleet of cars gets larger as well across America.

17:26And again, there's three large players in America who have 50 % of the market. And the other 50 % is very small individual groups of two or three stores locally, or maybe even just one store. And they can't compete on the distribution, sourcing, marketing, and availability. It's a very hard industry to operate in because you have to have every part for every car of every year in your inventory to be able to serve your customer. So the inventory is very thin and wide. And that's a real barrier to entry. So AutoZone we love. O 'Reilly is its competitor that's doing very well too. Does EVs threaten it or do they help fix EVs?

18:04I mean, you just have to have batteries instead of spark plugs. Yeah, and sort of, you know, door buttons and a few other bits that do work. So there are fewer moving parts in an EV. I think there's a few issues with the EV argument. The first one is where the penetration levels need to get to, to actually shrink the internal combustion engine car park, because you can work it through slightly like a population density. You know, you know how many EVs go in now. AutoZone doesn't really start servicing cars until they're about seven years old. And really, its sweet spot is seven to 12 years old.

18:34So you then got to wait seven years for that impact to be felt across the sector. And what they've shown over time is firstly, a lot of sales of diagnostic equipment for EVs, which is highly profitable for them, but also an ability to just price up each year. I mean, cars have been getting more complex and less serviceable for the last 20 years. There's some great stats from their 1991 report about people getting worried that, you know, autosome will go out of business. But I think their ability to price around the demand and the fact that at least for the next 10 to 15 years, it's almost certain the car park will grow.

19:10Gives me quite a lot of confidence looking out for the next decade and beyond. So you're not a buyer of the kind of robo-taxi argument that could drastically reduce the need for the number of cars on the road? I mean, it could in one argument. I think the truth is most auto-zone stores are more rural than central sort of city. And I think the robo-taxi trials, well not trials, they're sort of live, but Waymo, a business we own, is running. They are good in Phoenix and places like that, but I think they're a long way off. I mean, there's hundreds of cars at the moment and there's 200 something thousand, million in the car park.

19:46So I think in terms of getting there, I just think it would take an extraordinarily long time. This wasn't by design, but it's very good that we've scheduled this to be after Cathie Wood, because again, it's a good bull and bear set of arguments on number of stocks now on robo taxis as well. Tell me about Sony, because this is another one you've held for a while, and perhaps is misunderstood, you think? Yeah, I mean, Sony's getting better understood, I think, just again, to sort of tell everyone, because people probably close their eyes and think of Walkmans, robotic dogs, VHS players, things like that.

20:21And they do still have a consumer electronics business that makes very good cameras, very good TVs, and a few other things. and extraordinarily they still sell mp3 players but if you exclude that business as a kind of break-even lab they refer to it as sony is now a market leader in gaming which is a huge structural growth industry alongside microsoft and nintendo they're a structural leader in pictures so movies shows things like that uh they're very very um major player in that globally really through the US. It's a US business primarily. And the same in music. And alongside those three entertainment assets, they have a really, really powerful semiconductor business, which is, they're called CMOS sensors.

21:04And they're basically camera sensors. And they have 85 % high-end smartphone market share. And in as much as EVs do grow or robo-taxis do grow and deploy more cameras or phones use more cameras per phone, you'll see continued growth in that market as well. and I mean I've owned it since probably 2012 or 2013 so again another decade plus holding period the stock's up I don't know 10 or 15 times since then still only trades on 15 times earnings and I think the next leg of the story from here is one that they're talking about and is a bit of a Japanese phenomenon at the moment which is trying to improve returns on capital mostly through improving margins you know this business makes just over a 10 % operating margin a lot of the competitors in those media type businesses make 20 and i doubt it gets to 20 anytime soon but could it be 13 14 15 while we also have a kicker through free cash flow growth from the the gestion of the playstation 5 which was released two or three years ago i think you've got a really good couple of years ahead for sony where you'll see natural margin expansion continued growth in the entertainment assets an apple refresh cycle that apple's sole supplier for CMOS sensors.

22:20And it's just far less of that old-fashioned electronics business than people imagine. Is it though that cheap relative to the big US players? I guess media and entertainment in the US has a big range of valuations, like old media, which I guess I work for at Comcast, Sky's subsidiary, of course, of Comcast is pretty cheap. Some of the new media like Netflix is pretty expensive. So how do you think about that comparison? Well, these guys win because of the new distribution models, Netflix and Spotify and the other alternatives to those platforms. But that sort of model, I mean, their existence is the reason the old-fashioned media distribution stocks trade less expensively.

23:05But I think within the world of content, and when you are a really major provider of that content. I mean, Spotify and Netflix both basically gave stakes in their business when they were young businesses to Sony, just in order to sign them. That's how important their content is. I don't think you could exist without that content on your platform. So it works both ways, but they have a lot of power in those negotiations.

23:33Let's talk about some other asset classes, because obviously, Latitude Global is just how many stocks in that? There's 25, 30? 23 at the moment. Wow. So it's very, very, very focused. And then that's just equities. And then Latitude Horizon is multi assets. Within the bond portfolio, where are you on duration at the moment? What's your outlook? Yeah. It's sort of the$64 ,000 question. I think there's two ways to look at it. And either one could be true. And this is the reason. And if you say, you know, don't judge me by my opinion, and judging by my actions, the punchline is we're in very short dated bonds.

24:09So I think the two potential futures look like this. One is that we currently have very high real interest rates in the US and the UK and around the world. And that is not sustainable with a high level of deficits and a high level of government debt. It mathematically just compounds that problem. So at some point, we need to move back to financial repression and see bond yields drop below inflation and probably the short end of the curve. And that would be very positive for longer duration assets. The flip side is, and what I think is going on through the price action at the moment, is who wants to own government debt at 4 % when they've got these huge deficits and huge debt piles and ill-conceived spending plans in many cases.

24:53And so it's one of the reasons why the stock market's holding so strong, because if those are the two major asset classes, which they are and you have a new incremental dollar, where are you going to put it? I think the stock market at four with risk, the bond market with four yield with risk, or the stock market, which right now seems to be a free money tree. So that's sort of one of the ways it's working. So we're positioned very short duration. We're moving around the currency a little bit more. We've got more dollar exposure than we have in the past, which is quite counter-consensual at the moment.

25:25But that's how we're thinking about duration risk. It's not worth it at the moment. But But sorry to keep going, but we have quite a strict inclusion criteria on our non-equities. We want to make money, but we don't need to make a lot of money. Our stocks do a lot of the hard work in the multi-asset fund. What we're looking to do is reduce risk. And adding duration right now, given those two scenarios, it's 50-50 whether they reduce or add to the risk. So it's not worth the trade. What is your view on inflation-linked bonds? because clearly if you lengthen duration, you're taking some risk. And in the short term, there'll be marked market losses, no doubt.