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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
Essential guide for detailed evaluation of business quality aimed at investors in both public and private markets
A practical tool for investment analysis, On the Hunt for Great Companies: An Investor's Guide to Evaluating Business Quality and Durability helps readers analyze target companies in relation to 17 traits of business quality, as well as the nuances within them.
Readers will learn how to empirically evaluate the traits of a good business, including passionate management, staying power, abnormal reinvestment options, low dependency risk, and to identify emerging quality.
This book is supported by a wealth of real-world examples, both contemporary and historical, detailed original illustrations, and true business stories and anecdotes from investor and former comedian Simon Kold. In this book, readers will learn about:
- Practical guidelines for research into 17 nuances of business quality
- Methods to formulate falsifiable test statements and empirically test those predictions, rather than relying on heuristics or box-checking
- Incorporates memorable investment advice through Kold’s trademark humorous style
Detailed, sophisticated, and highly actionable, On the Hunt for Great Companies is an essential for professional investors of all sizes, in all industries, in both public and private markets.
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Seitenzahl: 433
Veröffentlichungsjahr: 2024
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Table of Contents
Cover
Table of Contents
Title Page
Copyright
Acknowledgments
List of Figures
List of Tables
List of “Let’s Sniff Around”
Chapter 1: Passion
Chapter 2: Long-term Incentives
Chapter 3: Capital Allocation
Chapter 4: Reliable Communication
Chapter 5: Economies of Scale
Chapter 6: Switching Costs
Chapter 7: Network Effects
Chapter 8: Brand Advantages
Chapter 9: Proprietary Resources
Chapter 10: Fair Value Extraction
Chapter 11: Staying Power
Chapter 12: Proven Business Model
Chapter 13: Predictable Demand Drivers
Chapter 14: Reinvestment Options
Chapter 15: Scalability and Low Incremental Costs
Chapter 16: Cyclical Risks
Chapter 17: Other Risks
Introduction
Notes
Part I: What Makes Some People Create Exceptional Long-term Per-share Business Performance?
Chapter 1: Passion
1.1 Perseverance and Internal Motivations
1.2 Focus on All Stakeholder Constituencies
1.3 Decision-making Time Horizons
1.4 Career Path and Tenure
1.5 Retention of People
1.6 Authenticity Indicates Passion
Notes
Chapter 2: Long-term Incentives
2.1 Board of Directors
2.2 Disincentives
2.3 Transactions in Own Shares
Note
Chapter 3: Capital Allocation
3.1 Value-accretive Buybacks versus Buybacks
3.2 Hurdle Rates Should Be Determined by Alternatives
3.3 Value Destructive Acquisitions
3.4 Unsung Capital Allocators
3.5 Metrics and Vocabulary
Notes
Chapter 4: Reliable Communication
4.1 Past Predictions and Ex Post Outcomes
4.2 Genuineness as Indicator of Reliability
Notes
Part II: What Makes Competitive Advantages Intense and Durable?
Chapter 5: Economies of Scale
5.1 Relative Scale and Relevant Market
5.2 Prohibitive Costs
5.3 Evaluating the Intensity and Durability of Economies of Scale Advantages
Notes
Chapter 6: Switching Costs
6.1 Sticky Customers, Add-on Products, and “Cost of Switching”
6.2 Switching Cost Multipliers
6.3 Evaluating Intensity of Switching Cost Advantages
Notes
Chapter 7: Network Effects
7.1 Boundedness
7.2 Critical Mass and Relative Scale
7.3 Evaluating the Intensity and Durability of Network Effect Advantages
Notes
Chapter 8: Brand Advantages
8.1 “Identity Creating” or “Uncertainty Reducing”
8.2 Brand Time Constraints
8.3 Luxury Brands
8.4 Evaluating Brand Advantages
Notes
Chapter 9: Proprietary Resources
9.1 Favorable Access to Raw Materials
9.2 Proprietary Technology
9.3 Favorable Locations
9.4 Favorable Government Treatment
Notes
Part III: What Makes Some Companies Less Risky and More Valuable Than Others?
Chapter 10: Fair Value Extraction
10.1 Tapped and Untapped Pricing Power
10.2 Lack of Value Capture
10.3 Determinants of Choosing to Withhold Value Extraction
10.4 Risk of Extracting Excessive Value from the Supply Side
10.5 Evaluating the Risk of Excessive Value Extraction
Notes
Chapter 11: Staying Power
11.1 The Pace of Technological Change in the Industry
11.2 Exposure to External Foundational Technological Shifts
11.3 Cultural Embeddedness
11.4 Cost-effectiveness
11.5 Demographic Exposures
11.6 Exposure to Industry Channel Changes
11.7 Age of Technology/Product Category
11.8 Staying Power Versus Growth
11.9 Evaluating Staying Power
Notes
Chapter 12: Proven Business Model
12.1 Geographical Replicability
12.2 Expansion Investments
12.3 Lifetime Unit Economics
Notes
Chapter 13: Predictable Demand Drivers
13.1 Line of Sight of Revenues
13.2 Predictability of Longer-term Industry Demand
Chapter 14: Reinvestment Options
14.1 Product Line Expansion
14.2 Territorial Expansion
14.3 Increased Capacity
14.4 Customer Acquisitions and Brand Building Investments
14.5 Buying Other Companies
14.6 Lack of Reinvestment Options
Note
Chapter 15: Scalability and Low Incremental Costs
15.1 Determinants of Marginal Cost
15.2 High Break-even Point
15.3 Scalability of Infrastructure
15.4 Operational Leverage Magnifies Cyclical Risks and Exit Costs
15.5 Capital-light Versus Capital-intensive Businesses
Notes
Chapter 16: Cyclical Risks
16.1 Cyclical Company: Good or Bad?
16.2 Degree of Cyclicality
16.3 Minimizing Analytical Risks Caused by Cyclicality
Notes
Chapter 17: Other Risks
17.1 Dependency Risks
17.2 Diversity of Income Streams: Risks and Benefits
17.3 Leverage Risks
17.4 Geopolitical Risks
17.5 Regulatory Risks
17.6 “Unknown” Risks
Notes
Chapter 18: Final Remarks
18.1 Analytical Errors
18.2 Price Matters
18.3 Predicting Quality
Notes
Appendix: Banana Peels of Inductive Logic
Prediction Based on Past Experience
Argument from Cause
Argument from Generalization
Argument from Analogy
Argument from Authority
Anecdotal Argument
Note
About the Author
List of Companies Profiled
Index
End User License Agreement
List of Tables
Chapter 1
Table 1.1 Overview of TSMC Management’s Tenure and Shareholding (as of Janua...
Table 1.2 Apple Leadership Changes from 2018 to 2023
Chapter 4
Table 4.1 Example of Predictions and Outcomes from Apple’s Earnings Calls
Chapter 10
Table 10.1 See’s Candy Shops
During the first 12 years after acquiring See’
...
Chapter 11
Table 11.1 “Catastrophic Loss” in Various Sectors (1980–2020)
Chapter 16
Table 16.1 Deere’s Equipment Operations, 2019–2023
Chapter 18
Table 18.1 Amazon.com Selected Financials from 1999 to 2003
List of Illustrations
Introduction
Figure 1 A dowser-investor’s dowsing twig.
Chapter 1
Figure 1.1 Effects of passion and its correlations.
Figure 1.2 Jensen Huang, the passionate CEO of NVIDIA, has a tattoo of his c...
Figure 1.3 Some managers are so passionate that they cannot confine themselv...
Figure 1.4 Masayoshi Son of SoftBank communicates in an authentic manner. Hi...
Figure 1.5 Example of a subtler form of authentic communication: The Danish ...
Chapter 2
Figure 2.1 Unilever is an example of a European company that has stock owner...
Figure 2.2 Details on board compensation can be found in DEF 14A Proxy State...
Figure 2.3 It is always reassuring to see a CEO’s ownership steadily increas...
Chapter 3
Figure 3.1 Buyback as a percentage of market capitalization of the firms in ...
Figure 3.2 Page from the 2022 Capital Markets Day of Dutch conglomerate Pros...
Figure 3.3 The first 21 words of Jeffrey Bezos’s 2004 letter to Amazon’s sha...
Chapter 4
Figure 4.1 Predictions versus ex post outcomes: Three scenarios each indicat...
Figure 4.2 Alternative asset manager Brookfield’s CEO, Bruce Flatt, has a lo...
Figure 4.3 Neither the word “Adjusted” nor “EBITDA,” so frequently combined ...
Chapter 5
Figure 5.1 Simplified illustration of a situation with and without economies...
Figure 5.2 Under the right conditions, as in
Gulliver’s Travels,
havin...
Figure 5.3 Comparing two scenarios of differential unit economics between le...
Figure 5.4 Necessary conditions for advantage: a steep cost curve and relati...
Figure 5.5 Anheuser-Busch InBev’s North American segment: Inflation-adjusted...
Figure 5.6 Positive indicator for advantage: Unit cost negatively correlates...
Figure 5.7 Distribution network. Black is denser than Gray.
Figure 5.8 Price per package, by delivery service product and carrier CY2023...
Chapter 6
Figure 6.1 Metaphorical illustration of switching costs.
Figure 6.2 Switching cost as a standalone advantage, without the combination...
Figure 6.3 Apple’s integrated hardware, software, and service ecosystem is a...
Figure 6.4 Enterprise software firm Atlassian demonstrated impressive revenu...
Chapter 7
Figure 7.1 Network effects: Utility increases with number of users.
Figure 7.2 Page from the 2019 Investor Day presentation of Adevinta, an onli...
Figure 7.3 Utility curves: Network effects in three distinct scenarios.
Figure 7.4 Variation in user preferences is a determinant of a network’s uti...
Figure 7.5 Multi-homing: A network effect “party-killer.”
Figure 7.6 Interoperability between two networks: A network effect “party ki...
Figure 7.7 “Video Wars”: Sony’s Betamax vs. JVC’s Video Home System (VHS). V...
Figure 7.8 The Dvorak keyboard layout was designed to increase typing speed ...
Figure 7.9 Specialized tools for professionals, such as the da Vinci Surgica...
Chapter 8
Figure 8.1 Customers buy Harley-Davidson motorcycles because of the sense of...
Figure 8.2 “Uncertainty reduction”: Due to its long-standing presence in the...
Figure 8.3 Brands are often geographically bounded: Moutai, deeply rooted in...
Chapter 9
Figure 9.1 ZEISS metrology for High-NA-EUV lithography: The high-precision m...
Chapter 10
Figure 10.1 Conceptual illustration on degrees of value extraction.
Chapter 11
Figure 11.1 An illustrative comparison of the market adoption “S-curves” of ...
Figure 11.2 Causes of staying power and its correlations.
Figure 11.3 An illustrative comparison of historical productivity increases ...
Figure 11.4 Pools have a flat slope of the adoption S-curve, which is a posi...
Figure 11.5 Railway transportation is an old and cost-effective technology. ...
Chapter 12
Figure 12.1 The fictional character MacGyver from the 1985 TV series
MacGyve
...
Figure 12.2 The relationship between Per-unit-profitability and Total-profit...
Figure 12.3 Netflix’s operating income, before and after the operational exp...
Figure 12.4 Illustration of customer lifetime unit economics: Cumulative pro...
Chapter 13
Figure 13.1 Determinants of predictability of demand.
Figure 13.2 Lifetime revenue of DUV tool. From ASML’s 2021 investor day.
Chapter 14
Figure 14.1 Illustration of the value of abnormal reinvestment options durin...
Figure 14.2 TSMC’s “Fab 21” is under construction in Phoenix, Arizona, as of...
Figure 14.3 Salesforce.com’s annual recurring revenue (ARR) is categorized b...
Chapter 15
Figure 15.1 Visa’s P&L in 2008 compared to Visa’s P&L in 2023.
Figure 15.2 Analyst neglecting to consider incremental ROIC.
Chapter 16
Figure 16.1 Cyclicality causes two problems: the cyclical risk itself and th...
Chapter 17
Figure 17.1 A comparison of headquarters of two conglomerates.
Chapter 18
Figure 18.1 In a game of Top Trumps, it is better to have a card that is pre...
Figure 18.2 Even the most experienced pedestrians can slip on a banana peel ...
Part II
Figure P.1 My definition requires at least one type of competitive advantage...
Figure P.2 The Colossus of Rhodes is believed to have stood for only about 5...
Appendix
Figure A.1 Uncritically assuming a causal relationship from observed pattern...
Guide
Cover
Table of Contents
Title Page
Copyright
Acknowledgments
List of Figures
List of Tables
List of “Let’s Sniff Around”
Introduction
Begin Reading
Appendix: Banana Peels of Inductive Logic
About the Author
List of Companies Profiled
Index
End User License Agreement
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Praise for On the Hunt for Great Companies
“Simon Kold is a clear and rational thinker in the mold of Charlie Munger. And he has a clear grasp of the many fallacies of thinking that are rife in the investment world. Armed with these, he dives deep into the critical factors that define business quality.
Unlike my book - which addresses the inner game of investing, Kold’s book carefully examines all the factors that contribute to business quality. Any reader will come away with a better set of mental frameworks to use in searching for and evaluating business quality.
Kold’s book is a must read for all serious investors and will certainly take its place along side other greats – especially other practically oriented books – like the Outsiders by Thorndike and Margin of Safety by Seth Klarman.”
—Guy Spier, Author of The Education of a Value Investor
“Kold provides an excellent framework to help investors navigate the treacherous path toward investment success. This book will help both sophisticated professional investors and beginners achieve their investment objectives.”
—Brian C. Rogers, Retired Chairman and CIO of T. Rowe Price
“Long-term fundamental value investing in high quality companies is the best way to generate consistent returns. Simon Kold has the track record to shed light on the key elements of this strategy.”
—Kasim Kutay, CEO of Novo Holdings
“Having personally worked with Simon Kold, I can attest to his investment acumen and the analytical rigor displayed in this sophisticated yet entertaining investment book.”
—Bjarne Graven Larsen, Founder of Qblue Balanced and former CIO of ATP and Ontario Teachers’ Pension Plan
“I’ve read (and written) my fair share of dry, technical tomes on finance. On the Hunt for Great Companies is an inspiring, very practical and wonderful written book on identifying ‘alpha return’ companies.”
—Thomas Plenborg, Professor at Copenhagen Business School & Chairman of DSV
“On the Hunt for Great Companies is not only a thoughprovoking and refreshing take on the arduous journey of the true value investor, it is a reflection of what I have seen Simon Kold practice throughout the years I’ve known him.”
—Salah Saabneh, Partner at Manikay Partners and former Chairman of Tel Aviv Stock Exchange
On the Hunt for Great Companies
An Investor’s Guide to Evaluating Business Quality and Durability
Simon Kold
Copyright © 2025 by Simon Kold. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4470, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permission.
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Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Further, readers should be aware that websites listed in this work may have changed or disappeared between when this work was written and when it is read. Neither the publisher nor authors shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
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Library of Congress Cataloging-in-Publication Data is Available:
ISBN 9781394285747 (Cloth)ISBN 9781394285761 (ePDF)ISBN 9781394285754 (ePub)
Cover Design: Thomas NeryCover Image: © Elymas/ShutterstockAuthor Photo: Courtesy of Simon Kold
Acknowledgments
At first I was afraid, I was petrified. Kept thinking I could never write this book without you by my side. But then I spent so many nights thinking about our editorial ping-pong. And I grew strong. And I learned how to get along… All jokes aside, I declare, without your help, this book would be absolutely nowhere. So thank you, for your golden touch, your feedback, and suggestions, meant so much. Thank you Alexander Pichler, Alex Petrin, Amir Saabneh, Anders Morgenstierne, Andrew Burns, Ashwin Aravindhan, Beeneet Kothari, Brian Rogers, Christopher Kjær Hansen, Claudine Innes, Daniel Ong Jia Qiang, Helen Gaffney, Henrik Kjær Hansen, Jakob B. Møller, Joachim Fogh, Johan Brønnum-Schou, Johannes Brenner, Jonathan Macklin, Josh Shores, Kasim Kutay, Kristian Korsgaard, Kaare Danielsen, Leo Zhong Li, Lil Oliefyr, Mads Horsted, Matthew Brown, Morten Kristiansen, Nataly Vukubrat, Niklas Landin Olsen, Dr. Nikolaus Werhahn, Nima Shayegh, Ole Søeberg, Per la Cour, Pieter Verrecas, Salah Saabneh, Sizi Chen, Sofia Hou, Stefan Culibrk, Steffen Jørgensen, Søren Funch Adamsen, Thomas Plenborg, Tiantian Lee, Tilman Versch, Victor Berg, Yash Bhatnagar, and Zi Hao Tan. Special thanks to those who helped me review multiple iterations or read the agonizing early versions.
Special thanks to Thomas Plenborg for encouraging me to use my humor in the book. I apologize to everyone for my bad execution of this idea. Clearly, I must have ignored any sensible feedback I got on this, and none of the persons listed above should be held responsible. Thanks to my agent John Willig for good content feedback and for getting me an incredible publisher. Thanks to my wonderful editor Judith Newlin, managing editor Richard Samson, and all their colleagues at Wiley for believing in the book and for excellent support. Thanks to Sunnye Collins and Sheryl Nelson for great editorial inputs.
Thanks to all my former colleagues at Novo Holdings, especially to Morten Beck Jørgensen and Johan Brønnum-Schou for enduring a decade of my drollery.
Finally, thanks to my dear family. Thanks to my wife for tolerating this book spoiling so many mornings, weekends, and holidays. Thanks to my parents, especially my mom, for helping out so much with the kids and for the immense supply of frozen meatballs.
List of Figures
1 A dowser-investor’s dowsing twig
1.1 Effects of passion and its correlations
1.2 Jensen Huang’s tattoo of passion
1.3 Cognex annual report covers
1.4 SoftBank’s Masayoshi Son’s “larger-than-life” Communication
1.5 Ringkjøbing Landbobank loan losses since 1987
2.1 Unilever’s stock ownership guidelines for executives
2.2 Apple’s Board compensation
2.3 Jeff Musser’s cumulative shareholding in Expeditors
3.1 S&P 500 companies’ buyback over time
3.2 Prosus’ slide on buyback approach
3.3 The first 21 words of Jeffrey Bezos’s 2004 letter to Amazon’s shareholders
4.1 Predictions vs. Ex Post outcomes
4.2 Alternative asset manager Brookfield’s CEO, Bruce Flatt, has a long track record of delivering on ambitious targets
4.3 Apple’s clean investor communication
P.1 Competitive advantage over each competitive interface
P.2 The Colossus of Rhodes is believed to have stood for only about 54 years. While it existed, it was a magnificent wonder, but it was taken down by the forces of nature. Similarly, competitive advantages can be intense but not durable
5.1 Simplified illustration of a situation with and without economies of scale
5.2 Under the right conditions, as in Gulliver’s Travels, having a relative scale can lead to benefits
5.3 Prohibitive costs
5.4 Necessary conditions for advantage: a steep cost curve and relative scale
5.5 Anheuser-Busch InBev’s North American segment: Inflation-adjusted cost per hectolitre as a function of volume
5.6 Positive indicator for advantage: unit cost negatively correlates with size
5.7 Distribution network density illustration
5.8 Price per package, by delivery service product and carrier
6.1 Metaphorical illustration of switching costs
6.2 Switching cost as a standalone advantage, without the combination of other forms of advantages, is kind of like darts without beer. It is functional alone but works much better in combination
6.3 Apple’s integrated hardware, software, and service ecosystem is an example of “switching cost multipliers”
6.4 Enterprise software firm Atlassian demonstrated impressive revenue cohort data in its S-1 filing in 2014
7.1 Network effects: Utility increases with the number of users
7.2 Leboncoin’s relative scale in French used car classifieds
7.3 Utility curves: Network effects in three distinct scenarios
7.4 Variation in user preferences is a determinant of a network’s utility flattening point
7.5 Multi-homing: A network effect “party-killer”
7.6 Interoperability between two networks: A network effect “party killer”
7.7 “Video Wars”: Sony’s Betamax vs. JVC’s Video Home System (VHS)
7.8 Dvorak keyboard layout
7.9 Expertise network effects: da Vinci Surgical System
8.1 Customers buy Harley-Davidson motorcycles because of the sense of identity they obtain from the product
8.2 Tylenol’s uncertainty reduction
8.3 Kweichow Moutai
9.1 ZEISS SMT lithography optics: The world’s most precise mirror
10.1 Conceptual illustration on degrees of value extraction
11.1 An illustrative comparison of the market adoption “S-Curves” of elevator technology versus MIDI Ringtone technology
11.2 Causes of staying power and its correlations
11.3 An illustrative comparison of historical productivity increases (a proxy for the pace of technological advancement) in semiconductors versus brewing
11.4 Swimming pools have a flat slope of the adoption S-Curve
11.5 Rail transportation has staying power
12.1 By definition, a business model incorporating “MacGyver”-like elements is not “proven”
12.2 The relationship between per-unit-profitability and total-profitability as a function of volume
12.3 Netflix example of “Expansion OpEx”
12.4 Illustration of customer lifetime unit economics: cumulative profits as a function of time
13.1 Determinants of predictability of demand
13.2 Lifetime revenue of DUV tool from ASML’s 2021 investor day
14.1 Illustration of the value of abnormal reinvestment options during the initial decade for two otherwise identical businesses
14.2 TSMC’s “Fab 21”
14.3 Salesforce ARR by “cloud.” Example of cross-selling M&A
15.1 Visa’s P&L in 2008 compared to Visa’s P&L in 2023
15.2 Analyst neglecting to consider incremental ROIC
16.1 Cyclicality causes two problems: the cyclical risk itself and the analytical risk resulting from it
17.1 A comparison of headquarters of two conglomerates
18.1 In a game of Top Trumps, it is better to have a card that is pretty good in all categories than a card with one amazing feature
18.2 Analytical banana peel
A.1 Uncritically assuming a causal relationship from observed patterns of correlation is like assuming that a mullet makes you good at ice hockey
List of Tables
1.1 TSMC’s management tenure and shareholding
1.2 Apple leadership changes from 2018 to 2023
4.1 Example of predictions and outcomes from Apple’s earnings calls
10.1 During the first 12 years after acquiring See’s Candy Shops, Berkshire raised the prices per pound by 9.5% per year
11.1 “Catastrophic Loss” in various sectors (1980–2020)
16.1 Deere’s equipment operations 2019–2023
18.1 Amazon.com selected financials from 1999 to 2003
List of “Let’s Sniff Around”
Chapter 1: Passion
Perseverance and internal motivation
Risk of management neglecting stakeholder groups
Decision-making time horizons
Career path and tenure
Founders specifically
Retention of people
Authenticity of management communication
Chapter 2: Long-term Incentives
Long-term incentives
Director incentives
Management incentives
Management’s transactions in own shares
Chapter 3: Capital Allocation
Management’s approach to buybacks
Capital allocation mentality
Historical acquisitions
Capital allocation “vocabulary”
Chapter 4: Reliable Communication
Reliability of past managements predictions
Genuineness of investor communication
Chapter 5: Economies of Scale
Degree of relative scale
Cost curve steepness
Market share and cost efficiency
Prohibitive costs
Likelihood of a plateau in scale benefits
Distribution network density scale advantages
Purchasing scale advantage
Marketing scale advantages
Production scale advantages
Chapter 6: Switching Costs
Costs of switching
Arbitrage of switching costs
Churn and retention rates
Risk of standardization
Chapter 7: Network Effects
Relative scale
Utility curve steepness
Diminishing of user utility gains
Extent of multi-homing
Users’ costs of multi-homing
Extent and risk of interoperability
Protocol network effects
Expertise ecosystem network effects
Two-sided network effects
Data network effects
Chapter 8: Brand Advantages
Customer utility from “identity creation” or “uncertainty/risk reduction”
Brand benefits
Brand dilution risk
Chapter 9: Proprietary Resources
Favorable access to raw materials
Proprietary product technology
Favorable locations
Uneven government treatment
Chapter 10: Fair Value Extraction
Risk of excessive value extraction
Chapter 11: Staying Power
Pace of technological change in an industry
Overall staying power
Chapter 12: Proven Business Model
Provenness of a business with group-level economics at or below break-even
Lifetime Unit Economic Margin
Chapter 13: Predictable Demand Drivers
Line of sight contribution from order backlog
Line of sight contribution from upgrade cycles and replacement sales
Line of sight contribution from contractual and recurring businesses
Line of sight contribution from aftermarket services and spare parts
Long-term predictability of the industry’s demand drivers
Chapter 14: Reinvestment Options
Options to expand product lines
Attractiveness of options to expand territorially
Options to expand capacity
Options to expand customer acquisitions and brand building
Options to buy other companies
Chapter 15: Scalability and Low Incremental Costs
Marginal cost structure
Constraints to scalability
Chapter 16: Cyclical Risks
Determinants of cyclicality
Historical cyclicality
Management’s historical behavior with respect to cyclicality
Mitigate analytical risks of cyclicality
Chapter 17: Other Risks
Dependency risks
Benefits and risk of diversification
Conglomerates
Leverage risk
Geopolitical risk
Regulatory risk
Introduction
This book attempts to provide practical analytical frameworks for investors to empirically evaluate the quality and durability of any business. The traits of a high-quality, durable company include:
People who are passionate and make decisions with a long-term perspective for the benefit of all stakeholders, with good skills in capital allocation and proper long-term incentives
Reliable communication
A competitive advantage that is both intense and durable
Modest extraction of the economic benefit generated for customers and suppliers
The ability to survive and be relevant for many years to come
Predictable long-term demand drivers
Lucrative reinvestment options
A robust and proven business model
Scalability and low incremental costs
Manageable risk exposures
I am sure that experienced long-term investors can agree on most of these traits. So, what can I bring with this book? This book provides you with actionable guides on how to empirically evaluate each of these elements, as well as the nuances within them. When combined, these frameworks can also serve as a unified model for the discussion of overall business quality.
Although the book is about the quality of companies, it is by no means limited to the discipline of “quality investing,” which focuses only on mature companies with pronounced overall quality. The book is equally intended for investors who focus on less mature companies or those with varying degrees of quality. It is intended for investors in all industries, in both public and private markets, and for investors who buy anywhere from one share to all the shares of the companies in which they invest. It is also intended for non-investors who are just interested in analyzing business quality and risks—for example, business operators.
* * *
There is a chasm in the analytical mentality among investors. Some appear to operate with mental checklists where each checkpoint is binary and must be ticked off with minimal effort. Obviously, in support of their preexisting investment thesis, that is. Or perhaps sometimes more accurately their boss’s investment thesis. They attach “labels” to companies based on broad-level historical pattern recognition supported by anecdotal evidence without further empirical analysis of the current circumstances. For instance, they might conclude that a business has a “competitive moat” because it’s evident that the business benefits from some degree of network effect. But what about obtaining specific, empirical data regarding the common causes of network-effect erosion? It seems that this doesn’t interest some professionals, who are too busy with other more important things such as making PowerPoint presentations or calculating whether their expected return is 10.1% or 10.11%.
Other investors have a different approach. They know that none of the traits are binary; they are nuanced. They know that they shouldn’t be evaluated based on theorizing, wishful thinking, or stock pitch arguments. They know what should be assessed by knowing what specific indicators to look for and evaluating the real-world evidence concerning those indicators. These investors are like sniffer dogs. They sense the world. Sniffer dogs are trained to search areas diligently and systematically, following scent trails or detecting specific odors. Sniffer dogs make decisions based on the sensory input they receive from their environment. They gather information from their surroundings and determine the direction and strength of the scent trail. Sniffer dogs undergo rigorous training to harness their natural sniffing ability for specific tasks.
What, then, of those investors not among the sniffer dogs? They are far from sniffer dogs. They are dowsers. They wander around with their Y-shaped twig looking for evidence that supports their hypothesis of underground water or precious metals. They do get out and walk around with their twig out, but the observations gathered about the world have little impact on their conclusions. The twig will dip when they pass over a supposed underground asset. This is, however, an unconscious, involuntary physical movement that occurs in response to thoughts or ideas rather than to external stimuli. Dowsers attribute successful finds to their skill and intuition, while failures can be rationalized as interference from other substances. Some dowsers may spend a lot of time and effort dowsing and brag about how diligently they dowsed—not realizing the nonexistent connection to the actual chances of discovering water.
Figure 1 A dowser-investor’s dowsing twig.
Source: Original artwork by Henriette Wiberg Danielsen. © 2024 Simon Kold.
Then there are the experienced senior dowsers. They are so senior and high ranking that they are simply above the need to do any real work. They can instantly find underground water and precious metals using only their gut. Or so they think. They don’t shy away from overruling diligently collected empirical conclusions based on random anecdotal experiences.
The investment industry is abundant with massively over-remunerated dowsers, tarot card readers, Feng Shui consultants, Freudians, and detox foot bath operators. I don’t think the world needs more of these. But I urge you to be a sniffer dog—like an empirical scientist who forms hypotheses, gathers empirical observations, and strives for the ideals of falsification.1
Consider this book an attempt to help you be more like a sniffer dog and less like a dowser. The book attempts to be a sniffer dog training manual. Specifically, a manual with regards to the question of the quality and durability of companies.
How to Use This Book Productively. I believe that investment analysis should be based on solid evidence. But it’s also important for investors to use their time wisely. This book provides guides for evaluating different aspects of business quality. The aim isn’t to make you expend enormous time and effort on every single aspect discussed. Instead, use this book to focus on what matters most for your investment:
Concentrate on the aspects from the book that are most crucial for your overall investment case in the given scenario.
Focus on the aspects from the book where your target company shows the greatest weaknesses.
For both points, prioritize seeking empirical evidence that might challenge or undermine your overall investment hypothesis, and critically assess your interpretation of this evidence.
I personally seek to find the path of least resistance to “kill” an investment idea. A time opportunity cost is associated with investment analysis. Analyzing one company means you are missing out on analyzing another. By focusing on what really matters and by trying to find the shortest path to rejection, you can hopefully manage this cost.2
Let’s Sniff Around
In each section, I have created a box labeled “Let’s Sniff Around,” which contains specific analytical actions that you can take to empirically evaluate that particular subelement of business quality and durability. For readers who are not professional investors and have no ambition to become one, these suggested steps might seem overwhelming or of little use to you. No problem—simply skip them, and you should still be able to enjoy the book!
It is a great pleasure to finally have succeeded in writing a book about the quality of companies, especially considering my earlier, painfully embarrassing failed attempt to write a book about the quality of coconuts. As the first “how to” business book in history, this book doesn’t guarantee overnight success (e.g., unlike my book about coconuts). At best, it promises to make you a gazzilionare in a currency where 1 gazzilion is pegged to the exact garage sale value of this book.
Enjoy the book!
Notes
1
. Falsification is the principle that a theory or hypothesis should be considered scientific only if it is testable and can potentially be proven false by evidence.
2
. However, there are also benefits in learning about new businesses, which can sometimes be overlooked if one focuses solely on the shortest path to rejection.
Part IWhat Makes Some People Create Exceptional Long-term Per-share Business Performance?
Chapter 1Passion
Control of companies is placed with people spanning a panoply of passion:
At one end are people for whom the job is a stepping-stone, something they do for a few years until a bigger company calls. They have a history of hopping from one job to another, spanning several sectors. They focus on meeting quarterly targets and maximizing results within a 2- to 4-year time frame and are not accountable for the aftermath.
At the other end are people for whom the firm is their life’s work. They are emotionally enthralled by the enterprise. When the business suffers, they care for it as parents would for a sick child. They feel responsible to all stakeholders and seek a maximum in a further future.
Expecting these two types of people to run a company the same way is like asking the sun to shine at night. But why does such passion matter for investors? Intense emotional investment is indispensable for creating exceptional outcomes in all fields of human endeavor. As Steve Jobs once said, “The only way to do great work is to love what you do.” An absence of passion results in complacency, a focus on short-term profits at the expense of long-term value per share, a mindless unwillingness to deviate from peers, or an excessive concentration on a single stakeholder group at the expense of others. To achieve exceptional long-term outcomes, a firm must simultaneously delight its customers, offer superior products, maintain satisfied suppliers, nurture a loyal and contented workforce, and operate within societal norms. A passionate management and workforce is a necessary ingredient to achieve all of these at the same time. It is easy to boost profits in a 2- to 3-year time frame by cutting employee benefits, pressuring suppliers, reducing service quality, or hiking prices. While such measures can enhance short-term profits, they erode long-term value per share.
The longer the investment time horizon, the more management decisions affect the outcome. Over longer periods, the decisions made significantly shape business performance per share. Just as passion drives exceptional results in arts, sports, and science, it also propels success in business. Managers who lack passion also lack the recipe for exceptional results.
Galileo Galilei, famous for his contributions to astronomy and the laws of motion, represents the ultimate level of exceptional results while embodying characteristics quite opposite to those of most modern corporate managers. These characteristics include perseverance, internal motivation, and independence from prevailing norms. Galilei did not engage in a conflict with the Catholic Church over the heliocentric model because it was beneficial to his short-term incentive program or because it was a “hot trend” at the time. He did it because he was obsessed with the truth and with his scientific work. He was so extremely perseverant in supporting the heliocentric model proposed by Copernicus that he was ultimately sentenced by the Inquisition to spend the rest of his life under house arrest. To the contrary, most managers prioritize short-term gains and align their actions with current trends or the prevailing corporate culture. Unlike Galilei, whose dedication to scientific truth led him to challenge established norms, most in the corporate community shy away from such risks. They focus on strategies that promise immediate returns and favor adherence to established methodologies. This contrast highlights a fundamental difference in approach: whereas Galilei was driven by his devotion to his beliefs and the pursuit of knowledge, most managers are guided by trends, near-term targets, and the immediate expectations of analysts, media, and shareholders.
Figure 1.1 Effects of passion and its correlations.
Source: Simon Kold.
1.1 Perseverance and Internal Motivations
Perseverance through setbacks is a manifestation of passion. An anecdote featuring Jensen Huang of NVIDIA during the company’s existential crisis in 1997 showcases attributes such as resilience, determination, adaptability, and boundless optimism. The company prepared to release the RIVA 128, one of the first consumer graphical processing units to integrate 3D acceleration, essential for rendering 3D graphics on computers. However, the company was running low on cash, with only enough to sustain operations for about 6 months. At this point, most people would have given up. But Jensen and his team decided to take an unconventional and risky decision.
My will to survive exceeds almost everybody else’s will to kill me.
—Jensen Huang (NVIDIA), 2003 presentation at Stanford eCorner.1
Instead of following the conventional course of receiving physical prototypes for testing, NVIDIA chose to conduct the entire testing in simulation, then committed the rest of the company’s financial resources to commissioning the production of the RIVA 128 without ever inspecting a physical prototype. NVIDIA bet the house, the silicon ranch, and the transistor tent on a product they had never tested in the real world. Not surprisingly, the product did not work as intended. The RIVA 128 supported only 8 of the 38 so-called DirectX image blending modes for which it had been designed. The team attempted to convince software developers to use only those eight supported modes in computer games and software. Despite the setbacks, the product surprisingly achieved commercial success. NVIDIA was lucky that the product performance, well, worked, despite the lack of prototype testing, and entered the market just as personal computer gaming began to bloom. Although luck contributed to the outcome, without passion, to bankruptcy, the company would have succumb. Still led by Jensen Huang, NVIDIA today is one of the world’s most valuable companies.
Figure 1.2 Jensen Huang, the passionate CEO of NVIDIA, has a tattoo of his company’s logo on his shoulder.
Source: Reuters/Robert Galbraith
In a passage from her 1985 autobiography, the then-79-year-old founder of her self-named cosmetics firm, Estée Lauder, answered her own rhetorical question, about what is the most important determinant of business success. According to Lauder, who herself was an exceptionally passionate businesswoman, the single most important trait is persistence.
What makes a successful businesswoman? Is it talent? Well, perhaps, although I’ve known many enormously successful people who were not gifted in any outstanding way, not blessed with a particular talent. Is it then intelligence? Certainly, intelligence helps, but it’s not necessarily education or the kind of intellectual reasoning needed to graduate from the Wharton School of Business that are essential. How many of your grandfathers came here from one or another “old country” and made a mark in America without the language, money or contacts? What, then, is the mystical ingredient? It’s persistence. It’s that certain little spirit that compels you to stick it out just when you’re at your most tired. It’s that quality that forces you to persevere, find the route around the stone wall. It’s the immovable stubbornness that will not allow you to cave in when everyone says give up.
—Estée Lauder in Estée: A Success Story.2
Investors often focus on figuring out whether executives exhibit the ideal incentive structure rather than investigating the intensity of their passion. While it’s vital to weigh financial incentives, the power of passion as a motivator should not be overlooked. Exemplary executives equate their personal success with the continued prosperity of the company and not solely the lining of their own pockets.
The same year as the launch of the RIVA 128, following Apple’s acquisition of NeXT, Steve Jobs returned to the firm he had cofounded and from which he had been fired a decade earlier. Jobs likely rejoined Apple more out of an emotional opportunity to revive his struggling brainchild than out of a financial motive. Ironically, it ended up also paying off financially, as Jobs successfully revived Apple and made it one of the world’s most successful companies ever.
Howard Schultz’s return as Starbucks’ CEO is another well-known anecdote. Schultz joined Starbucks in 1982 when it was a small coffee bean retailer in Seattle. He acquired the business in 1987 and rapidly expanded it until he stepped down as chief executive officer (CEO) in 2000, though he remained as chairman. Schultz returned as CEO in January 2008, during a challenging period for Starbucks, characterized by overexpansion, declining sales, and a diluted brand experience. Similarly, Morris Chang, the iconic founder of TSMC, made a comparable comeback. After retiring as CEO in 2005, Chang resumed his role in 2009 amidst the global economic downturn and production issues.
Let’s Sniff Around
Analyze perseverance and internal motivation:
Study responses to prior crises: history of confronting difficult challenges directly and persistence in the face of setbacks.
Evaluate product enthusiasm, detailed product knowledge, and personal product use.
Review interviews, conversations, and media appearances to decide whether management identifies personal success with the success of the business.
Assess the management’s lifestyle and appearance. A modest lifestyle can indicate internal motivation.
1.2 Focus on All Stakeholder Constituencies
A manager’s job is to maximize long-term cash profit per share. But these long-term profits aren’t achieved by aiming straight at them. Instead, they are the byproducts of delighting customers, offering great products, nurturing a loyal and committed workforce, and operating within the norms of society. Yet, many managers overemphasize certain stakeholder groups and neglect others. A business run solely for shareholders will surely be outrun by its neglect of other interests.
What’s good for customers is good for shareholders.
—Jeff Bezos, 2002 Letter to Amazon shareholders.
Michael Pearson’s tenure as CEO of Valeant Pharmaceuticals is widely regarded as an example of the risks of excessive focus on one particular stakeholder group, in his case shareholders, at the expense of others. He intensely focused on maximizing shareholder value, a practice that led to substantial stock market successes for a few years but eventually culminated in myriad complications. Mike Pearson’s playbook at Valeant was to acquire companies with profitable drugs, instead of investing in R&D, and financed these acquisitions with debt. Post-acquisition, Valeant would cut costs, especially in R&D and sales, and often raise the prices of niche drugs with little competition. Prices of heart drugs Isuprel and Nitropress were ruthlessly raised, causing controversy that contributed to a Senate investigation into Valeant Pharmaceuticals in 2015. Shortly after the announcement of the investigations, reports emerged about Valeant’s relationship with Philidor Rx Services, a specialty pharmacy that distributed Valeant’s drugs. Allegations suggested that Valeant was using Philidor to avoid generic substitutions and inflate sales figures. In early 2016, it also became public that the Securities and Exchange Commission was investigating Valeant’s revenue recognition practices and reliance on non-GAAP figures, which, the Securities and Exchange Commission (SEC) believed, could have misled investors. These factors collectively tarnished Valeant’s reputation in the pharmaceutical industry and ultimately led to the decimation of shareholder value.3
The story illustrates the unsustainability of prioritizing shareholders at the expense of customers, employees, and society. You should recognize and avoid such a narrow focus because it does not lead to permanent shareholder value creation.
Interestingly, Mike Pearson’s investor communication would have scored well using the methods for evaluating capital allocation discussed in Chapter 3. Mike Pearson exemplified the rhetoric of an accomplished capital allocator, which enticed some of the world’s top investors to invest in his company, despite his imbalance in managing stakeholder constituencies.
People who are passionate about creating value for all parties often demonstrate an undeniable enthusiasm for the products, an emotional duty to employees, and a reverent sense of responsibility toward suppliers and the greater society. By genuine responsibility toward society, I’m not referring to the practice of producing an abundance of soulless zombie corporate ESG content, blindly following the crowd without critical thought. I’m referring to the practice of demonstrating a sincere responsibility that arises from independent initiative and thoughtful consideration, aimed at truly doing good rather than just conforming to norms.
Let’s Sniff Around
Analyze the risk of a management neglecting stakeholder groups:
Evaluate their demonstrated knowledge of product details by reviewing their communication.
Evaluate the genuineness of enthusiasm for the company’s products and product development.
Research historical controversies: Investigate any past controversies involving stakeholder groups. This information can often be found through search engines, in litigation records, and in the legal proceedings section of the company’s 10-K filings.
Interview customers and ask them about their views on the management’s genuine sense of responsibility toward the customers. If available, review customer satisfaction metrics, such as Net Promoter Scores, to understand customer loyalty and satisfaction.
Look for price surges that are not accompanied by improvements in quality.
Interview former employees and ask them about their views on the management’s genuine sense of responsibility toward the employees and other stakeholder groups. High employee turnover rates can indicate dissatisfaction. This can be supplemented by examining employee reviews on platforms like Glassdoor.
Analyze changes in suppliers, high supplier turnover, and conduct interviews with suppliers to understand their perspectives if necessary.
Identify signs of arrogance or disrespect toward employees or suppliers.
Identify any tendency to evade questions on earnings calls or in direct dialogue.
1.3 Decision-making Time Horizons
Passionate people make decisions with a long-term perspective. These people suffer from competitive paranoia and willingly sacrifice short-term profitability to strengthen their long-term competitive position. They tend to be more conservative during exuberant periods of the business cycle. They go to great lengths to satisfy all stakeholder constituents, even when there isn’t an immediate payoff. Unlike their dispassionate, complacent “salary-man” counterparts, they are also unafraid to take risks and deviate from their peers. In contrast, corporate managers concentrating on maximizing near-term performance are averse to compromising short-term profits for a more distant future compensation.
The story of Intel’s decision not to produce the chips for Apple’s iPhone is a famous example of the unfortunate consequences of too much focus on short-term profitability. Apple had approached Intel, given their existing relationship supplying processors for Apple’s Mac computers. The proposed deal with Apple for the iPhone chips had a lower margin than Intel was accustomed to. Therefore, from a short-term profitability perspective, it did not seem attractive. Former CEO Paul Otellini and Intel’s leadership therefore decided to pass on the opportunity, leading Apple to turn to Intel’s competitor, Samsung, for the design and manufacture of an ARM-based chip. ARM’s architecture is more power efficient, making it ideal for mobile devices. This decision paved the way for Samsung, and later TSMC, to become dominant players in the mobile chip market and eventually challenge Intel in its core non-mobile chip segments. In retrospect, in a 2013 interview with the Atlantic, Otellini admitted this mistake, saying, “The lesson I took away from that was, while we like to speak with data around here, so many times in my career I’ve ended up making decisions with my gut, and I should have followed my gut…. My gut told me to say yes.”4
The Intel example illustrates that even capable managers, versed in their industries’ nuances (for context, Otellini was Intel’s first CEO who wasn’t an engineer, though he had spent his entire career at Intel), can sometimes make decisions that prioritize short-term profits at the expense of significant long-term value, whether due to their incentives or external pressures to meet immediate targets. Note that optimizing short-term performance isn’t just about overt actions like slashing benefits or skyrocketing prices; it can also manifest in more subtle decisions, such as whether to pursue a potential partnership with an existing customer, and it can happen even to capable and ethical management teams, such as Otellini and his colleagues at Intel.
Let’s Sniff Around
Analyze decision-making time horizons:
Consider their incentives as decision-making time horizons are often dictated by them. Use methods presented in
Chapter 2
.
Interview both former and current employees, seeking examples of short-term decision-making: Those who have had direct interactions with top management often have insights into this matter.
Identify instances where attractive projects were forgone to meet short-term financial targets.
Identify instances where monetization was/is intentionally withheld.
However, always approach such accounts with a critical mind, considering the subjective perspective of the individual recounting what they deem an “attractive project.” Moreover,
