Lawrence Cunningham is widely regarded as an expert on Warren Buffett and his book The Essays of Warren Buffett: Lessons for Corporate America, which is now in its fourth edition, has been labeled by some as one of the top investment books of all time.
Over his career, Lawrence Cunningham has authored more than a dozen books on Berkshire, Buffett, value investing and finance. His new book, Quality Investing: Owning the Best Companies for the Long Term outlines the investment philosophy of London-based hedge fund AKO Capital, and the lessons its portfolio managers, Torkell T. Eide and Patrick Hargreaves have learned over the years.
Ahead of the book?s release at the beginning of next year, Lawrence was kind enough to answer some questions for ValueWalk about Quality Investing, and some of the lessons learned from working with Warren Buffett over the years.
An interview with Lawrence Cunningham
Rupert Hargreaves: You?ve got a new book out, Quality Investing: Owning the Best Companies for the Long Term, co-authored with Torkell T. Eide and Patrick Hargreaves. Could you give our readers a brief summary of the book?
Lawrence Cunningham: Quality Investing outlines the investment philosophy of AKO Capital, and the lessons its portfolio managers, my co-authors, have learned. AKO, a London-based fund with $10 billion AUM, has achieved a return of more than double the market (9.4% per annum versus Europe?s 3.9%) since inception a decade ago. In the book, we discern the patterns that can make quality companies?those with durable competitive advantages?worth paying up for.
RH: What was the inspiration behind the book?
LC: AKO initially wanted to explain their philosophy and stock selections to clients, predominantly large U.S. university endowments with an inherent long-term horizon and a taste for quality. Knowing my philosophy meshed with theirs, AKO recruited me to help turn the data and research into a monograph. As we refined the product, it became obvious that a wider audience would be interested. So we transformed what began as an internal research project into an investment book for a broad investor audience.
RH: What are the qualities investors should be looking for when trying to identify the best companies?
LC: Go behind the obvious. Yes, look first for economic attributes: predictable cash flow generation, high returns on equity capital, and attractive growth opportunities. But then dig deeper to discern their causes and evaluate their durability. Patterns to look for: recurring revenue streams such as under service contracts; friendly middlemen who direct consumers to a producer?s output; and producers catering to customers who pay a premium whether due to brand strength or other intangibles that provide pricing power.
RH: Do you have any examples?
LC: We give more than 20 case studies, including global titans like Diageo, Hermès, L?Oréal, and Unilever?as well as lesser-known companies in different industries from agriculture to plumbing and banking. We also present examples of failed investment decisions, such as Tesco and Saipem. The companies analyzed in the case studies are exemplars of the patterns that we describe. For example, elevator manufacturers such as Kone illustrate the pattern of recurring revenue from service contracts. Geberit, Europe?s leading maker of lavatory products such as toilet flushing systems and pipes, has cultivated deep, loyal relationships with plumbers who routinely recommend its products to customers as ?friendly middlemen?. Hermès and L?Oréal are assessed as paradigms of companies that turn intangible customer benefits into pricing power. In addition, we explore the value of assurance offered by product testing companies such as SGS and Intertek; the appeal of technological advantages at Syngenta, the global market leader in crop protection; and the moat of research-led innovation at Novo Nordisk, which dominates the global insulin market.
RH: What do you hope readers will take away from the book?
LC: Three things: First, a company that can deploy capital at high incremental rates of return over a long time-frame will deliver significant compound growth in earnings. Second, the combination of competitive advantages that allows a company to do this are rare ? but there are common patterns that tend to indicate sustainable quality. Third, while quality companies do attract a valuation premium, these premiums tends to under-value the long-term compound growth. Quality companies are worth paying a premium for, even for a traditional value investor.
RH: There?s no doubt that markets are becoming increasingly focused on short-term returns despite the overwhelming amount of evidence which shows that investing for the long-term always yields the best results. What advice would you give to investors who are struggling to ignore short-term market fluctuations?
LC: Focus on the fundamentals. Are share price moves reflecting a change in underlying thesis? If not, dislocations should be seen as an opportunity rather than a negative. Focus on costs. Responses to short-term fluctuations entail the frictional costs of trading, taxes, and reinvestment risk?as well as the emotional and psychic costs of worry. Read history. Look back over decade upon decade and observe that upheavals recur but have all been overcome. Think about the position you want to be in ten, twenty, and thirty years from now.
RH: You?ve done a lot of work with Warren Buffett in the past, is Quality Investing an explainer of Buffett?s investment style, or does it draw from the lessons of business leaders around the world?
LC: The AKO philosophy draws on Buffett and others, especially Phil Fisher and Charlie Munger. In a sense, it reflects Buffett?s evolution from a pure or deep value investor to one who is willing to pay up for quality. In that way, the quality investing philosophy takes value investing one step further, by focusing far more on quality than price. Consider what Tom Russo said about Quality Investing when recommending this book: ?It shows why the best long-term margin of safety comes not from an investment?s price but from the value of a company?s competitive advantage.?
RH: One of your previous books, The Essays of Warren Buffett: Lessons for Corporate America has been labeled by some as one of the top investment books of all time. As you reflect back on the book, which is in its fourth edition, is there a lesson or two that really resonates with you as an investor or a student of business?
LC: Long-term, disciplined agility pays. Berkshire has had only one CEO for 50 years. He has lived by a short list of fundamental values while endlessly adapting to changing environments. He has varied his investing style and forged dramatic change in the asset mix of the business, from one dominated by
