The Art of (Not) Selling - Makings of a Multibagger
Letting time do its work - the paradox of expecting quick positive results
Introduction to Owner-Operators
Last week, Michael Gielkens from Tresor Capital was hosted on the “Jong Beleggen” podcast to talk about family holdcos, and a second one on serial acquirers will follow soon.
We highly recommend following him on X (if you haven’t already) and/or subscribing to their newsletter.
For non-Dutch readers, you can easily translate the documents via AI.
As an expert in the field (covering names such as Constellation Software, Investor AB, MBB SE, Aalberts Industries), he knows what it takes for long-term entrepreneurship to yield compounding results.
Previously, Michael was also hosted on Rowan Nijboer’s show to talk about “The Art of (Not) Selling” which was published by Akre Capital Management.
We found these podcasts a great inspiration for this new blog on what it takes to become a multi-bagger: time and management focus. Meanwhile, human beings are looking for instant gratification and thesis confirmation, i.e., if we buy a stock, it better go up quite quickly. Even more so because many feel the pressure of relative performance (i.e., comparing performance to an index).
Throughout this blog, we’ll highlight some of Michael’s best quotes and practical examples where it’s been very tempting to sell out, thereby interrupting the compounding process in a multibagger (stock that’s returned over 100%).
Most of this blog is free to read, so sharing it is much appreciated.
The Art of (Not) Selling
Starting with The Art of (Not) Selling episode. At the beginning, Michael mentioned Fastenal, the leading supplier of OEM fasteners, cutting tools and related equipment, and other industrial items.
We heard of it before, vaguely remembering it’s delivered a mid-teens percent CAGR for shareholders since the 90s. That’s very solid compounding for a boring company that’s been around for decades. Where can we sign up for this return throughout our investment career?
Michael said it well:
They make fasteners - all sorts of clamps, or whatever you need to make connections. A very simple product. They've been outperforming the S&P for years. It's incredible. A very boring company. But even back in the nineties, people wrote them off, saying, "Yeah, nothing special. This can't last very long." Yet, a strong company culture and a management team that focuses on the right things are, I believe, crucial for long-term growth and sustained outperformance. Buffett and Munger once said in one of the Berkshire Hathaway meetings, "You don't need to go for moonshots. It's amazing how far people like us get by consistently not being stupid. By consistently not doing foolish things." And yes, that's a bit of common sense, and it sounds very easy. But in practice, it's very difficult when it comes to large investments where you think, "Is this really wise?" It's often better not to do them. Or an acquisition that seems interesting - you'll naturally focus on that. So, investors' views on a company's "runway" have often led to doubts about multiple companies and divisions.
At the end of 1999, Fastenal’s market cap stood at 1.4 billion USD. Today? It’s at 55 billion USD. Including dividends, it’s achieved the 100-bagger status.
The company got highlighted in a 2024 Forbes article, titled: “Strong Business Model, But Little Margin Of Safety” and it’s always been cited as priced for perfection.
Steady revenue growth, except during the 08-09 crisis, while profitability took a little bit of a hit during 2001 (more on that below). Moreover, there’s some seasonal quarterly volatility in profit margins, meaning that any deviation from analyst expectations will be zoomed in on with a magnifying glass.
In terms of adjusted EPS and dividends, we see the same pattern.
Of course, the context of this performance is also relevant: Fastenal has enjoyed a high rolling ROIC in the low-30s and solid ROIICs with CAPEX exceeding D&A quite nicely. Additionally, there’s controlled growth in inventory as the business continued and continues to grow. Meanwhile, net debt is quite low too (0.4-0.5x EBITDA as we speak).
It’s delivered great results through stable gross margin (around 45%), stable OPEX (now 24% of revenues) benefiting from economies of scale, excellent financial expense management leading to a low-twenties percent EBIT margin. What’s not to like? A Tortoise pur sang as the French would say, although it’s trading at a rich valuation in our view.
That’s not the nob of the point here. What we’d like to draw your attention to: quite significant pullbacks in the stock price.
Basically, every single year, you had to digest one or more 15-25% drawdowns… Sometimes even >30%. Given that the stock returned 16% annually, the rallies were even more impressive, making it very costly to try getting ahead of potential drawdowns by selling out at a temporary peak. When do you get back in?
Our message here (and we’ll elaborate on it below): drawdowns are unpredictable and inevitable, which everybody knows. Secondly, even the most well-run companies go through periods of irrational investor behavior, irrespective of their valuation at that time. Thirdly, it’s true for highly predictable businesses as well. So, even with the help of hindsight, it’s tempting to sell a business you’ve been able to model quite well over time.
Put another way, we all want to get our hands on the 16% CAGR Fastenal generated (at least, we do), and we know we’ll get tested emotionally along the way. Yet, the moment we buy into a quality compounder, we seek confirmation on the thesis playing out. Therefore, we’d like to see the stock price go up shortly after we bought. Is that real confirmation? To us, confirmation should be measured over a multi-year time frame through no-nonsense KPIs such as growth in NOPAT/share, ROIIC, and how the balance sheet’s changed (i.e., we don’t look for companies using financial engineering to drive shareholder value).
Yet, whenever the stock falls on a quarterly revenue or EPS miss or just because of a steeper pullback coming out of nowhere, many will monitor if the fallen share price is just a blip or reflective of a structural change in the thesis (that’s what it will oftentimes look like in case of a sizable pullback; share prices always drive the narrative).
Fastenal Drawdowns
One of the reasons for this volatility in Fastenal’s share price could be that it publishes monthly sales data, which then drive downward analyst revisions “amidst concerns about the macro”. With short-term negative changes, investors also have a tendency to extrapolate these recent events (recency bias).
The beauty about relatively boring multibaggers is that you can go back in history and learn a ton from how they dealt with challenges.
Over the period 2000-2003, Fastenal kept growing its revenues, but the stock had multiple drawdowns of 25% and trading 35% below its all-time high for some time because of:
deflation in pricing due to Asian economic turmoil, pressuring gross margin;
incremental expense growth due to relocation of stores to larger locations to boost productivity;
streamlining and expanding IT systems;
integrating M&A;
expense growth related to the Customer Service Project, to strengthen the competitive positioning
As you can imagine, what happened after the above profit growth pressures abated? The stock rallied >170% over the next three years. At the time, analysts had likely given cautious recommendations on valuation, near-term risk/reward on expenses growing in excess of sales, the macro climate…
Over many decades, Fastenal’s management team has crafted a unique corporate culture that’s delivered the above highlighted results. It’s embedded in the organization, reducing the impact of a management team reshuffles on future growth. In other words, identifying and holding onto compounders is about maintaining a view that’s different from the market. Otherwise, all upside would have already been priced in, implying market-average returns for all companies.
Michael talked about Akre Capital’s game plan: buying when it’s attractively priced, letting the position, and only selling when the fundamentals or management change dictate to make such move.
But for example, they only increase a position in their portfolio when they find the valuation attractive. And then they just hold onto it. So, they don't reduce their position, or they only sell a position if they say, for instance, that the underlying case is under pressure. Or there's a change in the management team. And yes, we were very much tied to that specific manager.
For example, at Berkshire Hathaway, what if Warren Buffett is no longer at the helm? Who will then take over? And is your conviction to own Berkshire Hathaway based on the entire conglomerate they've built, or on Warren Buffett himself? Is the success of a Constellation Software dependent on Mark Leonard? Or is the culture, the board of directors, the business unit managers, and the broad group of people they now have within the organization - are they also of such quality that they are capable of further building this model? To essentially allow that legacy to continue longer? That can certainly be a trigger to make a change.
We look for companies where a change in the management team doesn’t influence future performance, because it’s inevitable to lose these brilliant people at some point.
Frederik Karlsson (former CEO of Lifco, now CEO and co-founder of Röko) left Lifco early 2019, prompting the stock to drop on the news. Meanwhile, Karlsson bought a lot more Lifco shares, reflecting his confidence in the serial acquirers’ future success that wasn’t too much dependent on him.
Similarly, Tapio Pajuharju, the former CEO of Harvia, retained a stake of around 5-6m EUR in the Finnish sauna and spa company (about 10-12 times his base salary).
Being Discouraged to Reinvest Back into the Business?
As we talked about previously, most high-quality companies with high ROIICs, operating in industries with a steady growth outlook and low risk of getting disrupted, should stick to their own proven recipe for success.
Given their high ROIICs, high cash IRRs (which takes into account the timing of when the reinvestment pays itself back) and attractive profitability, incremental expense pressure from a slower-than-anticipated growth in the top-line can be absorbed fairly quickly. During tougher times, they’ll find ways to be nimble and preserve shareholder capital.
In any case, if you have decent top-line growth, focusing on reinvestments in high IRR projects makes a lot of sense. The tricky part? The fruits will typically be reaped after two/three years or so, much longer than what the analyst recommendations will reflect. Also, not all reinvestments are a treated equally as accounting rules will dictate CAPEX should be getting depreciated over the supposed useful life. Meanwhile, initiatives on sales and marketing are expensed as incurred.
Put another way, there’s always a mismatch between what companies are investing in today (and what pressures current and near-term profit growth) and the future benefits (disproportionate earnings growth, as top-line growth accelerates and margins expand).
Their management teams know how the run the business; analysts focusing on the short-term negatives do not. Some analysts will not reflect or mention the future benefits from current investments in sales, product innovation et cetera in their reports. Instead, they’ll caution against margin pressure and stick to their 6-12-month horizon. By the way, that’s in line with an investor’s average holding period: 7 months.
In last week’s podcast, Michael referred to the owner-operators concept:
Many studies and surveys demonstrate that a large majority of managers, for example, on Wall Street, postpone important investments or cut various costs just to meet quarterly earnings forecasts. A family that invests for the next generation, however, looks twenty years ahead. So, they don't focus on one or two quarters just to meet those earnings forecasts.
We, for example, look for a minimum of at least 10 to 20 years of the CEO's salary to be held in company shares. Ideally, they'd be personally purchased, but not everyone has the same wealth at the start of a company. So, we look at that on a case-by-case basis. However, the vast majority of our portfolio companies have very serious "skin in the game" from the founder or a large family. Founder-led companies naturally fall under this, as they are essentially first-generation family businesses.
They aren't solely preoccupied with meeting quarterly forecasts or achieving profit reports. While they don't completely ignore the short term - they still aim for good short-term performance - their primary focus lies in strategic long-term investments, such as building a new factory.
A prime example of this mindset was seen during the COVID-19 pandemic. Many family-owned businesses, though not all, chose not to lay off their staff. Their reasoning was that they knew the company needed to remain successful three to five years down the line, and they would then have to find new people again. This demonstrates a fundamentally different mindset: a focus on sustainability and continuity rather than immediate cost-cutting.
It seems like a no-brainer for companies to prioritize long-term stability, so why are "agents" so susceptible to chasing short-term goals and laying off personnel, especially when, as you mentioned, the majority opt for short-term solutions?
This often comes down to compensation policies. Charlie Munger highlighted this, and there was a YouTube video a few years ago that dissected Unilever's incentive structure. A significant component was absolute revenue growth or absolute growth, but it didn't necessarily consider whether that growth was profitable. This can lead to actions like large acquisitions that might not add any real qualitative value to the company.
This phenomenon is known as the "agent problem" or the "agency dilemma." It describes the situation where the interests of the shareholders (the principals) and the CEO (the agent) are not aligned. This misalignment creates friction and is a challenge nearly every company faces, as there are more agent-run businesses than owner-operator businesses.
This is precisely why "skin in the game" is so crucial. If a CEO, for example, only has two or three years' worth of salary tied up in company stock options, their perspective is different. If the company doesn't perform well, or their long-term plans prove unfeasible, and the stock dips, leading to their dismissal by shareholders, they can simply try again at another company in two years.
However, if that investment represents their retirement savings, an entrepreneur will think very differently. They will manage the company's resources in a fundamentally different way. As an external shareholder, you effectively become a partner with that owner-operator, or the major shareholder-director, so to speak. This alignment of interests fosters a more dedicated and long-term approach to value creation.
The main obstacle to build a multibagger is this:
So, 75 percent of CFOs are willing to sacrifice long-term profits to meet short-term guidance. They issue an outlook, and then they want to achieve that in the following quarters to keep the market, so to speak, satisfied.
Essentially, it boils down to a very straightforward framework.
Based on the above, it’s very easy to come to the following conclusion: when you’re focused on short-term performance, you’ll be very mindful about not making many reinvestments as they’ll likely pressure EBIT margin and free cash flow. In order to grow, you have to make investments, and investors’ belief in sizable returns rests on management’s capabilities to deliver on the long-term game.
Just think about rolling out a new ERP system, which is likely to reduce future operating costs by 20%, cut administrative expenses by 20%, give much better insights into inventory management, increase customer satisfaction.
The downside? You’d have to stomach implementation costs, and there’s an upfront investment (whether it hits your OPEX or CAPEX) with a temporary impact on production levels (fewer deliveries or shutdown). Still, you project the 10-year IRR from this initiative to be 35%, excluding the return from cost savings being reinvested in production capacity extension and R&D.
If the analyst consensus doesn’t reflect this incremental expense pressure (nor the future benefits, but those could take more time), you’ll certainly miss on EPS during the current quarter. So, as your compensation is tied to this fiscal year’s EBIT margin, there’s no incentive to kill your bonus…
Keeping this in mind, it shouldn’t come as a big surprise to expect that future multi-baggers will be scarce and most likely come from past multi-baggers continuing their growth journey.
Quarterly Results and Price Targets
Although we share our quarterly recaps and update the expected return outlook, the main objective of these review is two-fold: to learn if the management teams remain consistent with their long-term view, and to get a sense of valuation (and implied investor expectations).
Just like Michael, we’re not big fans of price targets, yet the investment community is focused on absolute targets.
When a price target is issued by an investment bank, you have to question its independence. What do I mean by that? I think it was a few years ago that Berenberg gave a ridiculously high price target, 50-60% above the current share price, for Fastned, a Dutch EV charging company. Coincidentally, Berenberg had also been hired to sell some of the founders' shares on the market. That's a very peculiar coincidence.
I'm always hesitant about price targets. What are investors currently pricing into the stock? And do I consider that realistic, or do I think the market is being a bit conservative? Price targets always follow the stock.
The best example is in January 2024, Morgan Stanley issued a sell recommendation on Aalberts. They argued that, relative to its sector, Aalberts was historically valued at this level. However, because Aalberts operates in the chip sector, the e-mobility sector, and building sustainability that were expected to experience a dip this year, they put it on "sell." They said, "Based on our valuation, the stock should be 40 euros. That was our previous price target, which doesn't fit a sell recommendation. So, we'll just apply a 10% discount from its historical valuation relative to the sector." The stock was at 36 euros, and it dropped 4, 5, or 6% that day. A few weeks later, Aalberts released its annual figures, and things looked much less dire than expected. The chip sector suddenly picked up again, as we saw with ASML.
Frankly, I haven't heard much more about that sell recommendation. But for small-cap and mid-cap stocks, such reports have a significant impact because relatively few firms cover them. As an investor, you might be impressed and think, "They must know what they're talking about." It's often quite startling when you're in the industry, talking to people you believe are experts, to realize how many people are just winging it. - Michael Gielkens
O’Reilly Automotive & AutoZone
Time to take a closer look at some names we’ve studied and owned over the years.
On our Substack, we’ve talked about how, for many investors, O’Reilly has been a very tough stock to own over the past years. It’s been a phenomenal compounder, yet there’s always been something to worry about: elections, weather, more SG&A expense growth to drive market share gains, the pro-pricing initiative from early 2022, pressure on discretionary items.
Last year, we mentioned it in our 1H Letter:
Let’s elaborate on a couple of examples where one can distinguish the right long-term mindset versus talking about what analysts like to hear (and oftentimes damages the long-term compounding outlook).
FY2022 Inflation
Knowing you can’t make near-term predictions on the macro and inflation, O’Reilly’s former CFO McFall talked about price increases in 2022 quite vaguely.
We saw inflation pick up significantly in the back half of the last year. So as we lap those, we would expect to have less inflation, although we continue to see moderately more.
Greg Melich (Evercore ISI) then asked:
But in the 5 to 7 comp guide, you're assuming less in the back half, but it might be mid-single digits. Would that be fair?
The best answer a CFO can give, but highly frustrating for the short-term minded people:
Time will tell what that number is.
Guidance
Analysts are always keen to hear what’s going on quarter-to-date. Chris Horvers’ question
And then on your comment that you're trending below the midpoint of the guide. Is that a year-to-date comment, and would you say that you're trending below the low end of the guide as well?
The CFO refrained from making any quantified comments:
Appreciate the question. April is a short portion, and April to date is a short portion of the second quarter. So probably not appropriate for us to parse that out. Again, refer back to the last eight weeks have been much more consistent in volume.
As we talked about above, O’Reilly’s performance did accelerate meaningfully during 2022, relative to the competition. As such, analysts who were worried about SG&A expense pressure turned bullish and asked why not to accelerate expense growth.
In 2025, that’s now become a source of caution as we explained in our Q2 recap. It’s obvious that when you make growth investments, there’s a lagged effect on effectively realizing that growth. Analysts’ narratives remain based on getting evidence that initiatives are starting to work out.
Perhaps the best quotes come from former AutoZone CEO Bill Rhodes. One on incremental shareholder value creation, and another comment from the CFO on expense pressure from opening new locations to drive growth.
Gross Profit Dollars!
The goal of AutoZone (and O’Reilly) is to drive gross profit dollars, which then trickles down to EBIT too.
Given the success you have in DFIM, are you making trade-offs between how much quicker you can grow and the margin dilution? And then meaning can you grow even quicker and maybe a bigger detriment to margin. - Morgan Stanley analyst
I’ll say it crystal clear. No, we are not constraining our growth based upon the margin characteristics of the DIFM business. We said it for a million years. DIFM today operates at lower gross margins and lower operating margins. But it grows - it operates in operating margins the way we look at it on generally an incremental basis in the mid-teens. We will grow that business as fast as humanly possible.
If we could add another $4 billion in sales and the corresponding operating income that comes with that tomorrow, with the limited amount of incremental capital that we have to deploy, we would do it tomorrow. We were very focused on operating profit dollars. - Bill Rhodes
SG&A
I guess in the near term, what kind of SG&A pressure should we expect? I would assume there’s inherent deleverage just from preopening costs and then as they ramp. So kind of what kind of headwinds should we anticipate that puts on the SG&A line over the coming quarters? - Stephens analyst
Answer from CFO Jackson:
I mean it will clearly be some pressure on SG&A, but what I’ll say is that we’ve been very disciplined about managing our SG&A expenses. And quite frankly, when we have to make these kind of investments, number one, they have great payoffs associated - paybacks associated with them. But number two, we look for bill payers elsewhere in the P&L to be able to go do that. But what we’ve done over time, and what we’ll continue to do is, we invest in a very disciplined way in growth, and we’re not afraid to delever SG&A if we need to, to support that growth because in the long term, it’s the right thing for our business.
Ferrari
It appears some analysts are taking a surprisingly short-term view when it comes to Ferrari, even seemingly believing they can out-model the company's own management team.
In Q3 2024, Ferrari went ahead with its updated ERP system, pressuring quarterly deliveries and EBIT growth. The stock subsequently dropped by 7-8% on this report, although the IT investment and impact on production levels were planned by the management team, and therefore, the full-year outlook was kept unchanged. Management commented on the Q3 expectation earlier:
I started explaining already in Q2 that in terms of unit Q3 would have been softer. And this is because with ERP, you basically remain with your production and delivery stopped for some weeks. - CFO Piccon
Yet, analysts’ questions were extremely short-sighted. Several of them were focused on the near-term impact on deliveries instead of the long-term profit tailwind through operational efficiencies.
As a follow-up on SG&A, increased 2x faster than revenue this quarter. Again, you highlighted some of the reasons including the digital journey, ERP integration, et cetera. I just - any outlook on forward SG&A of how much further this temporarily - is this a temporary bulge in SG&A, which kind of reversed a multiyear decline in SG&A as a percentage of sales. - Morgan Stanley
The ERP volume impacts, just confirming that was pretty much done in Q3 and won’t happen in Q4. - RBC
Maybe one analyst asking a seemingly right question. Of course, Ferrari’s management team did a detailed calculus of the benefits…
And then the second one is a little bit more longer term. I’m guessing when you did the new ERP system, there was a cost benefit analysis. - HSBC
Let’s now move to another company.